What tax/accounting returns do I need to make for my business?

This is a common question?

To answer it, the first thing we have to do is to identify the form of your business.  Are you a sole trader, a partnership or a limited company?

This table summarises the key reporting areas.

Sole Trader

Partnership Company
Income Tax

Yes

Yes

n/a

Corporation Tax

n/a

n/a

Yes

VAT

Yes if thresholds exceeded

Yes if thresholds exceeded

Yes if thresholds exceeded

PAYE

Yes, if you have employees

Yes, if you have employees

Yes, if you have employees

Relevant Contracts Tax (RCT)

If involved in Construction, Forestry or Meat Processing – most likely YES

If involved in Construction, Forestry or Meat Processing – most likely YES

If involved in Construction, Forestry or Meat Processing – most likely YES

We have a note on each business type below to help you identify which business type you have.  We also have a short note on each tax type below.

Sole Trader

A sole trader is the simplest business structure where an individual directly owns and operates a business.

A sole trader must register for Income Tax, may have to register for VAT, may have to register for PAYE and may have to register for RCT.

Partnership

A partnership is where two or more individuals jointly own and operate a business.

A partnership must register for Income Tax, may have to register for VAT, may have to register for PAYE and may have to register for RCT.

Limited company

A limited company is a separate legal entity that is owned by its shareholders.  If you operate a business as a limited company, you, and possibly others, will own shares in the company and the company is a separate legal person that operates the business.

The main advantage of a limited company is that the liability of the shareholders is limited to the amount they invested in the shares of the company.

A limited company must register with the Companies Registration Office (CRO) and must file an Annual Return to the CRO.  A limited company must register for Corporation Tax, may have to register for VAT, may have to register for PAYE and may have to register for RCT.

 

CRO and Annual Returns

A Limited Company must register with the CRO and file annual returns.

The annual return mainly confirms or updates key information about the company.  For most companies, this will just cover the address of the registered office of the company, the officers of the company and the shareholders of the company and includes accounting information for the company.

The first annual return is due six months after the registration date.  Accounts are not required with the first annual return.

The second and subsequent annual returns are due six months after the previous one and will include the accounts information.

There is an option to change the date of the annual return.  This option cannot be used more than once every five years.

Each company has a Next Annual Return Date (NARD).  The annual return must be filed electronically no later than 28 days of the NARD.  Accounts and any other attachments are due with 28 days of the actual electronic filing date.

VAT

If you exceed certain turnover thresholds then you will have to register for VAT

The thresholds are as follows.

For sales of services only, you must register for VAT if your turnover is over € 37,500 (in any twelve month period) and for sales of goods only you must register if your turnover is over € 75,000 (in any twelve month period).

If you sell both goods and services (for example if you sell carpets (goods) and install carpets(service) the threshold is €75,000 but only if the goods element is 90% of the total. If goods element is less than 90% then the € 37,500 threshold applies.

Note that if you are not registered for VAT then you cannot recover VAT on your own purchases of goods or services.  If you sell mainly to VAT registered business, who themselves can recover VAT, you are likely to be better off registering for VAT.

If you are mainly selling to consumers or other non-vat registered businesses, then being registered for VAT increases the cost to them.  In this scenario, in most cases it will be better not to register for VAT until you exceed the threshold.

Depending on the amount of VAT payable you will have to file a VAT Return, called VAT3, either on a bimonthly or four monthly or six monthly basis depending on how much VAT you  have in the year.  The VAT3 must be filed by the 23rd of the following month.

You will also have to file an annual Return of Trading Details.  This show the figures for Sales and Purchases on which VAT was applied during the year.

 

PAYE

You must register as an employer if you have an employee.  There are exemptions low paid workers but in most cases these will not apply.

You must advise Revenue that you are making these employee payments within nine days from the employee’s starting date. You will need to include your name and address.

All employers are required to issue payslips to their employees the gross wage and details of all deductions.  To do this employers either have payroll software or outsource the payroll processing to either their accountant or a payroll bureau.  Its possible to do payroll manually but few businesses are doing that now.

