The Importance of Accounting for Small Businesses 1
Bookkeeping is necessary in any business. As a small business owner, it’s important to recognize that the best practices used by big or conglomerate (Fortune 500) companies also apply to you. Following basic accounting principles is essential for success in any size business; savvy record-keeping and financial analysis is key to not only monitoring your expenses, but to discovering new avenues of growth. In addition, it ensures you stay responsible for tax obligations to the government and to your employees.
Accounting entails more than just managing credits and debits, and it comes into play more often in everyday business decisions than you may realize. A few examples include:
- Closely monitoring your accounts receivable to illustrate trends or behaviors in your customer base. It can also cut down on the costs you incur by pursuing late payers.
- Establishing a detailed budget to help discover inefficiencies within your operations.
- Sudden changes in vendor costs or sales revenues can alert you to important industry changes.
- Understanding your financial position in order to spot problem areas that could interfere with loans earmarked for expansion.
As you consider your accounting strategy, review your company’s financial goals. Whether you are a solo entrepreneur or you employ a staff, your survival hinges on clearly stated financial objectives. You may be in business to reap as much profit as you can, or you may be interested in sharing a product or service that you believe in. Either way, experts agree that one of the most common reasons small business fail is because cash flow runs dry. To prevent this disaster, your business should implement policies for efficient record-keeping and a sound financial strategy.
Taxes are unavoidable. Depending where you operate and the nature of your business, tax authorities (the IRS) has very specific requirements about the documentation you’re required to file. Submitting improper or inaccurate documentation can get you into trouble, and it can be extremely costly in terms of fees and penalties. Preparing the required tax documentation has its benefits though, and it can give you vital information about the health of your business. Monthly or quarterly financial statements, cash flow statements, and asset and income statements can provide a clearer picture of your business than your bank balance. Understanding tax authorities (IRS) requirements and how you can make them work for you can give you a deeper understanding of your company’s financial health.
What information should I be tracking?
If you haven’t had formal training in accounting or are more interested in other aspects of your business, keeping meticulous records of financial data can be a chore. Furthermore, understanding precisely what information you should be tracking can be overwhelming and confusing. Most small businesses should track the following categories of data:
1. Cash Receipts and Disbursements:
Records of all cash coming into and going out of your business, sorted into applicable cash streams
Tracking different cash streams can highlight trends that will develop accurate cash flow projections. Regularly monitoring these streams can alert you to shortages before they happen, allowing you to make tweaks to prevent them. E.g. Customer sales and payments, Vendor purchases and payments, Petty cash on hand, Payroll, Monthly bills, Daily cash reconciliation, Monthly bank reconciliation.
2. Accounts Payable:
Any short-term debt, excluding payroll, that your business is expected to pay. Generally due in 30-60 days; does not carry interest fees.
An accurate accounts payable process leads to accurate financial statements, a key component of any business. A dependable system creates good relationships with suppliers and a good credit rating. Paying debts on time also reduces costs from penalties and late fees. E.g. Utility bills, Advertising and marketing, Travel, Office supplies, Entertainment, Vendor invoicing.
3. Loans Payable:
Any long-term debt that carries a written promise to repay. Generally, carries interest fees.
Outstanding loans are liabilities against your company’s overall health. They also carry costs in interest charges. E.g. Mortgage or vehicle payments, Equity credit line, Vendor credit.
The goods your company buys, usually tracked over the course of a year.
Information about specific purchases can highlight important details like discounts for early payment, shipping costs or insurance liability. Merchandise purchases must also be accurately reflected in inventory. E.g. Merchandise for resale or development, Technology expenses, Office supplies, Training materials.
Merchandise purchased by your company to be resold to customers. Inventory is an existing asset that has an associated cost; this cost reflects your company’s cost to produce or purchase it.
Tracking inventory is crucial to projecting net income, cash flow, taxable income and working capital. E.g. Goods for sale, Products that are combined to produce goods for sale.
6. Accounts Receivable:
Income you expect to receive from your customers.
Knowing which customers owe you money and when payments are due prevents you from giving away free product and helps you anticipate projected cash flow. Accounts receivable are a key part of a company’s assets, and correctly tracking this impacts your company’s worth and profitability. It also serves as proof of income to the tax authorities (IRS). E.g. Invoicing, Credit advances to clients.
Sales of merchandise to a customer, reported in the same time period that the goods or services were transferred to the customer.
In addition to providing accounts receivables information, tracking sales can help you measure the success of your marketing efforts. Analysis of sales data can also illustrate industry trends, help you evaluate the success of a new product or inform future product development. E.g. Gross sales, Net sales, Sales discounts, Sales allowances.
8. Owner’s Equity Capital Drawing:
Withdrawals of cash or other assets for the owner’s personal use, recorded as a debit to cash and a credit to owner’s equity.
Applicable to businesses that are taxed as sole proprietorship or partnerships, this is particularly useful for monitoring partners’ withdrawals of company assets. E.g. Cash, Merchandise, Stock shares.
9. Retained Earnings:
A company’s cumulative earnings since its beginning, minus any dividends paid to stockholders. This number is reflected in the owner’s equity.
An accurate accounting of this number can identify funds that can be used toward company growth, measure the company’s performance against its projected worth and demonstrate the company’s health to stockholders. E.g. Cash used to pay debts or reinvest in the business.
Are you tapping into the all the above benefits of accounting in your business? Please give your comments below. And for free consultation on your accounting challenges, click here