Financing a Purchase? Follow These Accounting Basics

Accounting for financed asset purchases is likely the most complicated bookkeeping procedure to untangle.

Where should you start? To avoid missing vital details in your books, you must record the entire cost of an asset, including the part you pay in the future as loan payments. This allows you to deduct asset costs appropriately and sidestep future errors when recording loan payments.

Use the following procedures to keep your books in order.

Lingering Liability

Loan payments do not belong on your Income Statement, which includes revenue and expenses. Repayment of loan principal applies to a liability on the Balance Sheet. Only the interest portion of a loan payment is recorded on the Income Statement as an expense.

For this structure to function correctly, the loan liability must appear on the Balance Sheet when the money is initially borrowed. Without this element, you have no Balance Sheet liability to reduce as the loan principal is repaid.

Judicious accounting of your loan payments ensures that the liability account on your business Balance Sheet precisely matches the lender’s record of what you owe. Periodically reconciling the loan balance on your books to a report from the lender is as essential as reconciling your checking account balance to a monthly statement from the bank.

Capitalized Curiosities

Most costs of doing business are recorded as expenses on the Income Statement. However, a capitalized cost is a special exception.

Capitalized costs are assets such as equipment, furniture, machinery, buildings, and improvements to rented business space. Some of these items, however, may cost so little that they are accounted for as expenses. Rely on your tax accountant to determine the cost threshold that requires you to capitalize a purchase.

Capitalized costs are recorded in an account on the Balance Sheet. The amount spent is deducted over time as depreciation. When this happens, your financial statements simultaneously document depreciation expense on the Income Statement and a reduction of capital costs on the Balance Sheet.

Financing Formalities

Cash that leaves the business bank account for a purchase is recorded as either an expense on the Income Statement or a capitalized asset on the Balance Sheet. Accounting software automatically deploys this double-entry process.

Since capitalized costs are typically larger than ordinary expenses, their purchase often involves borrowed money. Funding from a lender must be identified along with the amount spent by the business. Paying a capitalized cost with borrowed money does not change the amount paid for the asset. You depreciate the total cost, regardless of how much company cash is spent at the time of purchase.

Journal entries are used with computer bookkeeping programs to record the full cost for a capitalized asset along with the borrowed part of that purchase, which creates a new liability. Consequently, business owners must provide bookkeepers with all the information about the cost for an asset purchase and any loans incurred to buy it. This will allow for accurate accounting of your financed purchase.

Fact or Fiction? Small-Business Myths Debunked

Not all advice is good advice. To succeed, entrepreneurs must discern what counsel is sound and what is pure fiction. Following are three of the most common myths that can lead small-business owners astray.

Tax myth: Topping the list of management mythology is the notion of increased spending to reduce taxes. It’s true that the timing of expenditures sometimes yields beneficial tax consequences. But this does not mean that unnecessary costs are a good idea simply because they’re tax deductible. Especially disastrous is borrowing to pay for things that don’t add to business productivity. Burning $1,000 to obtain a $300 tax deduction simply results in a $700 net cost.

Image myth: Some people encourage frivolous spending on things the customers never see. For instance, retail stores need visible locations with plenty of parking, but a fancy office suite will not impress clients who interact with a business remotely. In addition, despite the importance of reliable transportation to jobsites or a decent car for client meetings, frequent upgrading to the latest model is wasteful. Remember, image cannot replace performance.

Payroll myth: Perhaps the most important myth to dispel is that you should always reinvest in your business before paying yourself. Instead, focus on operating a profitable business. If you have invested the right amount to launch the enterprise, it should provide some amount of compensation for your work. Always plan to pay yourself something first and expand with what’s left. If you aren’t getting paid for running a profitable operation, you’re only reinvesting in an unprofitable endeavor.

Managing Your Margin with Changing Costs

Successful operation of a small business hinges on managing two types of expenses: fixed and variable. As the names imply, fixed expenses are stable amounts that must be paid routinely. Variable expenses, on the other hand, constantly change depending on your sales. Here’s what you need to know about both:

Fixed Expenses

You have to pay fixed costs regardless of your revenue. For instance, telephone and internet are essential business costs. Bills for these expenses are paid even if you have no revenue for the month. Rent and payroll are other common fixed expenses for a small business. Every entrepreneur should also plan for some amount of recurring personal compensation. You don’t want to run your business without reward for your effort!

Variable Expenses

Controlling variable expenses is key to constructing a workable design for business success. Why? The management of these costs is necessary to fund your recurring fixed expenses.

Typically, variable costs should rise when revenue increases and decline when revenue decreases. The obvious category to examine for these trends is the costs of goods sold on your income statement. Examples of these variable inputs are materials, parts, and components necessary to complete business sales.

