This is a stream of consciousness concerning the value of accounting for small businesses. I’m not an accountant, I’m a business guy trying to understand how to put a value on what I should spend for accounting. I am concerned with the adage that a man who represents himself in court has a fool for a client. Should I do my own accounting?

Aside from the obvious need to file taxes, it is stated that accounting provides four essential services to a small business. First, it records revenue obtained through the sale of products and services. Second, it provides an accurate record of the expenses associated with the sale of those products and services. Third, it keeps a record of monies owed in relationship to those expenses and finally it is a record of what the company owns.

This is very succinct. So what? Running a company is about cash. Knowing your profitability is important in the long term. However, staying in business in the short term is about cash management. Cash based accounting helps the owner understand their cash position more clearly in the short term, but makes it difficult to determine if the company will be profitable in the long term. There are four types of taxpayers that cannot use cash based accounting; Corporations over $5M, C Corp Partnerships, tax shelters and taxpayers with revenues over $1M requiring inventory. (You might want to talk with your tax preparer about reporting inventory if you are using cash based accounting). Accrual accounting is great for accessing the financial health of an organization over time, but tells you almost nothing about your cash position on a real time basis. Mid-size to large organization use accrual accounting with cash projection reporting. That is they run a separate set of books that keeps track of cash sources and cash uses.

Therefore, it would seem the best approach would appear to be accrual based accounting with a cash projection worksheet. Sounds like double work. I don’t have the time to do this myself. The way I save time is using summary data as opposed to detailed data. The problem with summary data is that it tells me almost nothing about how to run my business better. If I hire someone to do this thing for me, how does the effort pay for itself? I’m a guy that believes you don’t invest in a business expense that won’t pay itself back with profit. So how much net profit will I generate by having a bookkeeper or accountant? That’s a tough one….

Well for one thing, I know inventory consumes cash. Increasing the velocity of my inventory (that is the inventory turnover rate) will help me hold on to my cash longer. In my business, it won’t earn me much interest, but it may help avoid a late penalty on a payment due. Having a detailed analysis of how much I buy verses how much I sell, by item, will help me conserve cash. It might also help me identify waste, spillage or theft.

Knowing the profit margin on each product I sell could help me set pricing better. The market is going to drive many of my prices, so I might end up discontinuing products I can’t make money on. This could help me pay for help.

If my accounting could tell me how much profit-per-employee I make it might help me manage my labor cost more closely. I might also be able to assess how much I really spend on marketing if I can include all the ancillary expenses like meals and give-a-ways. Knowing how much I spend will help me understand its value better. All I really have to do is find a one per cent reduction in expenses or a two percent increase in revenues. With the right help it might be there…. There might even be more…. However, I’m going to have to find someone who understands both my business and how I manage my business… they need to understand both accrual based accounting and cash projections to really be useful….. what I don’t need is another employee to manage….

I read an interesting article this week written by John Nessel. John Nessel is the President of Restaurant Resource Group, a Boston-based consultancy providing financial tools and support services to independent restaurants and the hospitality industry. John’s number one red flag to restaurants failure is “Absence of a well organized and implemented accounting system.” He goes on to say “Printed copies of basic financial statements (Profit & Loss and Balance Sheet) are not adequate for this task because they do not verify the accuracy of the numbers presented.”

Luis Luarca of Allectus, a business management advisory, says “As proper and accurate accounting is the life blood of business, accurate and relevant accounting procedures allow for the opportunity to affect all aspects of business efficiently and effectively.” They both agree on some simple yet extremely important indicators of a poorly run business.

1. An overall lack of understanding concerning financial statements and their importance in business decision making

Understanding the technical definitions of items portrayed in financial statements is a long way from understanding what it really means and how an understanding of the meaning can be used to help run the business for efficiently and more profitably. The structure of the financial statements can mask potential risk and hide growing concerns. Not knowing what do don’t know can hurt you.

2. Over reliance on online bank balances to manage cash flow

The statement or online bank balance doesn’t tell the real story. It doesn’t tell what deposits haven’t cleared, what checks have not been cashed or what credit card transactions are not reconciled. More importantly it does not provide a vision into future cash needs. It is a point-in-time view of the health of cash. It can be dramatically different within minutes as transactions clear.

3. Inaccurate posting of financial information

This can run from simple transposition errors, to the more complex allocation error. One of the most overlooked concerns for small businesses is that the chart of accounts does not reflect the way the owner operates their business. A badly thought out chart of accounts can actually hide business problems until they are too late. Because of this, the allocation of expenses may not accurately show their impact on the business.

4. Daily and Weekly financial information is not routinely collected, reviewed and acted upon.

Many business owners are too preoccupied with data input to take the time to routinely apply a logic test to the financial information. Expand the effort to daily or weekly information gathering and little time is left to run the business. Owners should spend the majority to their time reviewing financial information for trends and taking action on those trends to improve the business performance. Instead many spend their time with the low level activity of capturing data.

