Understanding the basic rules of business bookkeeping is the key to sound financial management. A very high percentage of failures in small businesses are caused by poor cash flow management, which ultimately relates to the inability to manage your finances.
The most common accounting and bookkeeping struggles involve; using the wrong accounting method, combining personal and business finances, not performing basic account reconciliation, overlooking ‘petty cash’ reserves, not knowing the difference between profits and cash flow and finally relying too heavily on a paperless environment. Below are six tips which will help your business succeed.
1. Which Accounting Method?
Cash and Accrual are the two main accounting methods. But what is the difference between the two?
Cash accounting is the simpler method as it is based on cash flow in and out of a business. This method is used primarily by sole proprietors and businesses which do not have an inventory. Whereas, accrual accounting records your businesses income and expenses as they occur, whether or not cash has actually been exchanged.
It is recommended that most businesses use both methods. The accrual method will always give a more accurate picture of your results, whilst the cash method when used by small businesses will often result in a lower tax burden. As your business grows, you should switch to accrual accounting as this makes it easier to accurately compare revenue to expenses.
2. Is Your Money Personal or Business?
Personal and business are finances best kept separate at all times, regardless of the size of your business. To help keep your accounts separate, small business owners should open a business bank account and have all business income deposited into this account.
The next step is to devise an earnings management strategy dictating how cash is withdrawn from the business to reach investment, expenses and savings goals. Seeking an accountant to help you do this is advisable as their professional experience and knowledge can help assure you are using the right strategy for your business.
Your earnings management strategy will be fueled by factors involving how much of your profits need to be reinvested, the timing of payments, your cyclical or seasonal cash flow necessities, and your long-term financial strategy.
3. Have You Agreed Your Bank Balance?
Your most fundamental accounting duty would be to compare your business’s books with your business bank statement every month. Doing this monthly helps ensure that accounting errors are found and corrected before they result in financial problems.
Account reconciliation is relatively easy, all you have to do is compare your books with your bank statement and make sure there are no discrepancies.
Another area is making sure your debtors list agrees with the balance sheet. Accounting systems often show differences and these are usually caused by data entry errors. In MYOB this is done by printing a debtor’s reconciliation report.
4. Do not overlook ‘Petty Cash’ reserves
Usually businesses overlook ‘petty cash’, although it is just an informal system that can be used by employees to cover small business expenses such as postage stamps, snacks and office supplies, that doesn’t mean that petty cash shouldn’t be accounted properly.
It is easy to log the amount of money that is initially put into petty cash using a simple accounting system which requires workers to submit a petty cash slip each time they remove money. The slips should total the amount of money originally put in when the petty cash is exhausted, and new cash can be withdrawn to replenish the cash tin.
5. Know the Difference between Profits and Cash Flow
It is extremely important to be able to determine the difference between ‘profits’ and ‘cash flow’ as a business can have negative cash flow in the short term but still be profitable. It can also work the other way around.
The first scenario is common in small businesses as they often have to pay suppliers and may not have enough cash to do so before they receive pay from customers. The second scenario is usually seen in point-of-sale and cash-based businesses, for example retailers and restaurants which pay vendors on terms.
Once it is understood that profit and cash flow is not the same, you can start making a profit and cash flow projection. A profit projection is a useful tool which shows you how much profit you can expect to earn over a period of 12 months, allowing you to assess the viability of your business.
A cash flow projection will take into account the timing of receipts from customers and the delay in paying suppliers. It often produces a very different picture than the budget or profit projection.
6. Do not rely on a Paperless Environment
For reasons such as reducing expenses and saving the environment, many businesses today are trying to stop using paper. However, in bookkeeping and accounting there is no substitute for paper documentation.
There are many cases where businesses will require paper documentation of financial records. The Australian Tax Office audit is a great example as you wouldn’t want to fail to produce requested financial documents as a result of loosing files in your computer system, or because your system has crashed. Being environmentally conscious is great, however, bookkeeping shouldn’t be the area where you rid the use of paper.
Taking these bookkeeping tips into consideration will help your business greatly.
If you have any queries or if you are seeking assistance with bookkeeping then please contact the experts at Lockwood & Ward on 02 9299 7044.