These variables directly impact your gross profit margin (revenue minus cost, divided by revenue). The goal should be to maintain a constant gross profit margin by properly managing your expenses. To do this, you must ensure that variable expenses rise and fall in step with revenue, so your costs don’t throw off the equation.

Semi-Variable Challenges

Of course, maintaining steady expenses can be challenging when costs are variable by nature. And in some cases, the expenses are semi-variable.

Labor is the main expense that falls into this category. While direct labor related to customer interaction is typically variable, general office personnel may be needed regardless of sales volume, and administrative wages are almost always a fixed cost.

General overhead expenses can also shift from fixed to variable. For example, you might choose to spend more on marketing and advertising if sales take a downturn. You may also divert some of your direct labor from other projects to beef up marketing efforts.

Market prices may also change, taking control of costs out of your hands and limiting your spending decisions. Entrepreneurs must adjust to changes in cost of materials and labor as they occur. The obvious course of action is to increase or decrease sales prices in response to new costs.

Eye on the Margin

Accounting for all these fluctuations is crucial to identifying optimal use of your resources. Remember, revenue minus variable costs is what’s left to pay for fixed expenses. You must know which expense categories are genuinely changing with shifts in revenue in order to effectively monitor costs and make necessary adjustments.

This will allow you to calculate a modified gross profit margin that provides a realistic look at your finances. You can multiply this gross profit margin by your expected revenue to calculate how much you will have to pay fixed expenses and how much will be left over to grow your business.

A financial professional can help you navigate these numbers and suggest steps to further the success of your company.

How Much Is Enough? 3 Keys to Pricing Strategy

Pricing strategy is a major consideration when launching operations, and it’s also an ongoing challenge for small-business management. Numerous factors are at play when setting a price for a new offering or adjusting prices for existing lines of business. To meet pricing challenges, focus on three key areas.

1. Efficiency: Business success is dependent on more than simply selling superior products or services. You must provide something that represents the best value. This means delivering what you offer in the best possible and least costly ways. It means taking steps to make prices fair to both you and the customer. The first step is to make a careful assessment of internal business processes. Could you improve the efficiency of your procedures? Be sure to look at general business functions that don’t directly affect customers. Having cost-effective organizational methods ensures a focus on output quality and customer service.

2. Costs: Fixed and variable costs directly affect pricing. Identify these costs and consider the costs incurred for each sale or service. Manufacturers must look at the cost for producing a number of units. Service businesses must consider labor expenses for the time needed to complete a project. Derived from these calculations is a price per unit/service that covers both production costs and overhead expenses.

3. Competition: What are others charging for similar products and services? Comparing your determined price to the prices charged by competitors is essential. If you decide that you offer something extra or distinctive, keep in mind that customers must perceive your added value to justify a higher price than your competition.

Financial Evaluation: Think Like an Investor

A small-business owner views an enterprise as a source of immediate income, while an investor examines the company for its long-term value. Looking at your business as an investment is certain to yield a new perspective.

Positioning your business for a long and profitable future is different than merely seeking current profits. Short-term income is the result of sales generation, but a sound long-term investment is something else. It’s a consequence of ongoing, sustainable, and rising short-term sales.

These elements can be challenging to fuse together without creating friction. Fortunately, an assessment of financial reports can allow business owners to manage their growth and build something worthy of investors. Two measures are important to consider.

Liquidity Measures

You may think that revenue and profit are the only relevant measures of business success. But an investor’s evaluation begins with the balance sheet.

This report conveys the amount of cash and the costs of assets held by the enterprise as well as how much has been borrowed. It tells you everything about company liquidity, which is how easily you can get money from your investment in the business.

Calculating key ratios using figures on the balance sheet reveals the company’s liquidity. Current ratio is the most commonly used measure. Simply divide current assets by current liabilities, and expect a result greater than one. Current assets are cash and receivables plus easily liquidated inventory. Current liabilities are all the bills you owe (accounts payable) as well as loan payments in the upcoming year.

Turnover ratios further reveal the liquidity of a business. This ratio demonstrates how quickly you collect accounts receivable, sell inventory, and pay bills.

A valuable company has high turnover ratios. It quickly collects on its invoices and promptly pays its bills. Turnover analysis reveals that accounts receivable and accounts payable are not staying on the balance sheet for extended periods, and any inventory is swiftly sold. An efficiently liquid business is not overstocked with inventory.

An accountant can assist you in identifying these ratios. Of course, this is possible only if you have up-to-date bookkeeping that provides a balance sheet along with an income statement, so don’t neglect these records.

Performance Measures

An investor would also consider the performance trends of your business. Revenue growth rate is a key factor in this performance measurement. This is calculated by dividing the change in revenue between two periods by the revenue in the oldest period.

