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Business Case Study - Cost Accounting I Implosion at Ecomom Ecomom.

Small startup internet retail company selling earth friendly mom and maternity products including food, toys, apparel, and other baby related items. Four years of history, 2011 revenue just over $1 million. Philip Prentiss. That's me. 42 year old single guy with a freshly minted CPA I had just received after 5 years of night school. I needed a job, and searching for a job sucks. After 6 rounds of interviews with every senior member of the Ecomom team, I got the nod for company controller, base salary $105,000 with another $100,000 of stock options. Reporting direct to CEO. Was I totally and completely thrilled? You bet. The CEO and founder, Jody Sherman, instructed me to show on my first day of work at the end of October 2012 at the Las Vegas headquarters. There was no previous controller or finance department; as with many small companies Ecomom had traditionally be run on the basis of the bank statements. Payroll and tax were handled by a third party bookkeeper who also received invoices and prepared all checks for Jody's signature. This system had worked relatively well when the company was small, but now with the enormous growth in size the number of invoices had reached well over one hundred a month, too many for a part time outside bookkeeper to handle. Things were starting to get out of control. Ecomom had received a large number of delinquent notices for missed payments and that was my first assignment: clean up Accounts Payable. In spite of the complete absence of established procedures, the financial processes of the company were actually in pretty good shape. All customers paid by credit card which was directly deposited into our bank accounts and so there were no accounts receivable. Payroll and tax were accurate and fairly efficient. No Balance Sheet or Statement of Cash flows had ever been prepared, but the Income Statement was quite presentable, and more importantly reconciled accurately to the bank account statements. The one big weakness was lack of matching between purchase orders, bills of lading, and invoices. In the past, either Jody or his co founder would initiate an order, and then since Jody signed all the checks, he would simply remember when the bill came in whether it had been received and whether to pay it. This worked well at $50,000 worth of cogs a month, but at triple the volume wasn't working anymore. Fortunately the solution to this problem has been known for centuries. I instructed purchasing to print each Purchase Order, staple it to the Bill of Lading when received, hand it to me, then I would staple that to the Invoice a cut the check. All payments paid on time and no double payments. The operations team was extremely excellent, and pointed out that my plan would kill a lot of trees in an eco antagonistic fashion, and that our computer system was more than capable of accomplishing this entire task electronically. Morale was high, the staff were treated well and many came from big companies with extensive operational experience. I had no more to say than "can you fix everything up?" while waving my hands vaguely and in less than two weeks the procedures were in place. The employees already knew how to handle inventory and non

We could easily have handled a million dollars of volume a month. Historically each of the 5 expense line items corresponded to each of the 5 major players in the company. vacations. We anticipated sales of over $1 million for November and without the one time costs there seemed an outside chance we might actually reach the break even point. for bloated travel and expense reports and questionable invoices. People Fund. the story was different. Jody left each manager with an enormous amount of freedom. Instantly I searched for abuse and waste. The honeymoon lasted that whole month. Next year's target was $10 million in sales and $30 million the year after that. While headquarters was in Vegas and San Francisco. but there were none. however. first class price. and the holiday party.inventory invoices and delivered tidy expense reports with collated receipts without prompting. He seemed to review major spending initiatives quickly and efficiently and smaller expenses such as travel not at all. probably even ten million. Jody looked over G&A while IT and Customer Service were run by the final two managers. Our infrastructure was built for size. had offices in Guatemala and parts of our marketing fit naturally right next . The VP of Marketing approved all Selling expenses and the VP of Operations approved the Operations line item. one of our backers. A few notes on the financial and management structure might be in order at this point. and it was more efficient for them to set up a satellite office there. a gamble that was invisible to me at the time. our third party shipper operated out of Los Angeles at any volume within 24 hours. but the company just received $4. At the local level the structure was excellent. The October Income Statement looked like this: ($000's) Revenue: 322 Cogs: 173 Gross Margin: 46% Selling: 288 G&A: 102 Operations: 169 IT: 87 Cust Service: 24 Net Profit (Loss): (548) A half million dollar loss wasn't great. The company had another co founder plus four VPs who outranked me and were compensated proportionately. black Friday was just around the corner. The IT and Operations group came from a blue chip background based in Virginia. After a month on the job I knew I was going to look like a hero.8 million in financing the previous month and a number of selling and operational expenses were due to one time website development fees. On a strategic level. Everyone was honest. I loved coming in to work and the staff buzzed happily about the upcoming holidays. and the VPs followed Jody's lead. Jody had taken an enormous gamble in a very critical way. More importantly. First class service.

