How to Best Use Your Value-Added Accountant

Small business owners often view accounting services as only delivering the necessary output for tax reporting. And, yes, financial professionals do fully understand balanced bookkeeping with accurate categorization of transactions, plus the forms for various taxes. However, your accountant isn’t just about your taxes; accountants are also capable of providing analyses that can strengthen small businesses and help them grow.

Consequently, tax season should not be the only reason for meeting with your accountant. Savvy small business owners arrange to meet frequently with the professionals who most understand their financial situation, as they have the tools to help owners build their companies.

New insights

Accounting professionals can use your financial data to give you insight into business trends and help you weigh risks against potential rewards. This kind of financial management service can provide solutions to support sustainability and growth of your small business.

Those savvy individuals who avail themselves of these services recognize that different phases of their business demand different skill sets. Taking a concept from development to a full operation is not the same as overseeing an evolving organization. To thrive in business, you need to understand the financial measures that promote success. And your accountant can help you.

Executives at large enterprises have at their disposal an extensive network of internal financial professionals to help them navigate their operations. As a small business owner, you have access to the same expertise through your accountant. Relying on him or her for financial mentoring will increase your knowledge and improve your decisions.

Understanding industry standards

Your accountant can explain the business facts represented by your numbers. Ask first for a comprehensive general overview of key financial elements for your industry. Find out how your business compares in the basic measures of financial soundness. Inquire about trends in your financial measurements. Keep asking until you understand the actions that deliver good results versus those that contribute to declining performance.

Strategic planning

Your accountant doesn’t live in the past; he or she can see where your business is headed and what’s required to reach specific targets. Consider your accountant a consultant who can identify likely future scenarios, explain new initiatives you could implement to attain improved results, and quantify the costs. He or she will ask you to consider factors you may be overlooking. From these, you can project cash flow to help in plotting an achievable course of action.

Planning for financial security

Your accountant can also help you plan for long-term financial security. Some of the cash your business generates exceeds what’s needed to sustain operations and provide for your own compensation. Saving techniques suggested by your accountant may ultimately enable you to fund a business expansion, save for retirement, or transition to a different business model. Best of all, they may also deliver tax benefits now.

Your trusted accountant provides solid guidance that’s crucial for the inevitable but uncertain changes every business owner faces. Make good use of him or her.

Forecasting Can Direct Your Actions and Impress Lenders

Financial forecasting is one of the greatest challenges confronting a small business owner. But the process is important because it allows you to use the lens of experience to peer into the future.

Nevertheless, financial forecasts are frustrating because they require time to establish expectations that are almost never achieved as planned. What forecasting does do is provide a guide to conditions that could exist for your business; basing your actions on this guide is the reason we forecast, and it’s crucial to your desired results.

Monitoring performance

A financial forecast enables you to monitor performance. And this is key: spotting a gap between forecasted figures and desired outcomes allows you to get ahead of problems before they become enormous disruptions. Acting on this (by making changes in spending, focusing on the most profitable sales opportunities, or developing a new marketing strategy) will put you back on track.

Your company will not always grow at the same rate as in the past. Based on your financial forecast, you may expect to grow at a faster pace – cash flow can change as a result of a growing or changing customer base, and new circumstances can trigger a need for capital.

Experience and practice help. As you learn to connect your projected numbers with factual data, you’ll become better at forecasting. And when your forecasts reflect the facts, you’ll feel more comfortable approaching potential lenders; your financial forecast will provide a believable foundation to support your loan request. Desired result: loan approved!

Business Owners Should Track These Monthly

Mentioning accounting and finance may be a sure way to clear a room full of members of the public. But a room of entrepreneurs? Not so much. Entrepreneurs realize the failure of small business ventures is primarily attributable to poor accounting practices or improper financial management.

Monitoring your small business’s financial statements is the only way to know how well you’re doing and where improvements are most urgently needed. So carve out a little time each month to conduct a proper financial analysis, and begin by focusing on the basics:

The income track

Revenue growth and/or stability is key to your business’s sustainability, so start with the top line on the income statement. Compare last month’s revenue to the month immediately preceding it. Then compare it to the same month the year before. While you’re at it, consider revenue per hour worked by all employees, including you. This a very informative measure of productivity.

Have you experienced a singular event, such as a particularly large sale? If it’s a one-off, treat it as a singular event. But if you want continued large sales, you’ll need to focus your marketing efforts on ensuring this happens.

Looking at concentrated income can also be informative; for instance, if a single customer provides a large portion of your revenue, it can be a problem if that customer buys less in the future.

