Management debt, as described by Ben Horowitz back in 2012, is incurred when an organization delays doing the right thing in favor of the easy thing. The right thing must eventually be done and the expense, including “interest”, will be much greater than it would have originally. Like financial debt, management debt is a tool, not an inherent evil. It becomes problematic when organizations fail to account for it, and become overwhelmed by it, even to the point of failure.
There are innumerable examples of management debt, but there are five we observe in the accounting & finance infrastructure of many companies. These forms of management debt can be prohibitively expensive to incur. Each is followed with a situation which might justify each instance of debt.
Unclear revenue recognition: Do you have a clear understanding of when your income is realized and earned? Is that reflected in your accounting? Without a compliant revenue recognition policy and the accounting data structure to support it, you’ll delay access to debt and incur cleanup costs to generate accurate historical financial statements.
Consider incurring if: Company growth is slow, transaction volume is low, and company is in initial months of operation.
Unfinished systems integration: Are the right systems integrated in the right way with your accounting platform? Without integration, you’re unnecessarily paying for data entry. With poor integration you’ll have significant cleanup costs to arrive at an accurate and insightful set of financial statements.
Consider incurring if: Company has not recorded any transactions yet. (This should be completed as quickly as possible.)
Incomplete data structure: Does your accounting data structure allow for the reporting you need to make business decisions? For example, is profitability by job or product clearly understood and accurate? Will your bank or investors accept your financials as complete, accurate and adequate for their purpose? A hurried and extensive accounting cleanup project can be costly.
Consider incurring if: Calculated delay in addressing potential data structure issues caused by experimental products, services, locations, or entities can be cost effective. Do not incur if data structure has never been considered/reviewed by an accounting team familiar with your industry.
Inadequate separation of duties: Do you have a single bookkeeper? Is everyone with access to your accounting system an administrator? In spite of the fact that financial fraud and theft is more common in small businesses than large, very few business owners consider the risks presented by the single bookkeeper until there’s a loss.
Consider incurring if: Insurance against fraud, theft, cyber security is cheaper than implementation and there are no reputational implications in your industry.
Insufficient accounting operations: Are your books kept by a team with the appropriate education, experience, certification and oversight to do the work? Is their process documented? Have you seen it? Is it auditable? We are regularly asked to repair or cleanup the financial data of companies who thought they were getting what they needed only to have an outside stakeholder illuminate the opposite.
Consider incurring if: Current small size, low volume and limited complexity allow owner to be the sole originator of transactions. This allows the owner to review/remember each transaction. “Interest” on management debt incurred in this way is the opportunity cost of owners time.
Not every company can afford to hire, retain and oversee an internal team of competent accounting professionals. Most can afford the fractional team model provided by well-regarded firms. The availability of this model changes the calculus of management debt in the accounting function by dramatically reducing the cost of doing the right thing sooner rather than later.