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The discussion around whether young companies should hire a full-time CFO centers on the trade-off between the upfront cost of an experienced CFO and the potential advantages they offer in terms of growth, strategy, fundraising, and operations. Scott Brown, a finance expert at Toptal, suggests a framework inspired by Maslow’s Hierarchy of Needs to help startups navigate this decision. Just as individuals progress from basic survival needs to higher-level aspirations, startups evolve through stages of financial requirements, starting with basic financial management and progressing to more sophisticated strategies as they stabilize, grow, and scale.
The Debate Over CFOs in Young Companies
The importance of having a Chief Financial Officer (CFO) for a young company sparks lively debate. While some argue that they are unnecessary expenses, asserting that a small, skilled financial team suffices, others advocate for the deeper strategic insights that CFOs bring, aiding companies in future planning and operational optimization.
Navigating the CFO Dilemma
The crux of the issue lies in the considerable value CFOs offer compared to junior financial teams, albeit at a higher cost. To navigate this dilemma effectively, businesses must gain clarity on their evolving roles, needs, and trajectories. As companies grow, they inevitably outgrow their initial accounting staff, requiring more extensive expertise as the complexity of financial functions increases.
Anticipating Future Needs
Successful businesses anticipate their future needs in advance. They recognize that as dimensions in the financial function expand, greater depth within their financial team becomes essential. By understanding their eventual requirements, businesses can mitigate risks and obtain necessary resources without overcommitting financially.
Assessing the Contributions of a CFO
Determining whether a company needs to hire a CFO can be evaluated by assessing where they stand on the “hierarchy of needs” in financial management. Similar to Maslow’s Hierarchy of Needs, businesses progress through various levels of financial requirements, starting from basic clerical tasks to more strategic insights.
The Hierarchy of Financial Management Needs
Much like Maslow’s Hierarchy, a business has a hierarchy of financial management needs. These needs progress from basic clerical tasks to more strategic insights, requiring different skills and levels of insight. Businesses’ needs evolve at different rates, influenced by factors like industry, market opportunities, ambitions, and resources.
Moving Forward Strategically
Understanding the hierarchy of financial needs guides businesses in identifying their current position and determining the best hiring options to address their needs effectively. By recognizing that one need cannot be met if a preceding need is left unmet, companies can strategically navigate their financial growth.
Level 1: Conducting Transactions
Every business’s primary need is the ability to conduct transactions, which includes buying, selling goods, services, and entering contracts. At this basic level, businesses engage in what I term as checkbook accounting. This involves recording transactions without the need for specialized financial knowledge. Essentially, businesses track transactions in a checkbook, using the change in balances to assess their financial status and success.
Checkbook accounting offers clear advantages. It’s cost-effective, requires minimal effort, and can be done swiftly without specialized resources. It’s a sensible approach for newly established businesses. However, relying solely on checkbook accounting can lead to trouble. Many businesses face challenges because they fail to transition from basic transaction recording to more comprehensive accounting practices.
While checkbook accounting may suffice temporarily for fledgling businesses, it’s not sustainable for long-term survival or growth. Without proper accounting practices, businesses may encounter difficulties in accurately assessing their financial health and making informed decisions. Transitioning to more sophisticated accounting methods becomes imperative for businesses aiming not only to survive but also to thrive in the long run.
Level 2: Efficient Record Keeping
Effective accounting revolves around accurately recording transactions, a task that can be handled by a bookkeeper or, as transaction complexity grows, an accountant. While business owners can fulfill this role based on time and skills, they should consider the opportunity costs involved.
A bookkeeper’s role is to record transactions from sources like bank balances and inventory. Typically, a bookkeeper is managed by an external accountant or the business owner. Outsourcing bookkeeping offers flexibility but requires detailed communication and review.
Both bookkeepers and accountants focus on recording historical transactions with varying degrees of accuracy and compliance. Accountants, trained to higher professional standards, ensure the completeness and timeliness of financial activity recording. Accounts prepared by accountants adhere to Generally Accepted Accounting Principles (GAAP) and meet stringent reporting requirements, particularly for companies seeking external financing.
I recently collaborated with a client who maintained excellent, GAAP-compliant record keeping for their early-stage business. Their comprehensive catalog of contractual obligations, managed by a former CFO founder, prepared them for future capital raises.
Businesses seeking enhanced oversight without substantial costs may opt for periodic reviews of the bookkeeper’s work by external resources. This process can be bundled with tax preparation or provided by a retained fractional CFO.
Advancements in technology have streamlined transaction capture processes, reducing reliance on manual data entry. Software applications and IT resources have implications for a business’s cost structure, as software replaces labor to save costs.