5. The absence of a well organized and implemented accounting system that includes business specific Chart of Accounting, key performance tracking and repeatable procedures.

This seems to be the last thing any small business owners wants to take on. There are a lot of reasons for this. Tactical operational issues take precedence. There is a lack of understand as to the quantifiable benefits. There is a lack of interest or aptitude. All of these are the very reasons that a small business owner should look outside of their own expertise and time. This is a primary skill, much like tax accounting, that should be outsourced.

These trying economic times have brought to the surface ongoing operational issues that were previously covered by a better economy. Although poor profitability might have still been a problem, cash flow allowed these problems to go unaddressed. Many companies managed this through short term borrowing or lines-of-credit. Once credit was constrained and cash flow became an issue, operational inefficiencies came to light.

A lack of attention to good operational accounting may have masked many of these issues until they became a crisis. Crisis management is never a good answer. For some companies it became the only viable answer. The owner must take back control. To accomplish this there must be an in-depth review of how they currently account for financial activity and what that tells them or doesn’t tell them about the health of their business. This many times requires a third party that can objectively assess the environment exclusive of day-to-day operational bias and business ownership pride.

The Georgia Society for Worker’s Compensation has chosen eProcess Pros to meet all of their outsourced accounting needs. eProcess Pros will provide all of the service previously provided by their internal accounting department. This included transactional accounting, financial reporting and annual financial planning.

Georgia Society for Worker’s Compensation is a society comprised of some of the finest business entities in the state of Georgia. Their focus is on improving working conditions for Georgia’s employees, while reducing overall expenditures in worker’s compensation for Georgia business owners.

Membership to Georgia Society for Worker’s Compensation gives you access to a team of professionals:
• Dedicated Risk Manager
• Dedicated Claims Management Specialist
• Nurse Case Managers
• Dedicated Human Resource Consultants

National Tax Break is a nationwide company that helps business owners and human resource executives implement an easy-to-manage system for taking advantage of employer tax credits designed to offset labor costs. They identify options to improve your company’s financial performance and lower its effective tax rate, and deliver unprecedented results through the expertise of their staff and their focus in the industry. Their team members research each piece of legislation to understand the qualifications and loopholes in depth.

They will work with businesses to:

• Identify their tax credit opportunities (both current and overlooked)
• Calculate their credits
• Automate the data gathering process
• Submit paperwork for certification
• Track certification status

Ensure every tax credit is claimed

The team at Land of a Thousand Hills (LOTH) is passionate about excellence in coffee, creating community, and promoting justice. They are also dedicated to serving their customers and Rwandan coffee growers. Jonathan grew a coffee company from a mission trip to Rwanda.

The beans in a bag of Land of a Thousand Hills Coffee™ travel more than 8,000 miles just to make it into your cup. Each one is handpicked on a Rwandan farm, travels down a bumpy dirt road to the coffee washing station, and is sorted five times before voyaging across the whitecaps of the Atlantic Ocean to their Roasting House. When they arrive in Roswell, Georgia, the beans are roasted in small batches by an Artisan Roaster for what will undoubtedly be one of the best cups of coffee you ever taste.

Passion for the best cup of coffee you ever taste lead to 40% annualized growth during a recession… and cash flow problems. LOTH turned to eProcess Pros to help them understand the movement of cash throughout their business, put a plan in place for managing that cash and supporting that plan with repeatable processes that can be monitored and adjusted. We are extremely proud to have them as a client. They produce an extremely good product with dedicated individuals who serve not only their local community, but the extended community in Rwanda.

P&L – Profit and Loss Statement
Your Profit and Loss Statement (or income statement) describes your company’s overall performance. The P&L tells how much money you’re making in your business and how you’re making it. It measures revenues received and costs incurred over a certain period of time. It tells you if you’re making money or not, and how much you’re making or losing.

Go over each line item, and compare it with the previous month’s P&L. If you don’t understand what a line item represents, find out. The numbers should make sense to YOU, not to your accountant. And if you haven’t already, organize the line items so that similar items are closer together. The default setting in most financial software usually lists the expenses alphabetically. For example, it makes sense to see “Product Packaging Materials” next to “Merchandise Purchased for Resale.” Feel free to combine line items to make your P&L more concise, and/or break apart line items to show you more details so you can make some sound business decisions based on what the numbers are telling you.

COGS – Cost of Goods Sold
Also referred to as the “cost of sales,” COGS are the direct costs attributable to the production of goods sold. This includes material cost and production (labor) costs but does not include indirect cost like advertising or R&D. COGS will show up on your P&L Statements. Watch the percentages, not the actual dollar amounts from one month to the next. The percentage should stay pretty much the same with regards to revenues.

EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization
This is the most complicated of the acronyms we’re discussing today, but essentially EBITDA measures the core income that your company earns before your cover your debt payments and income taxes. It’s an indicator of operating performance and profitability, but it’s not a good measure of cash because it doesn’t include changes in working capital.