If revenue is rising, it must be evaluated relative to turnover ratios. You have to make sure growth isn’t putting a squeeze on liquidity. This may occur when greater revenue triggers mounting costs, which are not being paid because of the time required to collect accounts receivable. Consequently, maintaining positive cash flow is crucial.

Is your business achieving a good balance of liquidity and revenue growth? This can be determined by examining the cash flow statement. This statement reveals whether your cash flow would provide a sound investment.

Consult with your accountant to ensure you remain current and accurate on each of these statements. As the biggest investor in your business, you should always know where your business stands.

Watching Your Money: The Where, How, and When

A central duty of every entrepreneur is cash management. Although making sales is essential, failure to maintain scrutiny over cash needs will chip away the rewards of growing revenue. Keeping an accurate accounting of revenue and expenses throughout the year is the crucial starting point.

Cash outflow for past expenses is a good guideline for assessing upcoming cash needs, so stay aware of your recurring monthly operating costs. Still, even with these figures, you have to dig a little deeper to construct a workable design for the future.

Keep in mind that expenses explain only partly how business cash is used. You may also have loan repayments and equipment purchases. Always know the current and upcoming debt that appears on your business balance sheet. The original costs of fixed assets, such as equipment, are also on the balance sheet, along with the amount of these costs that has been deducted as depreciation. As these assets become fully depreciated, it’s likely that replacement costs loom on the horizon.

After determining the full amount of your cash needs over the next three to six months, identify how much revenue you anticipate. Never assume you will be paid when expected. Add a buffer of one more month past the normal due date of your receivables. More revenue is earned as your business grows, but the payments will tend to arrive later. Meanwhile, your rising operating costs must be paid while you’re waiting to collect income.

If cash shortages occur, you may need to seek borrowing channels or ask some clients for retainers as your business builds.

Take Little Steps to Avoid Big Tax Mistakes

Small business taxes can be a tedious burden or an effortless exercise. The key to this transformation is putting the right strategies in place. Here are three.

Mind the Recordkeeping Details

A precise process for recording business expenses is essential to maintaining accurate tax deductions. Having an organized system ensures that bookkeeping is continuously accurate.

For example, income tax reporting necessitates classifying all ordinary and necessary business expenses in specific categories. To achieve this, a checking account and credit card dedicated exclusively to business purchases are crucial. Resist using these for personal expenditures. That creates a bookkeeping mess to clean up at tax time. Take recurring draws from the business account to a distinctive personal account for your non-business spending.

Check stubs or memo lines on check images should convey the appropriate business expense category for immediate recording of the correct bookkeeping category. If you happen to spend personal cash for a business expense, account for these immediately before losing track of the transaction or its categorical purpose.

Additionally, maintain a mileage log for business travel with your personal vehicle. The business may reimburse you for some vehicle expenses. Do not have the business pay for all your personal automobile expenses and expect this to qualify as a business tax deduction.

Put the Right People on Your Team

A qualified bookkeeper will ensure that you have complete records throughout the year. This professional should examine financial statements at least monthly to clarify any uncertainties. Then, at tax season, your books will be ready on time for your tax accountant. This has the added benefit of allowing an analytical review of expenditures to determine areas where you can reduce costs to improve profit.

Avoid the temptation to handle reporting of business taxes yourself. Income tax rules change and the logic applied to some expense categories does not apply for tax purposes. For example, the cost of fixed assets is generally deducted as depreciation over several years, but is not required in all instances. Don’t jeopardize valuable deductions by failing to rely on professional tax preparation for your business.

Be Proactive with Payments

Having an organized bookkeeping system and valuable people on your accounting team are only part of the commitment to streamlining small business taxes. The final element in the design is your resolve for proactive tax-related action. Never miss a tax filing deadline. Late-payment penalties are harsh, and late-filing penalties are even more severe. Remember, filing an extension for submitting a tax return does not extend the due date for paying your taxes owed.

Last, the amount of taxes should not come as a surprise. Your tax accountant can estimate the expected tax on your business profit when you keep accurate records throughout the year. A minimum amount of tax should be remitted during the year to avoid a penalty for underpayment of estimated tax. Even if you file your tax return and pay taxes by the due date, failure to remit estimated tax payments will trigger a needless penalty.

Your bookkeeper and tax accountant can help you avoid neglecting this important issue.

 

Financial Spring Cleaning Projects for Your Small Business

The arrival of spring stimulates feelings of renewal that inspire projects at home and in the garden. This stimulus should pour over to neglected areas of our small businesses. If best practices have recently gone on holiday for your business enterprise, start your spring cleaning by tackling these basic tasks.

Establish goals: Springtime is ideal for establishing your business goals in writing. Your daily tasks in the months ahead should focus on meeting these goals. Evaluate what you want to accomplish this year and consider what you need to do to achieve those results. Start dreaming and create some larger goals for the more distant future. Accomplishment of long-term goals starts with a strategic design outlined on paper.