Generally, businesses operating at this level may not require a CFO. Accurate transaction recording can be achieved with in-house trained labor or part-time external assistance, eliminating the need for a dedicated CFO.
The Challenges of Embracing Financial Technology
As businesses integrate financial and operational data into digital accounting systems, the focus shifts from manual data entry to ensuring data quality and proper capture methods. However, if not implemented correctly, financial technology (fintech) applications can create false impressions of accuracy, leading businesses to believe that the data in the system is correct when it might not be.
In many cases, fintech adoption replaces traditional checkbook accounting, where data is stored electronically but fails to provide significant value. To address this, accounting systems and operational interfaces must be set up by individuals who understand basic accounting principles. Quickbooks, a widely-used accounting software, recognizes the need for accountants as businesses grow, highlighting their importance in handling legal and compliance issues.
This emphasizes the importance for companies to engage external financial consultants to ensure proper application integration and the establishment of policies supporting financial reporting functions. Recently, I worked with a company struggling with faulty inventory tracking software. Despite experiencing significant growth, they failed to set up sales tax schedules and taxable items correctly, resulting in inaccuracies in sales tax reporting over several years.
Collaborating with the business, we rectified the implementation and filed corrected returns. However, the cost of penalties and interest exceeded the actual sales tax due for many months. Despite challenges, the project presented opportunities for improvement, enabling the client to report real-time profitability by product line and adjust product mix, yielding significant savings.
This case highlights potential problems associated with fintech. Even with well-connected IT-based financial systems, regular data reviews and account reconciliations are essential. These activities demand a solid understanding of accounting and the ability to incorporate operational data into financial records effectively.
Level 3: Effective Reporting
Once transactions are accurately recorded, businesses can move on to reporting their activities. Reports now focus on specific business areas, like sales revenue and costs, or on tasks such as customer service, rather than just listing transactions.
Thanks to advancements in financial technology, comprehensive reporting has become more accessible and reliable. Business schools have updated their courses to include fintech knowledge, offering specialized training.
However, it’s important to decide how reports will be used before setting up a reporting system. While accuracy is key, internal reporting may not need as much review as external reporting. Depending on how data was collected, reports can be presented in different ways, but it’s important to remember: “Garbage in = Garbage out.”
The main aim is to convey transactional information effectively to the intended audience. If bookkeepers and accountants can do this, their job is done. Otherwise, businesses need someone who can translate accounting information into understandable reports.
A common issue for early-stage businesses is using different systems for reporting, leading to uncertainty about data accuracy. Without a single data source, reporting may be incomplete or duplicated. Accurate and complete reporting is crucial, especially when preparing for Series A funding.
At this stage, a CFO becomes more relevant as they analyze transaction records to guide daily business operations. Bringing in a part-time external CFO is a common choice, especially when businesses need deeper analysis. This is where I often assist businesses and where I believe I can provide the most help.
Financial Reports: A Path to Understanding
For many business owners, receiving a stack of financial reports from their accountant can often lead to frustration and confusion. These reports, on their own, may seem like endpoints, but their true value lies in serving as tools for understanding business activities. Merely knowing the change in cash position for a period isn’t sufficient if one cannot discern the underlying factors driving that change.
In my earlier career experiences, I encountered a client who overlooked the seasonal fluctuations inherent in their business. Their bookkeeper provided cash balance reports without any explanatory context. Collaborating with them, we identified key metrics such as inventory turnover and days sales outstanding to gain a clearer picture of business performance and to anticipate future cash flow needs.
It’s essential to recognize that reports created for external stakeholders differ in purpose from those generated for internal management use. Internally-focused reports are intended to serve as means for understanding business activities and uncovering actionable insights. Skilled financial analysts play a crucial role in deciphering financial data, identifying areas where standard reports lack detail, and conducting ad hoc analyses as necessary.
Businesses undergoing rapid transformations heavily rely on financial reports and key performance indicators (KPIs) to navigate through uncertainties. However, crafting meaningful dashboards and reports isn’t a straightforward task. It requires a deep understanding of the business’s drivers and signals. Experienced finance leaders adeptly compile critical information or guide others in doing so, ensuring that insights gleaned from financial data are actionable and impactful.
Financial Planning: Looking Ahead Through Forecasting
With a comprehensive understanding of historical activities and the factors influencing success, businesses can leverage gathered insights to develop financial forecasts. As the adage goes, “You can’t know where you are going until you know where you have been.” Forecasting involves a distinct process and skill set from merely recording accounting activities.
