Mention accounting and some people want to shut down their brains and fall asleep. That’s unfortunate, especially for small business owners, because accounting is actually not only interesting, but also essential.
Accounting offers a tool with which business owners, managers and others can gauge success as well as identify areas that need attention and improvement. Properly structured, a good accounting system converts data into a format that tells a personalized story about your business.
To fully appreciate accounting, business owners must have a basic understanding of how the process works (debits and credits) and its results (financial statements). A balance sheet, for example, offers a window into your business at a specific date. A profit and loss statement serves more like a scoreboard for a specific period of time. This information allows you to control the course of your business.
Not only will an accounting system indicate how much money you have in the bank, a system also will provide information as to how much is owed to you. If you have even a few customers who pay on credit, it’s important to know both the individual and total accounts receivable. A business might enjoy exceptional sales. But if you haven’t received payment for those sales, it could hurt your cash flow. Following up on delinquent receivables is more effective when done earlier, rather than months after the goods or services have been provided.
It’s just as important to know what you owe to your suppliers and various governmental agencies. Money collected from your customers as sales tax and money withheld from your employees in payroll taxes isn’t your money. You have a fiduciary responsibility to collect and remit the collected amounts to the proper agencies in a timely manner. Failure to do so very likely will result in a visit from the taxing agency with the intent of shutting you down.
Understanding your profit and loss statement is essential as well. Revenue is a key figure to know in and of itself, but also when comparing to such benchmarks as your break-even point and sales projections. With the proper accounting setup and personnel, you can track sales by types or regions, allowing you to focus your efforts on those that are the most profitable.
An accounting system also should allow you to track individual expense categories to quickly identify how much is spent. If these expenses are categorized properly, you can easily determine the cost of your products sold, which in turn will allow you to calculate your gross profit and gross profit as a percentage of sales. Gross profit is a key measurement for any business that incurs direct costs relating to sales. When expressed as a percentage, this can communicate whether you conform to industry standards or meet your own forecasts. Expenses, other than those directly related to sales, are generally referred to as general and administrative expenses. These expenses tend to be more fixed in nature and not as influenced by sales volume. A properly structured and managed accounting system also will provide information as to how much equity has been injected into the business and how much debt is owed to creditors.
A successful business depends on a good accounting system and controls that provide accurate information in a timely fashion. In fact, there’s a direct correlation between the quality and timeliness of records management and information and profitability.
Quality records management also becomes important in the event of an audit by a governmental agency. An additional benefit of good accounting is the ease with which the professionals you hire to assist in preparing financial statements and income tax returns can do their jobs. What’s more, creditors and sureties will want to review your
in-house financial statements. The more accurate your records and the more consistent they are with certified public accountant prepared financial statements, the more credible your business will become. Increased credibility could mean increased borrowing or bonding capacity.
While some business owners might worry about the cost of developing and maintaining a good accounting system, the cost of a poor accounting system is far greater in the long run. This cost can include penalties imposed by taxing agencies for failure to pay amounts owed or paying the wrong amount. Another cost could be reduced proceeds from the sale of a business or transition to another owner. A new owner won’t pay for profits and cash flow unless they’re documented in reliable financial records.
There are many benefits from a reliable accounting system: improved business performance based on better information as well a reduced fees paid to professionals to prepare financial statements and income tax returns. In these troubled times, a good accounting system and internal controls also help to reduce losses from fraud and identity theft.