Depending on the size of your business you will have to file a P30 monthly or quarterly.  The P30 tells Revenue how much PAYE, PRSI, USC and LPT have been deducted from employees in the reporting period.  Revenue will then take payment for the reported amount.

Each year, the business must file a P35 report which informs the Revenue the total wages and payroll deductions for each of the employees.  This must be filed by Mid Feb and any Payroll Taxes over/under paid will be paid or received by mid-late February.

The employer must issue each employee with a P60 which shows their total wages and payroll deductions for the payroll year.  The figures on the P60 should be the same as the figures on the P35 for that employee.

A company must register as an employer and operate PAYE on the income of directors even if there are no other employees.

If you are a director of an Irish incorporated company you must pay tax (PAYE) on your income as a director. This is the case regardless of your residency status, or where you perform your work duties.

Income Tax

Individuals and Partnerships must file an Income Tax Return, for each calendar year, by 31 Oct of the following year.  When filing that return, you will have to pay any balance of tax owing that year and pay an estimate of the income tax (preliminary tax) for the current year.

Partnerships must file a Tax Return for the Partnership showing the profits/losses for the partnership and how those profit/losses are shared by the partners.  Then, on the partners individual Income tax returns, they report their share of the partnership profits but not the detail of how that profit was made up.

Corporation Tax

Companies must file a Corporation Tax Return for accounting periods.  The maximum accounting period is 12 months.

The corporation tax return must be filed with 8 months and 23 days of the end of the reporting period.  So, for a Dec 31 date, the return must be filed by the following Sep 23.

Companies must pay preliminary tax payments as well as balancing payments by certain deadlines.

For companies with taxable profits of less than € 1.6M (ie most companies) preliminary tax must be paid by the 23rd of month before the end of the accounting period.  For example, if the accounting period is 30 June, then preliminary tax for the current year must be paid by 23 May.

The balancing payment for the previous tax period is due on the day the Corporation Tax must be filed.

The Corporation Tax return includes details of share ownership.  It also includes details of salaries and expense payments to Directors and, also includes details of any loan balance due to/from Directors.

Relevant Contract Tax.

RCT is a withholding tax that applies to certain payments by principal contractors to subcontractors in the construction, forestry and meat-processing industries.

The rates of withholding tax are 0%, 20% and 35%.  All RCT transactions are submitted through the Revenue Online System (ROS).  The rate applicable to each subcontractor is determined by their own tax compliance history and status.

You can find a list of construction, forestry and meat-processing operations subject to RCT on the Revenue Website.  We can help you understand if RCT applies to your business and what this means for your business.

If you are a principal contractor in the construction, forestry or meat-processing industries, you must make all transactions with Revenue electronically through the Revenue Online Service (ROS). You should:

  • Notify Revenue of all relevant contracts
  • Notify Revenue of payment details
  • Provide details to the subcontractor of the tax you will be deducting
  • Submit a deduction summary, which is a monthly or quarterly return
  • Pay Revenue the RCT deducted from payments made to subcontractors.

You are a subcontractor if you enter into a relevant contract with a principal contractor in the construction, forestry or meat processing industries. This contract is not a contract of employment.

You must give the principal contractor the details they need to register the relevant contract with Revenue. These details must include the name you have recorded with Revenue and your tax reference number. You will also provide proof of identity, which can include:

  • a copy of your passport
  • a copy of your driving licence
  • details of your tax registration.

Once the principal contractor notifies Revenue of the contract, Revenue will send you the details in a contract confirmation letter. This will also confirm your RCT rate of tax deduction. If any details regarding the contract are incorrect, you should contact the principal contractor to correct them. If they cannot correct the details, contact Revenue directly.

ROS

Revenue Online Services is Revenue’s internet facility which provides you with a quick and secure facility to pay tax liabilities, file tax returns, access your tax details and claim repayments.

Revenue’s strategy to establish the use of electronic channels as the normal way of conducting tax business.  The vast majority of Revenue’s business customers are legally obliged to both e-file and e-pay. If you do not use ROS to file your returns and make payments, you may have to pay a penalty of €1,520 in respect of each transaction.

