What should a business owner do to make sure he has the best possible information at his fingertips? How do you start putting this accounting knowledge into practice?
We’ve already discussed how to identify the key transactions of the business. Also, how to record the information that’s important to your business and pull it into insightful reports. Now let’s look at how you put this all into action.
Making your finances work for you
With your understanding of the financial basics, how do you start putting this accounting knowledge into practice and making your finances work for you?
- Firstly, you must have systems that are appropriate for the business. Decide who’ll be responsible for the recording of information. The methodology and the level of detail you get into will depend on the size of the business.
- Secondly, you must list the types of reports you need. What types of information and analysis will help you prepare these reports easily. This involves adapting your accounting system to capture the information needed. Making sure it’s easy to pull the reports from the system, no matter how simple or complex.
- Finally, you need to have a routine to help you check the information. You’ve no doubt heard the hackneyed phrase ‘garbage in, garbage out’ – it’s a truism that’s as applicable for accounts. When someone gives you financial information, you need to know how reliable this information is.
So how do we sanity check your reports? What should you be looking for when carrying out these reviews?
Using your reports in the right way
In my experience, when business owners get their financial reports, most of them jump straight to the profit and loss report. However, I’ve learned that it’s more important to start with the balance sheet.
I will ask you to remember the ‘Wile E Coyote and The Road Runner’ cartoon that was on television years ago…
The roadrunner was always speeding along a road, with milestones at the side. If he first passed the 5km mark and later passed the 15km mark, he knew (and we knew) that he’d traveled 10km in total. However, what if someone mistakenly put the 15km in the wrong place, say at 14km? The roadrunner would think he’d traveled 10km when he’d actually only traveled 9km!
By unquestioningly relying on the milestones, the roadrunner is misinformed and doesn’t correctly understand its performance.
Similarly, this applies to accountants. The balance sheets provide the milestones and the profit and loss is a measure of the progress or profitability. If you get the balance sheet wrong so will your profit and loss projection be inaccurate.
I recommend that businesses start by looking at the balance sheet. Then ask if the figures for the various assets and liabilities look reasonable and reliable. If they’re reasonable then the profit and loss are also likely to be reliable.
Checking your balance sheet
So, how do we check the balance sheet?
One way is by comparing the sheet to the records that the bank has. This could be by reviewing your bank statements and being sure that you understand any emerging differences. The only difference we should have is timing differences ie. if we pay a cheque but it’s not yet processed at the bank. Accountants call this checking process ‘bank reconciliation’. Therefore, what you’re doing is simply proving your records are correct by comparing them to another source.
We should also look at customer balances. I find that most business owners are very much on top of who owes them money. If I give them a list of customer balances with something wrong then they’ll quickly tell me. So check your customer balances, look for anything inaccurate. If you find any, correct them immediately. Remember, if a customer balance is wrong then your sales figure could also be wrong.
Let’s move on to the supplier balances. Again, most business owners are aware of who they owe money to and thus will quickly spot any error. Again, if supplier balances are wrong, then your purchased costs could also be wrong.
Your inventory or stock number is a key figure in your accounts. If your inventory is overstated, this has the effect of making it look as if you got stock for free. In consequence, your profit will be overstated. If your inventory is understated, then it looks as if you lost stock somewhere so your profits will be understated. It is very important to get your inventory or stock number right.
Finally, we can quickly look at the other assets and liabilities that might be on the balance sheet. Check if they look ok. For example, if there’s machinery or equipment listed in your assets, do the balances look ok? If there are tax liabilities, do those amounts seem right?
Once you are convinced that your balance sheet is reliable, then you can rely on the related profit and loss account.
Getting your head around shareholder funds
There’s one section of the balance sheet that sometimes confuses clients. This is the section called ‘shareholder funds’ or sometimes called ‘owners equity/capital’. In essence, this section represents the value of the business to the owner.
To understand shareholder funds, you need to ask the question, ‘If the business makes money, who does that money belong to?’ The answer is that it belongs to the owners.
So the difference between what the business has (the assets) and what it owes (the liabilities) represents the value of the business. We call it shareholder funds (or owners’ equity) for companies or owners’ capital for non-company businesses.
Shareholder funds are reduced by money taken out of the business such as dividends or drawings. So the difference between any two balance sheets represents the profits made by the business in the period.
Check your reports regularly
Your reports are a real goldmine of information. So I recommend to my clients that they get into a routine of regularly – at least monthly – reviewing and checking their reports. By doing so, you learn as much as possible about the business and can quickly identify where action may need to be taken.
If you are familiar with the ‘Lean thinking’ approach to business, you may have heard about the three voices.
- The first voice is the voice of the customer, giving feedback on the quality of the service your business is supplying to them.
- The second voice is the voice of the people working in the business. They see up close what’s actually happening and are often an untapped source of information regarding how well the business is operating.
- The final voice is the voice of the process. We access the voice of the process by identifying the key measurements that let us know how the process is doing.
You should always look at your accounts as a voice of the process. A well designed and implemented account will provide extremely valuable information about the performance of the business. Therefore, rather than thinking of accounts as a compliance-type chore, think of it as a hidden hub with rich information. So try to find out how best you can access it.
Getting in control of your business performance
When you understand your accounting basics, the value of good reporting, and the insights provided by your business numbers, you’re in real control of your enterprise.
And when you add the benefit of working with an experienced, process-driven accountant, you’ll soon start to see the positive changes and improvements in your sales, cash flow, and the profitability of your business.
If you’d like to know more about working with AccountsPLUS, and applying our ‘engineer’s perspective’ to your accounts, please do get in contact. We’d love to help you get complete control over your finances and business performance.