Review accounting practices: Close examination of accounting reports is a key element in springtime business improvements. Regular scrutiny of financial data is key to diagnosing your small business. Get started with a little help from your bookkeeper or accountant to obtain and evaluate valuable financial reports. End guesswork about the profitability of various types of services or products you sell. Know the tax liability you’re incurring on profits throughout the year and review costs to ensure funds are being maximized to their full potential.

Clean up tax bills: Always paying your taxes on time is a crucial spring-cleaning measure. It avoids penalties and allows you to focus on what lies ahead. Even if you receive an extension on the deadline for filing your tax forms, proceed immediately with completing your tax return. If you still owe some unpaid tax, late-payment penalties are accruing right now.

That Expense Was Business-Related – Can I Deduct It?

Business owners share the common goals of maximizing sales and minimizing expenses. But when it comes time to prepare income tax returns, their focus shifts to maximizing expenses in order to make the most of write-offs. Entrepreneurs typically look for opportunities for deductions in every area of the business. This can prove beneficial to boosting their bottom line.

Unfortunately, not all business purchases are tax-deductible. An entrepreneur is confronted with limitations on deducting several types of expenditures that may seem like legitimate costs of doing business. Keep in mind, simply having your business pay for these things does not make them tax-deductible.

Customer Relations

Tax-deductible business meals are arrangements where the primary purpose is conducting business. Buying lunch for a customer so that business matters may be discussed is a deductible business expense. Dining solo is not. Stopping for lunch alone between business appointments is not tax-deductible. This holds true even if you would have avoided the restaurant cost were it not for your appointment schedule outside the office. The exception is meals you consume while traveling overnight away from home for business purposes. Additionally, only half of the cost for business meals is tax-deductible.

Giving gifts to customers is a common business practice. It builds goodwill and aims to garner referrals. But the IRS limits the tax deduction of a business gift to $25 per person for each gift. So if you give a gift of $100 to a customer, your deduction is limited to $25.

Appearances at Meetings

Getting to business meetings using your personal vehicle triggers a tax deduction based on the miles driven. Don’t count the miles commuting from home to your principal place of business. Going to a meeting before going to your office necessitates a little arithmetic. To determine the business miles, subtract the home-to-office commuting distance from the miles driven between home and the meeting location.

Looking sharp for a business meeting is certainly beneficial. Maybe you always prefer casual clothing, except when seeing customers. Nevertheless, clothing adaptable to other situations is not a tax-deductible business expense. Only uniforms, including clothing with a company name or logo, are deductible. Nothing else you buy that is common attire for occasions other than business is eligible for tax deduction.

Protection from Trouble

Life insurance on a business owner is definitely prudent, especially when the company is expected to survive the current owner. Tax deduction of the premiums is not allowed if the business is the policy beneficiary. If the owner’s heirs are the beneficiaries, the business may deduct the premiums, but doing so could be unwise as it jeopardizes the future income tax exclusion of life insurance death benefits.

Keeping out of trouble with the law is clearly a crucial business matter. But fines and penalties levied on an enterprise are not tax-deductible. A penalty for late payment of a tax assessment must be accounted for separately from the tax itself. You cannot deduct the penalty. Likewise, no deduction is allowed for parking tickets or traffic citations issued when traveling for business, such as making deliveries or attending meetings.

To ensure appropriate accounting, consult with your financial professional regarding deductions for your particular circumstances.

Self-Employment Taxes: Watch Out for the Double Whammy

Freelancers and small-business owners alike are required to make quarterly estimated tax payments. If you’re in this boat, you’ve probably noticed that Q1 estimated payments have the same deadline as the tax return for the previous year. If you owe more tax for the previous year, plus an estimate for the current year, this date can loom large on the calendar.

Fortunately, you can take steps to make these tax payments go smoothly. A good tax accountant can prepare your quarterly forms to send with estimated tax payments. Additionally, he or she can help complete tax returns on time so your estimated tax forms are ready when the first payment is due.

To estimate your tax for this year, your accountant can use the prior year as a guideline. In fact, the IRS permits you to avoid an underpayment penalty by paying estimated tax payments the current year that are equivalent to your tax from the prior year.

A byproduct of this “safe harbor” method is that you might eventually owe more tax (without penalty) if profit is higher in the current year than it was in the previous year.

To avoid this additional payment in Q1, your accountant can use an alternative process of estimating this year’s tax by projecting current-year profit. This makes accurate current-year records essential, so an optimal forecast of this year’s profit can be made. This includes up-to-date tracking of business revenue and expenses. In other words, don’t wait to identify your profit for this year until the tax return is due next year. Remain in regular contact with your accountant in order to manage these numbers and avoid surprises at the end of Q1.