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!

Avoid Those Year-End Accounting Surprises

It’s a true business maxim: When you understand your financial statements, you remove the obstacles that cloud your judgment, and you validate the success you believe is unfolding. And by scrutinizing financial details, you’ll get truly rewarding insight into the status of your business. Not just a general impression.

Status check: By monitoring your financial statements at least monthly, you can see why you’re profitable. Or not. Sometimes, for example, robust sales don’t really increase profits. In many instances, rising revenue may trigger greater costs. Inspecting the trends in profit margin in crucial: If variable costs increase faster than sales, the profit margin suffers. Your business’s opportunity for growth is stunted until you address the environment for expansion.

Remember that accrual basis financial statements best reflect current conditions. Under this system, revenue is counted when earned, regardless of when it’s collected. Expenses are recorded as they’re incurred, not when they’re paid. Consequently, accrual basis tends to match the timing of expenses to the periods in which they produce revenue.

Many astute entrepreneurs use accrual financial statements for decision making and cash basis financials for income tax reporting. Accounting software commonly produces reports for either method.

Cash flow statement: Businesses run on cash, so you’ll need a cash flow statement. This report compensates for accrued revenue not yet collected and accrued expenses not yet paid. However, if customers usually pay invoices immediately, and you remit payment of your bills promptly after receipt, cash basis financial statements are usually adequate; they’ll deliver the same general figures as accrual basis reporting and eliminate the need for a cash flow statement.

Cash flow is also impacted by money that flows to categories such as loan repayment and equipment purchases. Evaluation of the business balance sheet reveals the extent of these changing balances. Moreover, the balance sheet shows compensation to you as the owner or shareholder of your company. Make sure you’re not drawing too much. Your take comes after you meet priorities that keep the business prospering.

Waiting until year-end to examine financial results inevitably leads to false interpretation. No matter what the size of your business, insist on accurate monthly bookkeeping. If you do maintain your own accounting system, get regular professional assistance to correct errors and omissions and help interpret the financial status of the business.

The accrual method eliminates wide swings in profitability rendered by the cash basis. Note that you likely will need professional bookkeeping help, if, for example, you experience substantial time lags awaiting customer payments or expenses that vary with revenue.

Contract projects: Businesses that handle contract projects for customers should know the profitability of each individual job. In job profitability accounting, your bookkeeper needs sufficient information to properly record events. For example, a bulk purchase for multiple jobs must be allocated among various projects.

Happy 2017: With timely and accurate financial statements – and by following an optimal methodology – you avert year-end surprises, identify profitable opportunities and are able to immediately implement improvements. What better way to go into a new year…

Enjoy a Successful 2017 Thanks to These Four Resolutions

Your 2017 New Year’s financial resolutions may be all about saving resources and improving revenue. Again. But consider the following to really help you achieve your financial goals.

The best move you can make is to improve your financial recordkeeping. This helps you prepare for contingencies and monitor your circumstances. If things are good, chances are you won’t consider changing up your recordkeeping, but note: implementing high-quality financial practices now will create a climate for advancement later.

Here are four financial resolutions that will lead to financial success:

Separate personal finances from business records. Nothing creates more confusion than tracking personal expenditures and business transactions with the same system.

Reserve for taxes. Whether you base your effective tax rate on a projection for the current year, or the actual rate from last year, set aside this percentage of your monthly income for tax remittance.

Plan for major costs. Replacing, repairing, or adding equipment; adding more space; moving; or hiring all necessitate large upfront cash outlays. Know what these costs are and when you may need to make these investments. Set aside a little money each month; you’ll be ahead of the game when the time arrives.

Use one bank account and one credit card. Avoid lost receipts and overlooked business expenditures resulting from using personal cash or credit: When the business needs more funds, move personal money to the business account and use it for all company transactions. Have a dedicated credit card strictly for use in business transactions. And have a prosperous new year!

Double-Entry Bookkeeping Offers Major Benefits

Sound bookkeeping is a harbinger of financial success because it helps build a foundation of best practices.

Today’s accounting software allows small operations to enjoy the same bookkeeping standards used by large organizations, and offers a much simpler way of tracking revenue and expenses than the spreadsheets many small enterprises are using.

Although learning about new software can be daunting, understanding how accounting software functions makes that a very worthwhile task.

Data available from a sophisticated accounting system is especially important if your business is a corporation. Tax reporting for a corporate entity requires substantial detail. Moreover, satisfactory business management – even by a solo operator – requires informed decisions on profit utilization. You need solid guidance about when profits may be distributed to owners as dividends rather than used for expansion.

Single entry

A simple listing of revenue and expenses-such as on a spreadsheet-entails making a single entry for each transaction. Single-entry bookkeeping might work for someone with a low-volume sideline business. But entrepreneurs, who are committed to their businesses as their primary income sources for the long run, soon discover that the single-entry method may result in a series of small errors with enormous unintended consequences.