Companies with evolving business models benefit greatly from regular forecasting, minimizing risks associated with inadequate planning. Rolling forecasts projecting 12 months ahead, especially crucial for seasonal businesses, encompass profit and loss, capital expenditures, and cash flows. Leadership collaborates to align resources with goals, ensuring efficient utilization without wastage.
Businesses at this stage of the Hierarchy of Needs typically necessitate a CFO. A part-time CFO, in close collaboration with management, facilitates meaningful and accurate financial forecasts, pivotal for sustained growth and success. Through effective financial planning and forecasting, businesses can navigate uncertainties and seize opportunities for continued success and expansion.
Strategic Alignment: Advancing Financial Partnerships
As businesses progress along their growth trajectory, the role of financial management evolves into strategic partnering, where the financial function becomes deeply integrated into the strategic planning process. This strategic vision encompasses crucial decisions like long-term pricing strategies, scenario analyses, international expansions, and potential acquisitions, aligning new frontiers with the business’s overarching financial goals. A seasoned finance leader capable of collaborating with the business to craft financially viable strategies becomes indispensable at this level.
Embracing Lean Finance Practices
In today’s dynamic business landscape, lean organizations are demonstrating that with prudent financial discipline, substantial results can be achieved using fewer resources than previously assumed. Even mid-level finance professionals can propel organizations beyond Excel spreadsheets, enhancing planning, budgeting, and forecasting processes. Leveraging predictive analytics and forecasting tools enables managers to navigate ‘what-if’ scenarios effectively, driving informed decision-making.
Despite its limitations, financial technology (FinTech) serves as a powerful enabler, facilitating remote work setups and access to top-tier talent at reduced compensation costs. Advanced accounting and finance software streamline operations and support outsourced shared service centers, optimizing resource utilization. Collaborative technologies enable businesses to engage fractional CFOs and advisory boards, delaying full-time CFO hires until necessary.
Navigating Financial Milestones
However, as businesses approach significant milestones, securing a seasoned finance leader becomes imperative, especially during rapid growth phases and external financing rounds. While advisors and consultants can suffice in the early stages, a CFO’s strategic acumen becomes indispensable as the business expands. The CFO’s integration into the venture requires careful consideration, with hiring processes often taking several months. Effective CFO recruitment ideally occurs 12 to 18 months before IPO activities commence, ensuring sufficient time for acclimatization and strategic alignment.
Furthermore, regulatory compliance presents another challenge for companies without a CFO. Regulatory standards like ASC 606 mandate changes in revenue reporting for businesses with external investors, highlighting the importance of financial oversight and expertise. In conclusion, while hiring a CFO may not be an immediate priority in a company’s early stages, evolving ambitions and growth trajectories necessitate effective financial management to meet expanding business needs.
Hiring a CFO for Your Startup: What to Consider
Deciding when to hire a CFO for your startup can be tricky. Once you’ve made the decision, navigating the hiring process can feel overwhelming, especially if you’re new to it. It’s helpful to seek advice from someone experienced who understands your startup’s needs and can help you find the right CFO.
Here are some key things to look for when evaluating potential CFO candidates
- Financial Skills: Your CFO should be good at budgeting, forecasting, and analyzing financial data.
- Strategic Thinking: Look for a CFO who can think ahead and contribute to your startup’s long-term plans.
- Risk Management: Your CFO should be able to identify and manage risks effectively.
- Integrity and Communication: It’s important to find a CFO who is honest and can communicate well with others.
- Building Efficient Processes: Your CFO should be able to set up streamlined financial systems for your startup.
When building your finance team, consider these questions
- Will you need outside investment? If so, you’ll need strong accounting processes to attract investors.
- Is your business changing rapidly? Your CFO should be able to adapt to changes in your business.
- How much financial expertise do you have? Consider outsourcing finance tasks if you’re not experienced.
- Do you have enough money set aside for emergencies? It’s important to have a financial cushion.
- How complex are your operations? Your CFO should be able to handle the financial aspects of your business.
Conclusion
Hiring a Chief Financial Officer (CFO) marks a significant milestone for your startup, signifying a pivotal moment in its growth trajectory. It’s crucial to find a CFO who possesses the acumen to forecast and strategize for the future while adeptly overseeing the financial aspects of your expanding business. This individual should be capable of not only managing your current financial operations but also navigating the complexities that come with scaling up. As your startup evolves, your CFO should play a central role in shaping its financial strategy, ensuring that resources are allocated optimally to support your goals and aspirations. Finding the right CFO who can blend strategic foresight with effective financial management is essential for steering your startup toward sustainable growth and long-term success.
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