Don’t become so focused on top-line revenue that you ignore profit margins, which validate efficiency. Net profit margin (shown as a percentage) is derived by dividing profit by total sales. While a lower number can be acceptable in the short term, prolonged negative margins are cause for alarm: either your expenses are too high or your prices, too low.

Gross profit margin is the difference between sales and the product costs divided by sales. If you resell products, you need a consistent gross margin; rising costs would necessitate a commensurate increase in prices. Know which of the things you sell are the most profitable based on gross profit margins.

The operations engine

To be efficient, a business must promptly collect accounts receivable, remit accounts payable, and resell inventory. Know how many times last month these financial figures turned over. Receivables’ turnover is the period’s sales to customers on credit divided by the period’s average accounts receivable. Payables’ turnover is the period’s expenses billed by vendors divided by the period’s average accounts payable. Inventory turnover is the period’s cost of goods sold (for inventoried items) divided by the period’s average inventory.

The important information is the frequency with which new receivables, payables, and inventory replace the old. Consistently high turnover numbers represent management efficiency; low turnovers are warning signs.

Help is available

If you don’t want to crunch the numbers yourself, accountants and bookkeepers can help by compiling the financial data needed for evaluation, assessing this data, and comparing your business to others in the industry. Once you have this valuable information, you can adjust. And succeed.

Should You Loan to Employees? Know Your Options First

When employees turn to you for payroll advances to meet their unexpected cash needs, be sure you understand the impact of turning your business into a lender. While helping an employee with an immediate financial need is a virtuous act that promotes loyalty, there are downsides.

When word gets around, other employees may step forward with requests. If some requests are granted and others are declined, it will impact morale. And since a cash advance is usually repaid from the employee’s future wages, if he or she leaves the company before the debt is repaid, you may have trouble collecting.

Longer-term loans: Unlike a cash advance that is paid back from the next paycheck, an employee loan may be long term. Long-term arrangements should be set out in writing with an interest-bearing promissory note executed by the employee. These promises for repayment are business assets, not expenses. Your bookkeeping simply shows less cash assets and more notes receivable assets.

Failure to establish guidelines could open your business to claims of unfair or illegal discrimination. So if you do decide to provide loans or advances, establish a written policy that specifies qualifications, maximum amounts, and repayment terms.

A gift, not a loan: Lending to an employee also may lead to future requests from the same individual. To avoid this, the employer could make it a one-time gift with clear financial limits that should deter future requests.

Staff gifts are generally accounted for as payroll wage expenses. Employment taxes are applicable, and the transaction is typically treated like any paycheck.

Need a Business Loan? Think Like a Lender

When you apply for a business loan, you have great reasons to want the lender to respond positively: as an entrepreneur, you’re confident about the future of your business; you have accepted the risk of devoting your time and knowledge to the venture; and with more cash, your dreams of greater profitability will surely be realized.

Or will they?

Banks are not confronted with the same risks and rewards as business owners. A bank lender doesn’t participate in the upside potential of your company. The bank isn’t entitled to a huge payoff by sharing in future profits. Lenders only earn a modest amount of interest. And they may not even receive that if the loan doesn’t produce the desired cash flow.

Therefore, as a borrower, you must demonstrate that your business is worthy of the lender’s risk.

Business financial history

The bottom line, as far as the bank is concerned, is that the loan is repaid. So walking into a bank without proof that you can be trusted to do this is a fool’s errand. The loan application process is an informative presentation of facts, not a sales pitch.

When your business is ready to seek a loan, approach the bank with up-to-date, accurate financial records. You will not succeed with financial statements that are like an un-watered Christmas tree with its needles shedding everywhere. Lenders must be comfortable with the completeness of your financial data. Your lender will consider you unfit for borrowing if your accounting is inaccurate.

Ensure you have Balance Sheets, Income Statements, and Cash Flow Statements for each of the past three years plus the most recent month-end. You’ll also need the previous year’s tax returns that match your financial statements.

These statements reveal profit margins, overhead costs, and cash coverage for loan repayment. Be prepared to discuss these measures and the trends they show over time. Understand each figure and its past fluctuations. Practice sentences that begin with, “This loan has a reduced risk because . . .”

Loan benefit and repayment

You will need to show how you will repay the loan. This is generally a function of how your business deploys the loan proceeds. Therefore, present the borrowing purpose clearly and explain how it will benefit your company’s ongoing success. Perhaps the loan will permit the company to expand with new space or equipment, or it may allow you to accept more work while waiting for payment for completed jobs, thus improving cash flow.