As the name implies, single-entry bookkeeping is characterized by having only one number recorded for each event. But, in fact, every business transaction has two impacts: an expenditure of cash is a simultaneous decrease of business funds and increase in something else (such as an expense category).

Single-entry bookkeeping can only reveal cash flow; it doesn’t track accounts on the balance sheet like inventory, accounts receivable, accounts payable, and debts-information growing businesses require.

Double entry

The value of accounting software is that it automatically accomplishes the heavy lifting of double-entry bookkeeping. You make one entry, but the system records two. Both sides of every transaction occur in the background, but you can easily find a single transaction in both accounts that were impacted.

When a check is recorded in the software, it appears to only reduce the bank account. But in this software entry, you also select how the funds were used, and that selected account increases.

To select the correct account, consider the purpose of the check: For example, did you increase an expense, add to inventory, or purchase equipment? Or did you increase the amount you’ve repaid on a loan, lowering the liability balance owed? These are debits, and the bank account shows a credit.

Similarly, entering a bank deposit involves selecting an account representing the source of money received-company revenue, sales tax collected for future remittance to the government, proceeds from a loan, or personal cash contributed by the business owner. These sources are, respectively, credits to accounts for income, sales tax payable liability, note payable liability, or paid-in capital. A debit is recorded to the bank account for the cash increase.

Understanding the double-sided nature of every transaction provides superior information on which to base decisions. And this will make you a very savvy entrepreneur.

Try This Simple Hack for Projecting Next Year’s Revenue

With a new year on the horizon, it’s time to lay the groundwork for next year’s operations. Although many business owners believe that budgeting is impossibly useless for small operations with widely fluctuating incomes, forecasting revenue reveals where you’re going in the coming year and helps estimate marketing targets.

Here’s a simple way to project next year’s revenue: On a spreadsheet, list in the first column your existing and prospective projects for January. A retail business with sales to the public will list normal minimum sales volume and extra customer volume. Consider allowing for possible higher weekend traffic by treating weekends separately.

In the next column, record the expected revenue for each line in the first column. Then add a percentage of probability for the projected revenue in the next column to the right. For example, you may have a 100% expectation of some work, but only a 50% chance of closing a new deal or attracting above-average traffic on weekends.

The last column to the right multiplies projected revenue by the probability percentages for each row. The sum of this column is your revenue forecast for January. Repeat the process for the subsequent eleven months, and add the twelve revenue forecasts together to determine expected revenue for next year.

This technique results in a meaningful scenario by turning hoped-for revenue into realistic results based on probability. So a 25% chance of making a million dollars realistically means you can expect a quarter million.

It’s easy, it’s useful, and you can start now.

How to Save Taxes as an S Corporation

Toward the end of each year, unincorporated businesses begin considering tax structure advantages to implement in the following year. One of these is obtaining S corporation status. When your annual profit reaches approximately $50,000, you may want to consider this option as a way to save on taxes.

If you do decide to convert your business into an S corporation next year, you’ll need to know that a great deal of planning is involved. The issue of converting to an S corporation is surrounded by multiple guidelines from the tax authorities, but no solid formula. Your accountant can help you navigate this labyrinth of guidelines and assist you in deciding whether the option is a good one for you and your business.

How it saves

Figuring out how converting to an S corporation can reduce a tax burden begins with understanding how proprietorship operations in the United States are taxed. Profit is subjected to two distinct taxes – regular income tax and self-employment tax. The latter is reported and paid on your annual income tax return, but it’s calculated separately from ordinary income tax.

Self-employment tax is a flat rate assessment on profit; it comprises contributions to the owner’s Social Security and Medicare accounts. Corporations – as distinct entities from their owners – do not pay self-employment tax.

How do you get paid?

Unfortunately, incorporated small businesses are confronted with the confusing problem of having to forward corporate profits to their owner(s). This is confusing because receiving a salary from a corporation you own doesn’t reduce your tax burden. Why? Because this salary incurs the Social Security and Medicare taxes you’re trying to avoid.

Compensation via dividends is even worse. Dividends do not represent an income tax deduction for a corporation. As a result, corporate income remitted to an owner as dividends is considered taxable income for both the corporation and the individual.

Special S corporation status eliminates this double taxation. Profit simply passes through to an owner for calculation on his or her individual income tax. No self-employment tax is assessed because the owner is receiving taxable profits as a shareholder.

Officer compensation

More complexities arise when the shareholder is the working operator of the enterprise in addition to owning the business. Tax rules do not allow this person to receive all of the compensation as a shareholder’s taxable profits. Enjoying the tax savings from operating an S corporation – in which you’re both the shareholder and officer – is only allowed when you receive reasonable compensation for your operational services. That means receiving some compensation as wages, which then incurs Social Security and Medicare taxes. But the remaining corporate profit after the cost of your compensation does escape these employment taxes.