Conclusion

Obviously, this can only be a summary of the various taxes.  If you require help understanding how all this applies to you, feel free to contact us by phone 086 2323525 or by email jim@accountsplus.ie

 

Xero Certified Advisor

Is Xero right for your business?

What is Xero?

Xero is a cloud accounting application that provides similar functionality as most of the standard accounting packages such as Sage 50 or QuickBooks.

Being a cloud service, the data resides in the cloud and the application is accessed via a web brower.   Xero is  an example of software that are classed as Software as a Service (SaaS) and you pay a monthly fee for the use of the service.  Being a cloud service it has some advantages that traditional desktop applications don’t have.

What are the advantages of Xero?

1.     User friendly

The first and the main advantage of Xero is that it is quite easy to use. The online accounting packages tend to be designed for non accountants and they focus on the key actions that the user needs to complete, for example creating sales invoices and logging purchase invoices.  Xero is designed so that its fairly intuitive to use.

2.     Accessibility

As the software is a cloud application, it is accessible anywhere. You can use Xero from your desktop browser.   You can use it from your tablet such as the iPad or an Android tablet.  You can have Xero on your smartphone.

This allows you to check your accounting information wherever you are.  I’ve had a TV documentary maker who was out on one of the Aran islands and needed to check a balance.  He had his iphone and a signal which allowed him to just go online and check it on his phone – that is a big advantage for some clients!

3.     Software is always up to date

The software is always updated, unlike a desktop where you buy an application which you may get as a download or on a disc, and then that application doesn’t change unless you choose to update to the latest version. With Xero, updates are being introduced regularly, so you always have got the latest, most up to date version and it is all included in the price. And every time new features are added, you have access to those features almost immediately.

4.     Integration with other Cloud applications

As Xero is in the cloud, it can easily be connected to and exchange information with other cloud applications. There are lots of cloud applications that can work with Xero such as inventory management applications, CRM applications, banking applications.  Xero has the ability to push data out to these applications or pull data in from them.
Several years ago I had a client who did a lot of work online.  The nature of the work was that he had a lot of small transactions for which he got paid very small amounts of money – usually cents. This money was paid through PayPal.  He was able to set up his accounting package to connect to PayPal and this high volume of small accounting transactions were pulled in, immediately on login, into his accounting application.  This really streamlined his online operation and made it a whole lot more efficient for him.  So the ability to talk to other could applications can be very useful.

5.     Your accountant can help you remotely

Xero makes it easy for your accountant to access your data remotely.  Let’s say my client is using Xero, and they are having a problem. He or she can ring me up, we can go onto a Skype call or use some sort of other conferencing type call.  We can share our screen, so they can be looking at my screen or I can be looking and his/hers screen, whichever we want.  Using these tools we can resolve the question fairly quickly.   This could save a trip out to the clients’ premises for me which then makes the service less costly for the client if all they need is five or ten minutes of my time.

6.     Safe data back-up

Xero is always backed up.  The software provider will have the application and data stored in a number of different data servers, so if anything happens to one data centre, they have a backup  and can be accessed from another  data centre.  You won’t be aware of this happening. You won’t have the need to take backups or store them off site.  With Xero you also have the option of downloading data, just to be sure, to be sure, but in fact, that is not not needed.  They have it backed up better than you would probably do yourself.

7.     Functionality

Xero is a mature product  and at this stage, it has a lot of very useful functionality.  It offers reccurring invoices, multi-currency processing and automated bank reconciliations among other features.

A big advantage of Xero is that it has some very basic “intelligence” built in to the software. For example if a payment goes through your bank that might be for Three or Vodafone, you can set up a rule that this is a telephone bill, and that is normally a subject of VAT of 23%.  Every time that comes through, Xero will let you know it thinks that’s a telephone bill with VAT at 23% and you can accept or reject/edit the suggestion.  You don’t have to do any more with it.  You set up the rule initially, and once Xero recognizes that it’s a payment for Three or for Vodafone, it will code it properly.  It makes the process of coding at month end accounting simpler, easier and faster.

What are disadvantages of Xero?