Financial forecast

Whatever the purpose, it should define an expected business improvement and demonstrate the advantages – and the loan repayment strategy – with a financial forecast.

These projections of future cash flow are built by using the time and cost of sales to customers, the gross profit on sales, and overhead expenses. Forecasts must be consistent with known facts. So don’t be overly aggressive in your assumptions.

Remember that your accounting professional can be a great source of support. He or she will be able to help you construct a conservative, believable forecast so you’ll win your loan.

Avoid Future Tax Stress: Plan Now for This Year’s Tax Bill

Discovering you owe more than you thought on last year’s income taxes is about as welcome as the flu.

And the end of the year, when your tax obligation calculated, is too late to start considering how to pay it. Do yourself a favor: start planning for this year’s taxes now.

To reduce last-minute tax stress, you need a system to ensure you have funds available when your tax bill is determined. Understand that only a portion of your business income has ever actually belonged to you; basically, you’re “holding” a certain percentage for the government, which you will remit at tax time.

So now that last year’s income tax has been finalized, your accountant can provide your effective tax rate, defined as your total tax liability divided by your taxable income.

However, you may want to consider this number: total income tax as a percentage of gross income before deductions. Assuming your deductions vary with revenue, applying a tax rate to every dollar of revenue is a reasonable general estimate of future tax.

That said, some deductions are fixed, not variable, and rising sales this year may push you into a higher bracket, but a finely formulated tax estimate can consider these factors in quarterly checkups.

Whether the tax percentage is general or finely calculated, set aside that portion of every dollar earned this year to prevent last-minute scrambling to pay your next tax bill.

And you’re also less likely to spend it before you need it for 2017 taxes.

Link Financial Reports for Long-Term Success

A business owner’s singular focus on revenue commonly results in false interpretations. Long-term prosperity requires management of risk. That process demands knowledge of all operational variables, including costs, assets, and debt.

Wise entrepreneurs differentiate themselves from the mass of people who respond to financial records with blank stares. Rather than seeing mere numbers on pages, a business manager visualizes an interconnectedness of various reports that paints a picture of current conditions. Here’s how:

1. Review reports: Accounting software has relieved business operators of the burden of compiling financial statements. Since these records simply come together when transactions are recorded, ignoring them is a strong temptation. Instead, the wise entrepreneur uses the time saved on this process to frequently examine financial reports.

2. Connect the dots: An Income Statement shows revenue and expenses. The resulting profit or loss carries over to Retained Earnings on the Balance Sheet. Profits producing positive Retained Earnings are offset on the Balance Sheet by increasing Assets. Knowing which of these was acquired with profits is crucial to uncovering where the money is going.

Losses or lower profits on the Income Statement reduce Retained Earnings. The Balance Sheet shows either fewer assets or higher debt. Frequent examination of the Balance Sheet allows business owners to identify what’s occurring in the relationship between revenue and expenses on the Income Statement. This examination provides the data needed for accurate interpretation and continued business success.

Financial Forecasting: Is There a Better Way?

Some business owners react to adversity like the impulsive person who buys a four-wheel drive vehicle after a late winter blizzard – when springtime is right around the corner. Rather than panic and needlessly overspend, the superior entrepreneur is guided by a plan. A financial forecast is the perfect tool for this plan.

A financial forecast presents prospective revenue, expenditures, and resulting cash flow. Most importantly, it conveys capital inflow needs and indicates when those needs are expected to arise. The forecast alerts you to make adjustments in areas you control when surrounding circumstances vary from your estimates. As actual events unfold, any deviation from the forecast is cause for corrective action.

Creation of a financial forecast is often an unfulfilled goal because the process is bounded by uncertainty. The forecast is based on estimations about a future that is always somewhat unpredictable. Therefore, a sound mechanism for maximizing the reliability of estimates is essential. Business owners can utilize one of two methods to construct their forecast: top-down or bottom-up.

Top-Down

Most small-business operators deploy top-down forecasting. This method starts with an estimation of the top line-item in a forecast-revenue. A common practice is reliance on past revenue. Added to this figure is an optimistic amount of growth. Sometimes future revenue is projected based on anecdotal evidence about the performance of similar companies in your industry or local competitors. Top-down forecasts frequently estimate the size of a customer market and the expected share of this market the business will capture.

A problem with this analysis is that industry trends constantly change. Failure to consider the direction of change is a major drawback. Moreover, top-down forecasting is especially difficult for businesses with limited histories on which to base estimations of market share.

Hence, a dependable top-line number is very elusive. When actual revenue strays from the predicted top line, the foundation of the entire forecast is skewed. You constantly adjust the financial forecast with new wild guesses.

