Many small and medium business enterprises would rather focus on making and selling their products than on keeping their books and accounting records. However, bookkeeping and business accounting are just as important as marketing and doing business. Many a great business ideas have failed due to a poor bookkeeping system. And ultimately, a business will cease if money going out is more then money that is coming in.
Apart from business owners desire to stay in business, two other reasons why business accounting a a bookkeeping system is most important are :
- Legal requirement compliance.
- Bookkkeeping records are an excllent business management tool.
Good basic accounting system will provide useful information that will enable you to run your business proactively rather than reactively when it comes to important financial decision.
Many businesses will operate using checkbook and receipts. It’s more efficient to go with an automated system, and there are now many business accounting software packages for bookkeeping on the market. Most of the accounting software systems don’t require CPA to operate and intepret it. Most of the windows account software is very user friendly.
Most business use of of the two basic accounting methods in their accounting system : Cash basis and accrual basis. Cash basis is the simplest one between the two and is used for small business. Income is recorded when it is received, and expenses are reported when it is actually paid. From tax point it is sometimes advantageous for a new buiness to use cash basis accounting.
With accrual method, income and expenses are recorded as they occur, regardless of whether or not cash actually changed hands. Credit sales are excellent examples of this. How to decide which accounting system to use? The accrual method is usually needed if your company is structured as a private limited. Business with inventory must use this method. This is highly recommended for any business that sells on credit, as it more accurate, as it matches income and expenses during a given period. Whereas cash basis is more appropriate for a small, cash basis business or a small service company.
Accounting system has the following key components:
- Chart of accounts.
- General Ledger.
- Accounts receivable.
- Inventory.
- Fixed asset management.
- Accounts payable.
- Payroll.
Even if you hire an outside accountant for all your book-keeping and payroll management, we should understand the basic elements of accounting system.
Chart of Accounts. This is the first step in setting the accounting system for your business. This will decide which accounts you have to track for your business. Account numbers are used as an easy account identification system. In general two or three number systems will suffice for most of the business.
General Ledger. After chart of accounts, we need to establish the general ledger system, which is the engine that actually runs your business on a daily basis. Every account that is in your chart of accounts will be included in the general ledger and also in the same order as specified in the chart of accounts. General ledger does not include every single accounting entry for a given period, it reflects only the summary of the transactions made. Important component for any general ledger are source documents. Two example of source documents are copies of invoice to customers and invoices from suppliers. Source documents are very critical and very important for audit trail. Source documents are also important documents for the taxman at tax time. Other examples of source documents are cancelled checks, utility bills, payroll tax records and loan statements.
General ledger entries are doubel entries. For every financial transaction in your business money goes from one place to another. For example, when you write a payroll check money goes from payroll account onto employee account as an expense. When you sell an item from a business, you record a sales income but must have a journal entry for accounts receivable. The system used in recording entries on general ledger is of debits and credits. In general ledger debits allways go on the left and credits go on the right.
Accounts Receivable. If you plan to sell goods, or provide services on account in your business there should be a method of tracking who owes you how much and when it si due. If you are selling to different customers then the best way to track is through an automated system. thsi will ensure the billing and collections are done in a timely manner.
Fixed Assets. Fixed assets are items that are for the long term use of the company. Fixed assets include computers. vehicles, land, buildings and othe machinery. In the accrual system of accounting, fixed assets are not fully expensed out by the company. But, expensed over a period of time that coincides with the life of an item. Thsi process is called as depreciation of an item. Most business will keep a fixed assets sub ledger with the depreciation schedule.
Accounts Payable. Accounts Payable sub ledger is similar to the one that used to track accounts receivable. The difference is the account payable occurs when you purchase inventory or other assets on credit from a supplier. It is important to track the accounts payble in a timely manner. Many supplier relationship with your business may be damaged due to poor accounts payable system. Good automated tools will enable you to alert when to pay.
Payroll. Thsi is one of the most challenging subject for a new busines owner. There are many federal and state laws regualting what you have to track related to a payroll. Failure in doing so will result in heavy fines. Many business owners use outside payroll services to comply with the applicable laws. It saves a lot of time for the business owner to keep out of trouble with the law and saves time that can be devoted to something else in the business.
Cost Accounting. Cost accounting is a process of allocating the costs associated with generating a sale, both direct or indirect. Direct costs include material and labor. Indirect costs include all other costs associated with generating the product. By knowing the total costs associated for generating a product you can determine the items which are profitable to make.
Financial Statements. One of the primary benefits of a good book-keeping and accounting system is to generate timely useful financial statements. Most accounting software packages offer capability of producing balance sheet, income statement and cash flow statement.
Financial Statements :
- Enable you to assess the short term working capital
- Set Targets
- Analysis of improving the profit margins
- Efficient organization of sales and expenses
- Better tax planning
- Planning for employee benefits
- Manage proactively
- Helps in borrowing money from financial institutions
- Financial planning for investors
- Making the bsuiness more profitable
Income Statement : Income Statement measures the revenue souces against business expenses over a period of time. Major components in the income statement are :
Sales – This is the gross revenue generated from a sale. This is the main component generated from the income for your business.
Cost of goods sold – This is the direct cost associated in generating the sales. These costs include all kinds of resources which include direct labor, manager salaries and other operating costs.
Gross profit – It represents the amount of direct profit associated with the company.
Operating expenses – These are the general selling expenses, those are necessary to run the business.
Operating Profit – This is the amount of profit earned during the normal course of operations. It is computed by subtracting the operating expenses from the gross profit.
Other Income and Expenses : This represents those returns that do not arise from the normal course of the business.
Net profit before taxes – This is the amount earned by the business before paying any taxes.
Income Taxes – Total amount of state and federal tax paid.
Net profit after taxes – This is the amount of earnings for your business computed by subtracting taxes paid from net income before taxes.
Balance Sheet : Balance sheet provides snap shot of business assets, liabilities and owners equity for a given time.
Assets – these are assets that can be converted to cash in a year or less. They include cash, stocks, other investments, accounts receivable and prepaid expenses.
Fixed Assets : These are the tangible assets of a business that will not be converted to cash within a year. These include land, buildings, machinery and vehicles.
Intangible assets – These are the assets which cannot be touched or seen. These include franchise rights, goodwill, agreements and other items.
Other Assets – These include cash value of insurance investment properties and all other dues.
Liabilities – These are the obligations for your business that are due. These include notes payable on lines of credit and other short term loans, current maturities of long term debt, accounts payable, expenses and taxes, payroll that is due to employees and amounts due to stock holders.
Long term liabilities – These are the obligations of the business that are not due for at least a year. These consist of bank debt or any loans payable outside the twelve month period.
Owner’s equity : This is the total amount invested by stock holders plus accumulated profit of the business.
Cash-Flow Statement. In the earlier part you have seen the difference between accrual and cash flow basis of accounting. The acrual basis of business is generally preferred for the income statement and balance sheet because it more accurately mathces the revenue sources to the expenses however it is important to analyze the actual cash flowing in and out of the business.
Cash-Flow statement is divided into 4 categories :
Net cash from operating activities – Operating activities are daily internal activities of the business. These either require cash or generate cash. These include cash collection from customers, cash paid to suppliers and employees, cash paid for operating expenses, interest and taxes.
Net cash flow from investment activities – Investment activities are discretionary investments made by the management. These primarily consist of the purchase or sale of any equipment etc.
Net cash flow from financing activities – Financing activities are those external sources which include sales of common stock, changes to short term and long term loans and dividends.
Net change in cash and marketable securities – The results of first three calculations are used to determine the total change in cash and marketable securities caused by fluctuations in operating, investing and financing cash flow.