Monday, November 25, 2013

How much do you know about accounting? Part III

We have discussed the Balance Sheet and the Profit & Loss Statement so today we will address the Statement of Cash Flows.  This financial statement is the most complete because it encompasses everything that happens in a business.  The Balance Sheet deals with assets and liabilities and only gives the net profit activity.  The Profit & Loss Statement only deals with revenue and expenses and ignores all activities involving assets and liabilities.  The Statement of Cash Flows details exactly how money came into a business and how it left, whether this was by earning it, collecting it, borrowing it or spending it.

The Statement of Cash Flows starts with your net profit or loss for the period you are examining and then adjusts for any expenses which were not truly cash expenses such as depreciation.  It then goes on to look at other ways the business spends money or bring money in.  If you borrowed money from the bank, that improves your cash flow as you now have brought cash into the business which can be used to buy equipment, buy inventory or pay for expenses.  If you use a credit card or get terms from a supplier, the same thing happens: you get products or services for your business which you didn’t have to pay cash for.  So as far as cash flow is concerned, increasing your debt is a good thing.  There is one exception: loan payments are a reduction of cash flow. 

The next thing the Statement of Cash Flow considers is the other ways money leaves the business besides normal operating expenses.  If you are a sole proprietor or an LLC, your owner or member draws are a use of cash.  Draws don’t show up on the Profit & Loss so business owners sometimes wonder why they made a profit but have no money in the bank?  The answer is Cash Flow.  Other ways money leaves a business besides loan payments and owner draws: Increasing your inventory levels, purchasing fixed assets or paying down your credit cards or loan balances.


Understanding cash flow is very important to running a successful small business.  There have been many cases where a business is successful as far as generating sales, but fails because it doesn’t generate enough cash flow to keep going.  

Monday, November 11, 2013

How much do you know about accounting? Part II

Last week we talked about increasing your knowledge of accounting and focused on the Balance Sheet. This week we will focus on the Profit & Loss Statement (P&L) also known as the Income Statement.

The P&L provides all the information about what you earned (sales or revenue) and what you expended for whatever period of time you are interested in.  Our QuickBooks program can show us a P&L for a day, a week, a month, a quarter, a year or even longer.  You can also get this same information with the same time period from the previous year along side it for comparison.

A typical P&L starts out with the Sales or Revenue.  The amount of detail provided depends on how you have set up your books.  When we are setting up accounting programs for clients, one of the first things we ask is "What kind of information are you looking for from your books?  How much detail do you want/need?".  Some people want different categories for their sales and others are content with one number.  We track revenue by the different types of services we provide so we can see what is generating the largest amount of money for us.

If you are a manufacturer or a business with inventory, the next section of the P&L will deal with Cost of Goods Sold (COGS).  COGS is exactly what it sounds like: the cost of making or buying the goods you then sell.  The amount of detail here will also depend on what type of business you have (do you have labor as well as materials needed to produce the goods) and how your books are set up.  It is nice to see percentages along side the dollars at this point of the P&L.  Dollars alone won't give you the whole picture as your COGS may have increased in dollars, but only because you have made more because you are selling more.  The percentages would show you that the COGS increased in dollars, but remained the same % which would mean that you did make more because your sales are increasing.

The next sections of the P&L deals with all the other expenses which occur when you run a business.  The detail here is also dependent on the set up of the books.  Do you want  to know how much you spent on credit card processing fees and bank service charges or are you comfortable lumping them together?  Do you want to see what you spent on repairs for equipment vs. repairs to your facilities or is one number for repairs and maintenance enough detail for you?

The end of the P&L is what most people are interested in: is there a net profit or loss?  If your expenses are larger than your revenue, there will be a loss.  Sometimes you will have a loss for a specific period of time (typical for seasonal businesses) which isn't alarming as long as the business generates a profit for the whole year.  A company can survive a loss, the economic downturn of a few years ago proved that.  Having sufficient cash flow makes that much easier which we will address next week.

Monday, November 4, 2013

How much do you know about accounting?

We love to increase our clients' accounting knowledge.  Even though they won't ever become experts, it helps to have them have a basic understanding of accounting concepts.  This basic understanding helps them to manage their business better, even when they are utilizing our services.

We usually start with the financial statements.  We will walk our clients through their financials every month, explaining what we see and what improvements can be made.  I will walk you through the Balance Sheet this week and we will tackle the Profit & Loss next week and the Statement of Cash Flows the week after that.

The Balance Sheet shows a business owner what they own, what they owe and what the difference between the two is.  What they own is their assets, what they owe are the liabilities and the difference between the assets and the liabilities is the equity in the business.

Assets are listed by liquidity from most liquid (current assets) to least liquid (fixed assets).  Liquidity refers to how easy it is to convert the item to cash.  Obviously cash, checking or other bank accounts are the most liquid because they are cash!  Next comes accounts receivable and they just need to be collected to become cash.  Then we have inventory which must be sold first which converts it to a receivable which then needs to be collected. There are other types of current assets such as prepaid expenses (if you pay for a whole year of insurance coverage in one payment, you can have one month's worth be insurance expense and the remaining 11 month's worth will be prepaid insurance - an assets.  Each month you will expense a portion until it is all gone and it is time to pay the next year's premium).

Fixed assets are the least liquid and are the things that you buy and expect to use for over a year.  This includes computer and other equipment, vehicles, furniture, and real estate.

The next category on a Balance sheet is the liabilities which details all the debt the business has.  This is also listed by liquidity and starts with current liabilities.  Current liabilities include credit card charges, accounts payable (people who you owe money for goods or services provided which you didn't pay for at the time the service was provided or when the goods exchanged hands), payroll items (wages and taxes), the loan payments due in the next year, the balance on a line of credit, deposits or down payments you have received from customers or clients, and sales taxes are the most common types of current liabilities.  If the payment has to be made within the next year, it is a current liability. Long term liabilities are the portion of loans which will not be paid in the next year.

Equity varies depending on the legal structure of the business.  For LLC's it is usually Member equity (the amount of money the owner has put into the business to start it and any additional funds they provided over the life of the business) and Member draws (the money the owner has taken out of the business).  For corporations (S or C) there will be a more complex equity structure which includes Retained Earnings, the current year's net income and often stock of some sort.

Ideally, the assets of a business will be larger than the debt so the business will have positive equity.  The balance in a Balance Sheet comes from the equation Assets=Liabilities + Equity.  This is best explained by realizing that assets must be paid for so how were they paid for?  If you didn't pay cash for them, then you incurred debt so as your assets increase, usually so will the debt. All the other nuances in the equation as to numerous to detail in one blog article Balance Sheets must always balance!  Modern accounting software programs have taken some of the difficulty out of this process as QuickBooks and Sage and other programs are written so that your Balance Sheet will always balance even if it doesn't always look good!