EBITDA is a good way to measure your profitability, but be forewarned: even businesses with a great EBITDA can go out of business due to cash flow. EBITDA leaves out the cash needed to fund working capital and the replacement of old equipment. Profits are great, but if you have no cash, your business will “bleed out” pretty quickly.

BEP – Break-Even Point
This is one of those numbers you want to know by heart and just like it says, this important indicator tells you at what point your business “breaks even.” It is the dollar amount of revenues that exactly covers all your operating expenses (variable and fixed costs), with nothing left over for profit. It’s an important indicator of risk because it shows you how close your business is to the “no profit” line. For instance, if your business is currently producing revenues at the level of $100,000 per month, and your break-even point is $60,000 per month, you are comfortably above your no profit line. You want your BEP swimming in your head at all times. It’s your minimum target for slow months, and it’s where emergency on your hands.

CR and QR: Current Ratio and Quick Ratio
Current Ratio = [Current Assets ÷ Current Liabilities]
The current ratio measures your ability to meet short-term obligations by determining if you have enough current assets to cover current liabilities. Ideally, your current ratio should be near 2.00, meaning your current assets are two times, or 200%, of your current liabilities. If your current ratio is below 2.00, your short-term debt-paying ability is reduced. This is an unstable financial position, and you should examine your finances to see where improvements can be made. If your current ratio is above 2.00, you have above average debt-paying ability; however, if it is too high, it may mean that you are not utilizing your assets effectively. If it’s below a 1, then you’ve got an emergency on your hands.

Quick Ratio = [(Current Assets - Inventory) ÷ Current Liabilities]
Like the current ratio, the quick ratio measures short-term debt-paying ability. It is calculated without inventory because inventory is not as easy to turn into cash as your other current assets. Thus, the quick ratio examines assets that can be turned into cash in the least amount of time. Businesses that carry a lot of inventory need this important planning tool. Ideally, your quick ratio should be at 1.00 or higher. If it is lower than 1.00, you may have trouble meeting your current obligations. Below 0.5 is an emergency. Note that if you don’t carry inventory, your current ratio and quick ratio will be the same.

This doesn’t have to be  complicated, or difficult
You don’t have to be a finance expert; you just have to understand enough to make the decisions that matter. You begin all of your budgeting and forecasting. At a minimum, your revenues (sales) should be at least as high as your BEP. The goal, of course, is to increase this number over time so that revenues (sales) are above the BEP.

Deferred Revenue is revenue that is considered a liability until it becomes relevant to the business at hand. There are many forms of deferred revenue: gift certificates, software license, prepaid professional services and possibly some retainers when the service delivery schedule is not pre-determined.

Cash is an asset.  Period.  It is never a liability; never an expense; never anything but an asset.  Cash is a current asset, and serves to increase the net worth of whoever is in possession of the cash. Deferred revenue provides cash, but it also establishes a liability because it represents a future event. All deferred revenue will become revenue at some point. You will have to pay sales tax, income tax and possibly royalties eventually.

If your deferred revenue has an expiration date, it becomes revenue on that date. If your deferred revenue does not have an expiration date you will need to develop a procedure for expiring unused services.  Anything sold but not redeemed must become revenue at some point. The IRS will not allow you to carry deferred revenue on the book indefinitely. If you don’t have a procedure to recognize this unused revenue they will give you one. Their procedure will accelerate revenue recognition faster than you may want.

How can a business owner use deferred revenue to help their business? It comes down to cash management. During slow periods cash becomes a problem. Selling products or services in a slow period that will be redeemed at a later date is a way of evening out your cash flow. You might have to provide an additional incentive to buy now and collect later, but the discount might be worth the value to you of accelerating cash flow.

In these hard economic times, when banks are not as forthcoming as they have been, it might be wise to find a way to “float a loan” from your customers. Careful accounting is important. You don’t want to sell what you can’t deliver. Understanding the future consideration of your deferred revenue is critical to long term success. Using gift certificates or pre-paid services might be a way of getting over that financial hump in the middle of your down cycle.

Three Firehouse Subs® locations, founded by firemen and renowned for hearty, oversized portions and piping hot subs, are now looking to eProcess Pros for all of their transactional accounting and financial reporting. eProcess Pros completes daily sales posting, three way invoice matching for accounts payable processing, cash reconciliation and monthly reporting.

Chief financial officers (CFOs) should implement finance and accounting business process outsourcing (BPO) to allow them to spend more time on strategic activities, according to Gartner Consulting, a unit of Gartner, Inc.

Gartner Consulting recommends that CFOs consider delegating transactional tasks to a third party whose core business is finance and accounting BPO.

“Outsourcing some of the finance and accounting processes that are focused on tasks such as accounts payables, expense management, and payroll, frees up the CFO’s time,” said Michael Montonen, vice president for Gartner Consulting’s Strategic Sourcing Practice. “The CFO can then focus more on activities such as planning, activity-based costing, process metrics and decision support at the CEO and business unit leadership levels.” [...]