There is a lot of money to be made selling online. But understanding your company’s profitability is critical to making the right decisions. Confusion over cash-versus-accrual reporting creates continuing questions for business owners. Using the wrong approach can obscure the results with disastrous consequences.
The business’ part-time CFO was providing financials that didn’t match the reports they received from their accountant. Plus, internal statements showed wild swings in profitability, which meant that until year-end, the owners were never able to truly understand whether they were making money or not.
The company had very limited cash, large AP balances, and was increasingly relying on their limited credit availability with vendors to purchase products. Since the owners weren’t drawing large salaries, and sales were increasing, questions arose as to the actual use of cash and the company’s profitability.
The company’s financial results varied wildly from month to month. Some months had huge profits, which alternated with other months containing huge losses. It was only at the end of the year that they felt that they had any idea as to the actual profit results of the company.
As with many internet retailers, the company had its share of returns. Their channels took credit on their payments for items that they returned to the company. But although these returns showed up on the income statement, there was only a minimum amount of returned stock in the warehouse. In addition, there was little promotion of the returned items for resale.
The company used home-grown software to automatically set item prices. The markets move quickly, and the software automatically changed prices online to keep the company’s sales among the low-priced leaders. Sales volume was high, so sales and cost transactions were posted in aggregate, rather than individually. Therefore, it was difficult to identify the true margin of any individual sale.
The first red flag that gets raised when a business gets into trouble is a cash shortage. If it’s not a significant change in business that’s causing the shortage, then the ultimate culprit is profitability. Ironically, many businesses look at cash basis financial reports because their accountant has recommended that they use a cash basis for tax reporting. But even though that might be a good decision for taxes, there is no reason to use a cash basis to determine your company’s operating profit on a monthly basis.
Revenue and expenses for each transaction need to be aligned so that they fall into the same period—otherwise, there is no understanding of profitability. In addition, it’s not just the accounting method that is responsible, it’s the timeliness of the entry of AP and AR activity that assures the accuracy of financial reporting. Without the right information, it’s impossible for business owners to know what they should do when questions arise. It’s vital to make sure that the information is timely, accurate, and financially significant.
Our people are unique CFOs. They are all operationally
based financial executives.
Created Custom For Your Company By an Experienced CFO