49) Perfect Accounting

Behind-the-scenes building Vambrace AI, a company on a mission to figure out its mission. Please pardon the stream-of-consciousness style. Subscribe to follow along or visit the site here:

(typos are to make sure you’re paying attention)

Introductory Remarks

Dear Vambracers —

In last week’s post, Culture, I explored what I’m looking for in a first hire. I wrote that post from a place of optimism and excitement about what the future held for the company. But as I also become more familiar with the realities of operating my own thing, I’m increasingly convinced that hiring will be critical to my survival and wellbeing. I’m content with how the past 9 months have gone, and I know I’m most likely going to be on my own for at least another 6-9 months—but I also know that I want to bring others along on this journey and I want to start thinking about systems and processes that free me up to spend more time on the things I enjoy (and can be uniquely good at) as opposed to the things that I only sufficiently perform. [sheesh long sentence]

I think these are natural growing pains, and it’s sort of a luxury problem, since it means I think I’ll have sustained demand in the coming months (and years). Now, on to today’s post: Accounting!

Perfect Accounting

My latest engagement involves a more robust financial reporting pipeline. The project got me thinking about how a perfect accounting system would work conceptually. Maybe I’ll start with some (loose) personal definitions of the topics at hand.

• Accounting: a standardized system of tracking the economic health of some entity (individual or business).

• GAAP Accounting: an accrual-based accounting system that recognizes revenue when it is earned and costs when they’re incurred—regardless of the actual exchange of capital.

• Cashflows: the actual transfer of capital into or out of the entity. Common inflows include revenue (including prepaid revenue) and proceeds from financing events (debt or equity issuances). Common outflows include the cost of doing business (e.g., payroll, T&E, parts, fuel, etc.) and then repayment of debt, distributions to shareholders, etc.

• Financial statements: the GAAP accounting system is memorialized in the three financial statements: Income Statement, Cashflow Statement, and Balance Sheet.

  • The income statement captures the earnings position of the business, including gross and operating margins, and earnings attributable to shareholders.

  • The cashflow statement reconciles the accrual-basis of the income statement, adjusting for the actual exchange of capital among the entity and its stakeholders (customers, investors, creditors, employees).

  • The balance sheet captures the overall financial and economic health of the company at a given point in time, including cash in the bank, A/R, A/P, debt, equity, retained earnings, etc.

I think everything above falls into the general bucket of financial accounting, so honestly it might not even be relevant to the discussion. Oops!

Perfect (Cost) Accounting

Really what I want to focus on today is perfect cost accounting, which is the process through which costs are properly attributed to revenue such that the organization can arrive at the most accurate snapshot of profitability, per atomic unit of revenue. In the case of my new client, which is a healthcare clinic, that would mean attributing the cost of delivering care as perfectly as possible.

In a sort of dystopian-adjacent manner, we could imagine some perfect analytics system that could measure the economic cost of every single component of service delivery at its atomic unit.

For the doctor, we would assign economic value to each heartbeat (or maybe breath), which would be total compensation within a given period of time divided by total work-heartbeats within that given period of work-time. We could look at the rent of the facility and then calculate the cost per second of the use of each room within that facility based on the size of the room as a percentage of overall facility. We could allocate the depreciation of each instrument used by the doctor in each visit. We could probably do the same thing for any use of software within each visit (although that’s probably less relevant or impactful from a cost perspective, etc.).

Okay so I put a lot of this into ChatGPT and it created a much better visualization than I was expecting, so I’ll just put that here:

So, basically, all I’m trying to say here is that I’ve been thinking a lot about what a theoretically perfect cost accounting and cost allocation system would look like such that we would have a perfect view into the profitability of the company per atomic unit of revenue. I’m sure many larger businesses probably have the systems and intellectual heft to get them most of the way there on this type of an endeavor. The opportunity for me is to make available maybe 80-90% of the insight for smaller organizations.

The Case Against Everything I Just Said

Now, to look at the other side of the coin here, I do think that there’s such a thing as over-analysis and that at a certain point there are diminishing returns with data analysis. There’s only so much we can really do with super rich data, and then I think also that there’s a cost associated with sifting through all the data and stuff—and then maybe it starts to shift attention from the right thing to the wrong thing. We’ve seen this sort of debate play out in sports with the increased popularity of analytics, and I’m sure it’s also playing out in other arenas.

Ross Johnson, former CEO of RJR Nabisco, once said “millions of dollars get lost in the sands of time” and I don’t really know if that applies to the current discussion, but I do generally agree with the sentiment. I sort of think economic abundance and operational excellence are downstream of positive culture and general enthusiasm for the work and being a good person that wants to do right by customers. Really I think pretty much all economic abundance is downstream of those things. So, if that’s the case, then what do hyper-specific analytics really get you? [I don’t know if I also totally believe this either. There are gray areas here.]

Looking Forward

I’m not sure that we really accomplished anything with this post. I guess it exposes the tension within me, where on the one hand I really love thinking about perfect analytical paradigms, but then I also generally subscribe a vibe-first approach to life, and I just think it’s a fascinating dynamic.

Like analytics should reflect vibes. And we can’t necessarily leverage analytics to directly improve vibes. But we can use analytics to identify where vibes are off, and then intervene to improve vibes, which then will improve analytics. I guess that’s pretty straightforward now that we’ve gotten to the heart of it. Oh well, who knows. Who cares?

Have a great week!

Sincerely,

Luke