Identifying compensation that satisfies the requirement for reasonableness presents a challenge to anyone serving in the dual role of S corporation shareholder and officer. But it’s not insurmountable. As mentioned previously, discuss this in your annual pretax meeting with your accountant, and he or she will ensure you’re in compliance.

Don’t Use Your Retained Earnings Account ‘Til Year-End

One item on your financial statements that can provide you with really useful information is called “retained earnings.” So it pays to understand it.

As one of the equity accounts on a balance sheet, retained earnings accounts show changes in assets. Most commonly, business profits trigger increasing cash or accounts receivable – both of which are assets. Profit growth raises retained earnings; on the other hand, business losses have the reverse effect.

Changes in retained earnings only occur at the close of an accounting cycle, which is typically at year-end. Throughout the year, the retained earnings account doesn’t change. Instead, the balance sheet has another equity account for current year profit or loss. Only when the year is complete does the balance in the current year account flow over into retained earnings.

Throughout the current year, retained earnings should continuously match last year’s final number. If you increase retained earnings to a figure that’s greater than the balance at the previous year-end, your tax accountant has no choice other than to adjust the current year’s profit; you’ll pay income tax on an additional amount that wasn’t really income. If retained earnings decline, the tax accountant must record the change as a non-deductible distribution or dividend rather than a deductible expense.

Never record a transaction that alters retained earnings. Distributions or capital contributions are changes in cash assets that are not a consequence of business earnings. If you want to record these events correctly, use different equity accounts – not your retained earnings account!

Start Planning Next Year’s Business Budget Now

Successful business owners start planning their annual budget early. In fact, now is the time to start. But relax: It can be a simple task. And when the planning process is wisely handled, the benefits of budgeting will far outweigh the cost of time spent preparing it.

Budgets should not be time-wasting exercises without staying power. To create a useful budget that will stand up through the following year, you shouldn’t be spending much time jotting down figures on a page; it’s clear thinking that will produce a strong financial model.

Budget according to business type

A budget should be as simple as the business type it embodies. A one-person operation, for instance, will probably have a basic budget that easily adjusts to rapidly changing conditions. A store or company with several employees generally requires a more refined budget. But take note: Detail is not the aim. Your objective is a useful plan.

A business budget is more than numbers on a spreadsheet. Instead, budgeting is a thought-provoking process. By creating a budget, you’re quantifying your expectations for the future. The process forces you to predict what’s likely to happen as a result of your intended actions. And with a budget, you also calculate the predicted impact of industry trends, demographic changes, and general economic conditions.

Build in flexibility

The simpler your budget, the easier it will be to compare with actual results. And you can always alter the budget for changing circumstances.

Budget planning begins with differentiating fixed and variable costs. Some business costs are fixed monthly amounts, but many other costs are dependent on the revenue you bring in.

When expected revenue changes as actual results unfold, it should be easy to revise the upcoming variable expenses as percentages of sales. Costs directly related to sales volume are either moved forward or scaled back, depending on the way the revenue is going.

With both fixed and variable expenses considered, your other concern is major nonrecurring expenditures. Your budget should give you confidence that spending plans are reasonable based on cash flow. If the budget shows available liquidity, you can plan for major expenditures. As the year unfolds with better- or worse-than-expected results, you can shift these expenditures to occur either sooner or later according to the level of importance you assigned to them.

Think before quantifying

Budgets ultimately save money because they compel you to prioritize. Adjustments to your budget assumptions depend on the thinking you did before you actually began quantifying anything. Although expenses are a certainty in business, cash is a limited resource. Budgeting identifies how much money to allocate for each category of expenditure and tells you when you can afford nonrecurring cash outlays for important but revenue-sensitive items, such as training, new equipment, staff additions, or a special marketing campaign.

Because budgeting entails as much thinking as calculating, it’s a wise move for all business operators to begin the mental portion of the process well before the year-end…like now!

Asset Trades Can Pose Accounting Challenges

What is an asset trade? Well, like trading in your older vehicle for a newer model, an asset trade occurs when a business owner wants to trade up to improved technology and a vendor offers trade-in value for the older equipment.

This can pose an accounting challenge. The main issue with asset exchanges is that they differ fundamentally from ordinary business income. Savvy business owners will want professional accounting advice to properly record these transactions in their companies’ books.

In a cash sale, the gain or loss is the difference between the book value and the money received. When you receive more cash than the book value, it’s a gain; when you receive less, it’s a loss.

In an asset exchange, the relinquished asset has a carrying value on the company’s books, typically its original cost less allowed depreciation calculated up to the exchange date. The gain or loss is the fair value of the received item minus the book value of the relinquished item.

This is the case only when it is a nonmonetary exchange for dissimilar assets, such as trading furniture for computer equipment. When assets are similar, as is the case for most trade-in events, no gain is recognized from the trade.

In these instances, the gain simply reduces the fair value of the received property. The new asset’s book value is equal to the relinquished item’s book value, plus additional cash spent. Gain is not realized until a future date when the received asset is disposed of for cash or dissimilar property.