Often times entrepreneurs are not very attentive or interested in keeping the books. They may have a special talent that makes them a great inventor, technician or salesperson, but they view paperwork and bookkeeping as drudgery. However, to remain in business there are certain basic bookkeeping standards that must be followed. These standards are necessary not only for determining taxable income, but also to monitor the financial and operating health of the business.
For any business, well organized bookkeeping records are a necessity in order to prepare the financial statements which represent the score sheet of the business success. Financial statements are also vital in providing owners with clues that may show where the business is faltering in time to head off a potential financial disaster. Financial statements that document the results of your operations will also be required by many outside decision makers such as banks, creditors, and investors.
The importance of well-organized accounting records should never be underestimated. In fact, one of the leading mistakes made by small businesses owners is improper or misguided business decisions based on inadequate information from poor financial records. A bookkeeping system does not necessarily need to be complicated in order to be effective. It is better to have a well-organized basic system than to have one that overwhelms you with complexity to the point where it is not used effectively. The wrong system can be almost as bad as no system. Rather, you need to strike a balance between one that is sophisticated enough to provide the information you need to run your business yet simple enough for you to operate. Your bookkeeping system must also be able to provide the information required of governmental taxing and regulatory agencies in the specified format. Your CPA can be an invaluable resource in helping you design the proper bookkeeping system for your business.
Developing a chart of accounts for your business
Your chart of accounts provides the basic financial reporting foundation for your business. As such, it needs to be designed with a great deal of consideration for your present needs as well as for future growth of your business. This means the numbering and organizational structure of your chart of accounts needs to be dynamic in order to evolve with the changes in your business over time.
The complexity of your chart of accounts will vary depending on the type of business you operate. Among the considerations will be:
- Whether your business uses cash, accrual, percentage of completion or some of basis of accounting
- The extent of your inventory and whether you use a perpetual or physical inventory system.
- The extent of capital assets used in your business.
- Whether you need to track accounts receivable and accounts payable
- Whether you will be selling different types of products or services and need to report revenues and expenses by profit centers.
- Whether your business will operate in multiple locations.
- Will your business have payroll.
Each of these considerations (and many others) will influence how your chart of accounts should be developed. Again, a CPA such as myself can help you to design the ideal chart of accounts and related subsidiary records best suited for your business.
Accounting methods: cash vs. accrual
By the time you are ready to enter your first business transactions you will need to make a decision whether to use the cash or accrual method of accounting. The advantage of cash basis accounting is its simplicity for small businesses. Under this method, you record sales when you receive payment and record expenses when you write the checks. However, simplicity is not always better. Cash basis accounting also has significant disadvantages as well. Among them is the fact that net profit recognition can be extremely erratic due to the payment patterns of your customers and the timing of when you pay your expenses. Consequently, financial statements prepared using the cash basis of accounting can be distorted and misleading.
Most users of financial information, including investors and bankers, want to see results reported using the accrual basis of accounting. Under this method, revenue is recognize when earned, not when collected, and expenses are recognize when incurred, not when paid. This allows for matching of revenues against related expenses and provides a more accurate representation of operational results. It should be noted that if inventory is a material asset, your business is required to use the accrual basis of accounting.
Who should maintain the accounting records?
Basically, there are two broad choices here. You may wish to process your accounting internally by hiring a bookkeeper or doing it yourself. Your CPA can then focus of providing the higher accounting, tax and consulting related services. Doing the accounting in-house, however, does require a significant commitment to detail, skill and time involvement.
A second option is to outsource the complete bookkeeping function. Many small businesses find this to be the option of choice simply because they can get accurate financial record-keeping at an affordable cost without having to buy expensive software or hire an internal bookkeeper and incur the related salary, benefits and training costs. For example, our firm provides a complete outsourcing service whereby we set up the company s records on our computer system and generate laser printed checks, invoices, statements, financial reports, etc. all customized to the specific needs of the business. This approach still provides the business owner with complete control over check signing and decision making without getting bogged down in paperwork.
Using accounting software
There is little debate that next to the creation of double entry accounting, the invention of the computer and related accounting software has revolutionized the way businesses are able to record, process, organize and report financial information. In fact, if any of the following are characteristics of your business, you will most assuredly be able to benefit from a computerized accounting system over a manual based system:
- You process numerous checks and invoices each month.
- Many tasks are repetitious throughout the month.
- You process your own payroll.
- You have extensive inventory and desire perpetual reporting.
- You need to maintain detail transactions for numerous customers and vendors.
- Your reporting needs are complex.
The most important aspect of computerizing your accounting function is selecting the right software package for your business followed by the proper setup and implementation of that package. No accounting software regardless of how expensive or sophisticated it is will solve the problem of poor accounting procedures. The software will simply allow your to generate inaccurate results faster.
This is where the knowledge of an accounting professional can provide invaluable insight. Be wary of software sales people who do not have experience in complex accounting and tax reporting issues let alone knowledge of your business or the industry in which you operate. Invest the time up front to assess the accounting needs of your organization as well as the skills necessary to effectively use the proposed system.
The above discussion is intended to be only an overview of these topics. If you wish to set up a meeting with us to address your specific situation, or even just have general questions, feel free to contact me.