Bottom-Up

A bottom-up approach to forecasting takes you out of the backseat and into the driver’s seat. This technique ignores guesswork about market size and market share. Rather, it considers the resources at your disposal and identifies projected revenue based on what you have to invest in the business.

Consider how many sales you can make utilizing your available time and money. With this information, you determine the number of customers you’re likely to capture and identify revenue by multiplying by the average price each customer pays.

Key to bottom-up financial forecasts is what drives your sales. This could be advertising expenditures, rent for an optimal physical location, investing in an efficient inventory tracking system, spending on tools needed for project completion, or reserving funds for necessary business travel. Comparing your eventual revenue and expenditures to forecasted figures reveals the true relationship of spending to revenue. This permits sensible modification to your financial forecast. You uncover what revenue to truly expect and how much additional investment is needed for robust growth.

How to Account for Products Bought for Resale

Whether your business is driven by product resale or selling components with accompanying services, it’s necessary to account for inventory. Special rules apply to inventory accounting, even for a smaller operation maintaining cash basis books that record expenditures as they are paid.

Financial trail

Inventory is defined as merchandise your business obtains for the purpose of selling to customers. Accounting for expenditures for these items is not considered a business expense until the merchandise is sold. Rather, the cost for resale merchandise is recorded on the company balance sheet as inventory. The business merely exchanges a cash asset for inventory assets.

Inventory appears on the balance sheet at its cost, not its retail value. When inventory is sold, the cost for these items is transferred from the balance sheet to the income statement as “cost of goods sold.”

The cost of inventory includes delivery. So purchasing 1,000 units of item “X” for $3,000 plus $50 in shipping expenses results in a cost of $3.05 per item. When one hundred items are sold, inventory is reduced by $305.00 and cost of goods sold is increased by the same amount.

The circumstances clearly become complex if cost for the same item changes. Acquiring another one hundred units of item “X” for $320 plus $15 for shipping results in $3.35 per unit added to inventory. When two hundred more items are sold, confusion reigns.

The default accounting method for variable inventory unit costs is called FICO-an acronym for First In, First Out. Accordingly, the cost for the two hundred sold items is $3.05 each. You’re still selling from your original 1,000-item batch. But if you’re selling 1,000 items, the first nine hundred are the remaining units from the original batch and the next one hundred are from the second batch, and have a cost of $3.35 each.

Simplifying inventory

All small businesses should consider an inventory tracking system. The “periodic” system places all inventory purchases in a “cost of goods sold” account, a temporary holding station. At the end of an accounting period – at least annually – a physical inventory count is taken, and the known inventory cost is recorded on the balance sheet. The difference between inventory figures from one period and those of the next offsets the cost of goods sold, so the purchases no longer belong in a temporary holding station. The difficulty in this method is assigning differential costs for units acquired at various prices; however, it’s satisfactory for smaller companies with few types of inventory items and little fluctuation in cost.

By contrast, “perpetual” systems continuously update the costs for all units on hand in the inventory account. Most accounting software will automate these systems, which are superior for tracking inventory in stock, as they constantly update the income statement for true FICO cost as items are sold.

Learning the data entry steps for these programs is challenging, but for larger organizations with multiple components of inventory, the output is certainly worth the effort.

It’s Easy to Account for an Asset Buy and Its Loan

Borrowing to acquire fixed assets is a widespread practice among small businesses, but it gets confusing when the business doesn’t account for the entire cost when it makes the purchase, but instead accounts for much of it when paying back the loan used to buy the assets.

In fact, companies are considered to have paid the full cost for an asset even if they take on debt to buy it. When a fixed asset is acquired, the bookkeeping process requires a journal entry.

An asset account on one side of the balance sheet is increased for the entire cost. On the other side is the addition of a note payable for the funds borrowed to buy the asset. A down payment made with company funds is the difference between asset cost and loan amount. This reduction in the cash asset balances the journal entry.

How it works

For example, consider a $10,000 equipment purchase that’s paid by $2,000 of company cash and $8,000 of borrowed money. A journal entry increases equipment assets (a $10,000 debit) while decreasing cash asset (a $2,000 credit) as well as increasing notes payable (an $8,000 credit).

Sometimes, owners are confused about where to account for their expenditures on loan payments. However, after accounting for the portion that is interest expense, each loan payment is simply applied to the note payable liability.

The takeaway: Loan principal is neither an expense nor an addition to the asset. Rather, the full cost of the asset was already recorded upon purchase. Easy!