1.     Slow with high number of transactions

There are some disadvantages to Xero.  You are using an online piece of software and if you have a lot of transactions and/or a slow connection, you may be waiting for a while until the screens re-build.  So if you have a lot of transactions, Xero might not be for you.

Book-keepers who come into a company once per week or month to bulk enter the transactions often find it doesn’t suit the way they work.

2.     Lack of support in Ireland

The Irish Banks don’t support the online accounting packages very well right now.  Elsewhere around the world, banks are providing feeds to Xero, so the bank statement can be pushed straight into Xero and then when you log into Xero, the application will tell you that you have these transactions waiting to be posted, and will use its intelligence to suggest to you what it thinks the posts should be.

There is a  workaround to overcome the lack of a feed – exporting the transactions from the bank and importing them to Xero but its more cumbersome.  Having said that, I use the workaround and I have dramatically reduced the amount of time I spend on monthly accounts.

3.     Cost

Xero costs more than a traditional desktop accounting software.  If you use something like QuickBooks online, you may have bought that for maybe €180-€200 for the licence, and you may get three to four years out of that before you decide to upgrade. So it could cost you €50 a year.

Xero typically costs around €25 a month, so you would be spending maybe about €300 a year on your software, which is a little bit more than you might be used to be spending.

How do you decide if Xero is right for you?

First of all you should look at the number of transactions that you have. If you have a low number of transactions – a low number of sales invoices and a low number of purchase invoices, then I would say Xero would be well worth looking at. If you have a high number of transactions, it might slow the process of entering these transactions down when you try and enter them all into the system.

Think about your  broadband.  Is it fast enough?  If it can handle something like Netflix, then it’s ok and can handle Xero comfortably.  If you speed is 1MB/s or less then maybe no.

If you are already using some cloud apps, like a CRM app or an inventory app or maybe something like Expensify for managing expenses, Xero can integrate with those cloud apps, and can make transferring data from one to the other a lot more streamlined.  If you are using any of these applications, I would strongly consider looking at Xero.

You would have to be comfortable with .csv files.  In Ireland at the moment the banks don’t provide the banks feeds for us, so what you have to do is use the workaround mentioned above where you go into your bank account and export you bank statement into a .csv file, which excel can work with. Then you have to tidy up that file, to make sure that the columns are in the right order and that it is ready to be imported into Xero.  So if you are not comfortable doing that process manually, you should probably shy away from Xero

If you do your own books, you will find that Xero will give you a lot of insight into what is going on in your business.  Xero will help you to really understand your accounts.  Completing the tasks of entering your costs and your invoices, knowing where they go, and being able to run the reports and drill down, will all make a whole lot of difference to how well you understand your accounts.

There are some businesses where Xero would be a good fit because of the type and number of transactions that they have.  For example, I am aware of furniture retailers that use Xero and they don’t have a till system or a point of sales system, all they have is an iPad. They can walk around the shop, they might have a small number of high value transactions per day and they can easily process those with an ipad and Xero. They can be with a customer, enter the sales invoice there and then, print it off on a wireless printer, give the sales invoice to the customer, and that transaction is already in their accounts.

Alternative applications

Xero is not the only online accounting package.

There is also Kashflow – a product that initially came out around the same time as Xero, but hasn’t grown as fast as they chose to grow organically rather than by investing loads of money into marketing as Xero did.  I think it is a bit simpler and a bit more user friendly, but it hasn’t developed functionality to the same extent that Xero has.

A newer product is Quickbooks online.  You may be familiar with QuickBooks – one of the bestselling desktop accounting packages in the last number of years. I heard recently that QuickBooks has made a decision to move online totally and that they will no longer be updating the desktop versions. At the moment I feel that QuickBooks and Xero will be the two main competitors of the online accounting packages. They will probably fight it out. I think they will probably end up having similar functionality.

SAGE have also introduced an online accounting package. The initial feedback was very poor, I know it has gradually been improved but I think they are a bit behind Xero and QuickBooks online.

Some of these online packages are a little behind, and don’t have as many integrations yet. Whether Xero will stay as the main player in the future, I am not sure. But right now, it is definitely the main player and should be considered if you are thinking of an online package.