so useful for a traditional manufacturing business. it was downright harmful. Sales are great.. there must have been some mistake. VP Marketing: Marketing is on track to over deliver. Let's recast the Income Statement into a Cost Volume Profit format. Black Friday was indeed the best sales day in the history of the company. How was that even possible? Surely. as each of the chances for success slip away.000. November started out well and sales tracked towards the million dollar mark. Each decision made sense for its own reason. If the sales volume caught up to the size of the infrastructure. consulting fees for October were $156k. was not so useful for an online them. but infinitely superior for business management purposes: . November's Income Statement looked like this: ($000's) Revenue: 1089 Cogs: 548 Gross Margin: 50% Selling: 849 G&A: 126 Operations: 334 IT: 65 Cust Service: 30 Net Profit (Loss): (864) Our revenue had indeed surpassed a million dollars. Jody had several heated discussions with the head of marketing. Perhaps October was a fluke? No. it was worse than useless. The normal financial presentation format. but instead of breaking even we had lost $860. Sales rang the fire bell at every hundred orders and everyone clapped. but the sum total of individually optimized decisions spawned a behemoth . when a dream dies. it dies all at once. Payroll for October was $115k. and we watched sales numbers by the hour. Jody: But where's the money? I'm not seeing the money in our bank. Marketing revved the engine for Black Friday. not so good for our management incentive structure. a very expensive behemoth.. Sometimes. In fact. almost always along the lines of: Jody: What are you doing? Where is the money? VP Marketing: We're on track to hit a million dollars. And there were an army of web design and computer consultants. killed in an instant by a meteor from outer space. But in business that rarely happens. Consulting fees turned out to be constant and stable as salary and wages. But there was no mistake. the biggest sales day of the year. piece by piece. this gamble would make everyone at Ecomom very wealthy indeed. and usually the dream dies bit by bit. but simultaneously I would guess that the possibility of spectacular failure first entered Jody's mind.

Said another way. the more we lose. and the warehouse manager who had been there from day one. Said another way. Not a single minute was spent discussing any of these statements. The Ecomom brand existed only at the website level and did not extend to the product level. Jody called an offsite meeting for the management team to discuss our condition. and one that incurred double freight. For diapers and baby food our contribution margin was close to negative 100%. A classic business school question for any new business is: what is your competitive advantage? It's a good question. Ecomom sought to establish itself as a niche player catering to eco conscious moms. but here too we faced intense competition. I had prepared the Income Statement in both the standard and CVP format showing our severe losses. a gross margin by line item report. Our own suppliers would list the exact same items on their own website. Not a bad idea at all. and after Jody I was the number seven guy at the table. What value. do you mean to tell me our Contribution Margin is really negative 48%? Yes Robin that's correct. if we cut all our sales to zero and sat around and played ping pong all day we could continue to pay ourselves handsomely for two more years while at the current sales rate we'll be out of cash in three months. And with comparison shopping as easy as clicking the mouse button. Customers could easily buy the exact same item at Whole Foods or any of the other dozen or so internet retailers targeting the exact same market. and here Ecomom was failing miserably. for every additional $60 average order shipped our variable cost is $89 and we lose of $29. contribution margin was almost zero. then. but we can't limit them by customer so every order ends up sold 50% off. . Our discounts are meant to be one time only. the more we sell. The co-founder and four VP's flew in from their respective cities. But once you get your brand you have to protect it. our best product. was Ecomom providing to our customers? We became simply a middleman.($000's) Revenue: Variable Costs Cogs: Discounts: Warehousing: Freight Out: Fixed Costs Employees: Consultants: Advertising: Overhead: Net Profit (Loss): 1089 548 751 152 134 141 111 44 41 (864) Contribution Margin: -48% Holy guacamole Batman. Said another way. we became slaves to the lowest price. Said another way. now would be a very good time to pull the fire alarm. Also joining us were two more marketing managers. and also a statement of Cash Flows showing us declaring bankruptcy in March. the customer service manager who was brother to Jody's wife. For toys.

