Financial statements tell you how your company is doing – accurate financials give you the full picture of your business. Are sales up? How about gross margins? What is the biggest expense category? Are there any numbers that jump out as unusual? And, the ultimate question, how much money did we make last month? Sometimes these reports are delivered quickly, sometimes business owners wait for months to get them. The gold standard is less than 10 business days. So, if you’re one of the many CEOs that is waiting 6 weeks or more than 2 months, there’s something that needs to be fixed.
But no matter when you get your financial reports, it’s important that they be right. They need to tell you how the company is operating. In short, your financial statements should provide you with two things:
Reporting is very personal. Once you get beyond the rules of the IRS, the FASB and GAAP (a lot of initials, right?) there are still a LOT of decisions that you can make – that someone NEEDS to make, that will shape how your financial reports are created. These decisions determine how your reports are structured, and whether the reports will provide you with information that will allow you to drive your business forward, or if they will give you numbers that give you misleading information that will either confuse you, or prompt you to make decisions that don’t give you the results you’re looking for.
So many small business owners file their taxes on a cash basis, and as a result, they think that they should be doing their day-to-day accounting on a cash basis as well. But looking at operating reports on a cash basis gives you a skewed view of your business. It’s totally based not on how your business is operating, but how money is flowing through your bank. Just think about it this way. The invoice that you sent out doesn’t get paid at the same time that the payroll and AP invoices you receive get paid. You need your expenses and income to post to your financials at the same time. If it happens weeks apart, it will obscure whether you are profitable, or operating at a loss.
Your accountant calculates your depreciation annually, and you post that to your financials annually. But that might be a really big number for your company. There’s nothing magical about it happening at the end of the year. You should break that up into 12 installments, and post it every month, to level out those costs.
You write out big checks for insurance payments or other ongoing big expenses. Those should be posted to a Prepaid Expense account. Then you expense them, use up the prepayment on a monthly basis, just as you move through the calendar year. Not only is that correct accounting, but it keeps you from having an unusually high expense the month that you pay the bill. The result being an unusually low profit.
If you have invoices that haven’t been paid, and you don’t really expect to get paid for them, then write it off. You may hope that you’re going to collect some or all of the invoice down the road, but if it’s over 120 days old, collecting it is unlikely. You can still leave it on your AR aging, but then you should also create a Reserve for Doubtful Accounts. This will be a liability on your balance sheet that will offset the amount you might not collect, and keep the value of your company accurate.
There are going to be two months during the year that are going to have three payrolls in them. If you post your payroll based on when you run the payroll, then those months will have an unusually large payroll expense. If you accrue for the number of days worked, then the variance between one month and the next is going to be a few days, not several weeks of pay.
Many companies receive deposits for work to be done. Unfortunately, some companies list those deposits as revenue. They aren’t revenue until the work is done. If you invoice your clients for work in advance, billing them quarterly for the next three months, that’s only going to become revenue one month at a time, not all three months at the time the invoice is issued. This will smooth out your revenue.
You haven’t been able to sell it. You paid too much for it two or three years ago. It’s just sitting gathering dust. Get rid of it. You’re carrying it on the books as an active asset. It’s not. Either sell it for whatever you can get, or take a reserve against it – Reserve for Obsolete Inventory. At least then you are accurately tracking the inventory that you can sell.
Do your manufacturing costs include freight, a percentage of overhead, insurance, actual setup times, cartons and staff time? If you don’t accurately include all of the expenses involved, then you are likely to price your products or quote your projects incorrectly, costing you money. Without a firm handle on all of your expenses, you could potentially be selling product or services at a loss, and not even know it.
These are some practical things that any business owner can do to help smooth out the financial reports that they get. The more stable the reports are, the better you’re going to be able to manage by exception. By removing the variances that are in your reports, you end up seeing the exceptions to your day-to-day operations. You also see the real answers to how your business runs, and are able to make decisions today that affect profitability tomorrow.
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