that increased sales resulted in increased losses. It's been nearly half a year and I can't remember exactly what else was discussed. To pay for this Jody indicated he would bring in additional financing. We discussed the possibility of expanding our email and customer base and "driving more traffic into the funnel. we might one day demand exclusive distribution rights for some products. Outgoing. Perhaps with another $30 million or so we could hit our 2014 P&L forecast and reach the size necessary to make all these things happen. after three years of negative margin. Perhaps we might arrange for private label products sold at a premium under the Ecomom name. personable. in the amount of $2 million. he had some serious weaknesses too. No financial numbers were ever presented." He did not understand. At the end of December when things were getting truly desperate. funny. I would bring the financial statements to Jody who would glance at them so cursorily and wave me away with "no one can understand this without extensive analysis. On the other hand. was surreal. he was a great guy. he did not understand margin. enthusiastic. Business wise he was full of ideas and excelled as a pitch man.Perhaps. I called my recruiter and let him know I might be looking for another job soon. I never heard him insult or say a bad word to or about anyone. with enough market power. but before I tell you how our remaining cash reserves were pitched into the furnace. Jody was upset and let everyone know it. Jody never said no to a vacation request and bent over backwards to make sure every member of Ecomom got health insurance. Perhaps we might acquire a small manufacturer that could make use of our A+ customer service and distribution system. None of these ideas were discussed in any serious way. He was not a numbers guy. but he never came right out and said "we are losing money. First of all.2 million in the bank and the real hope of "getting unfucked" as Jody would colorfully say. but I can tell you for sure the word "margin" and the word "profit" were never mentioned. he said to me "Phil." Critically. The management meeting. possibly from People Fund. except year over year sales growth. Surreptitiously. . Jody was a master marketer and led a management meeting that focused on an awesome feel good marketing plan. We discussed the advantages of expanding our Guatemala marketing team. Perhaps our customer service and shipping department might one day become so good that customers would pay more for the convenience and satisfaction of doing business with us. in retrospect. just bring me a forecast that shows how much we need to sell to break even." We discussed market strategies for selling the Ecomom lifestyle. We closed November with $2. which of course looked fantastically good." We discussed moving the warehouse operations in house to Vegas. I want to play armchair psychoanalyst and tell you my experience with Jody himself. Perhaps we might discontinue all low margin items and focus exclusively on items with margins of zero or better. He had built his house by raising money and when times got tough he went with what he knew.

Sales dropped off precipitously without discounts to only a few hundred thousand per month and we could not move a large portion of our inventory at all. It took our $860k loss for Jody to notice.1 million after variable cost. I did not want to ask Jody. 2013. the business silo managers were separated by great distances. Secondly. There was no mechanism to identify this problem. Jody held financial information and control very close to the vest. not according to margin or profit. I received only copies at the end of each month. At the end of the day I turned in my resignation on Jan 14. We closed December with less than $1 million in the bank.. the VP of Sales was compensated according to sales before discounts. Taken together. and by that time inventory had built up to $1. None of the VPs were privy to the financial statements and losses were not discussed in public.2 million in inventory. the compensation structure. We had built it. and the lack of management cohesiveness allowed a poisonous discount strategy to grow for 8 months without anyone noticing. Thirdly. this was in many ways the best job I ever had and I was 30% Jody would raise additional funds and keep the business alive. and neither did our outside accountant who had worked for the company for three years. Immediately following November's results Jody made some big changes . In a long and complicated story that has nothing to do with Ecomom I was a dating a nice girl I had met out of town. Laying off half the staff at the beginning of December and freezing sales might have given Jody another few months of breathing room.he dropped the discount strategy and the VP of sales left the company. Our GM quit towards the beginning of December to pursue other opportunities . and locked up another $1. I dared not call the bank. but nobody came.8 million capital raise in Aug for the 5 months through Dec 31st we lost $1. What kind of controller doesn't even know if his own company has a bank covenant? At this point I was debating with myself every day whether to fish or cut bait. and pursing the relationship would require me to leave Las Vegas. I had a front row seat to the painful disintegration of the company which. but the final bills for our huge inventory accumulation still needed to be paid and enough old discount coupons were still floating around that they would dog us for several more months.. It was a step in the right direction. my last day of work would be Jan 31st.2 million to support that same strategy in the months going forward.There were some big problems with the management structure too. the lack of financial information. I did shake her hand once a the Christmas party. spent $1. First and foremost. Our discount strategy resulted in enormous losses. but for the VP of sales the strategy optimized his bonus. and certainly none to talk about it. On the other hand. . I was the ostensible controller. and yet I did not have check signing authority or even access to the bank statements. but it was too little and too late. The company had never had a profitable month in its entire history so turning the ship around would not be easy. did she know? She lived in San Francisco and I never actually spoke with her.7 million more on overhead. Our bank credit line happened to be exactly $1 million was there a bank covenant? I did not know. Each of them lived in a different city. Over the course of January the consequences of the great failed gamble became apparent. No substantive changes were made to the business strategy and starting from a $4.

I drew up multiple different forecasts at Jody's request. and some were detailed expense forecasts with spending cut to an absolute minimum. and employees handsomely. That was a painful assignment for me. Jody looked haggard." For many calls he would end up leaving the office to speak in private. I discontinued all payments except for payroll. and now his baby was dead. and utilities." and "I'm too old to start over. The last few staff meetings were very depressed. The failure of the business would be a bitter pill to swallow . A week before the end." One week before the end he drew up his will and handed it to his secretary. Philip Prentiss 22 April 2013 . Instead he would be faced with humiliating explanations for lost money and painful layoffs of his loyal far as disintegrations go. 2013. 2013. On Feb 15. Some were 2013 P&L forecasts at different levels of was Jody's baby for four years and he had hoped to reward all of his friends. and assuming the bank did not seize our assets. Would he have to give up the big new house he had purchased not just a few months earlier? Would his gorgeous wife have to quit medical school and become a waitress to support him? I don't know anything about Jody's personal life. and I didn't even have to face anyone. Jody asked me to draw up a forecast assuming half of the staff were let go and we used the empty space to transfer all our remaining inventory from Los Angeles. January 26-27. I never had a close relationship with Jody but I did sit right across from him in the office and overheard a large number of unsuccessful fund raising calls. and made a number of very morose comments such as "I feel terrible about this. Ecomom entered into Assignment for Benefit of Creditors. I speculate Jody was either trying one final time to raise capital or preparing for severe downsizing otherwise. but I do know that Ecomom was his dream and his baby. if you guys want to fire me that's ok. angel investors. I remember him quite clearly ending one with "well. On my very last weekend. Even at this drastically reduced spending. was a relatively calm and orderly. He was personally extremely pessimistic that he would ever be able to raise money again. benefits. our forecast showed us out of cash by March. I'm not really in love with this conversation either. many of whom had followed him from Los Angeles to Vegas. Jody committed suicide by shooting himself on Jan 28.