We have worked with all the main SME accounting packages.  We also have significant experience helping select and implement software for larger businesses.  If you are thinking of going with Xero, or another cloud accounting package, feel free to contact me at jim@accountsplus.ie.

Struggling with your work-life balance?

jeremy-thomas-75753One of the most common problems for self-employed people is achieving or maintaining a good work/life balance.

I recently had a client who was finding that he was overwhelmed by the amount of work that had to be done and was seriously considering pulling back from the business because of work life balance issues.  So,  I thought it would be useful to write an article on how owners/managers should manage their work/life balance.

There are four steps in getting control of the situation:

Step 1 – Log your time

The first step is to figure out what exactly is happening with your time.  You have got to start to keep a log and record your time.

You should categorise how you are spending time so that you can see how time is being spent of the various work/life areas – your business, relationship time, your relaxing time, your family time, personal development time, exercise time, maybe spiritual time or personal admin time.

It would be useful for you to split out what is happening with the business so you have better information.   You can break business time down into a number of different categories. Are you problem solving? Are you in business development mode? Are you stepping in for other people who should be doing their job? What exactly is happening within your business?

Start to keep your log and use it to track your.  You need data for a reasonable period of time  – ideally for something like a month, but it might be worth looking into tracking for shorter period if you think it will be representative.

Step 2 – Decide how you want to be spending your time

Once you get that log and start getting an idea of where your time is going, next thing you want to do is sit down and decide what do you want your week to look like.

You need to make realistic decisions about how you are applying your time.  Take the key time categories that you used when logging and decide how much time you feel is optimal to spend on each of those.

Again, when analysing your business, it would be useful to break that down into different areas such as business development, production/operations, staff development.   Your business categories will depend on what stage your business is at and can be different for different people.

We know that there are 168 hours in a week – 7 x 24. During these 168 hours in the week you will be engaging in different activities – sleeping, eating, exercising, family time – all sorts of different things.  You need to decide how you want to spend that 168 hours? What is the best mix for you.

So develop a list of activities for the week and allocate the amount of time you think is best for each.

Step 3 – Identify the gaps

When you have a log of where time is going and a decision on how you would prefer to be applying your time, you go back and compare the two, identifying where the biggest problems are.

Let’s say you are spending 12 hours per day, 6 day per week at work, which is 72 hours, and your plan is to spend 10 hours per day Monday to Friday and 5 hours on a Saturday, which is 55 hours. I am trying to be realistic here, you might think it is still too high but let’s try and make incremental changes rather than dramatic changes.

Identify where the biggest gaps are. If you are spending, say, 20 hours a week problem solving, you might think you should only be spending 5 hours a week problem solving. If you are spending 10 hours a week for administration, you might think you should only be spending 5. Work down through the actual v desired time and identify the problem areas.

For each gap, consider how are you going to improve the situation. You have a few options.  You could stop doing it or you can reduce the time you spend on it or you could delegate it to somebody else.  Implementing these decisions may require other actions  You may have to hire someone or train someone already on your staff.

Step 4 – Make a plan to close the gaps

For each one of the area you want to improve,  you need to create a specific plan.

To do that there are a few tools that you could use. There are two that I find most useful.

1.     Time Management Matrix

The first one is what’s known as the Steven Covey time management matrix.

If you can imagine a grid and on the horizontal you have urgent – non urgent, and on the vertical you have important – not important.Covey Matrix

That grid then divides into four quadrants – see above.

Once you cateogorise tasks in that way you will see that the items in the not urgent and not important category may not even be worth doing.

Urgent but not important items might be stuff that you may delegate to somebody else.

For the urgent and important items, you probably don’t have much choice about, it just has to be done.

The key area to spend your time on those items that are not urgent at the moment, but that are important.  If you don’t deal with those and they are important, what is going to happen is that they will soon become urgent and important.

The trick is to classify all the things that you are doing into those four boxes and then you decide how you deal with them.

2. Must/Should/Could

Another slightly simpler tool that I have come across that many people find very helpful is just to categorize everything into ‘MUST’, ‘SHOULD’ and ‘COULD’.

The things that you MUST do are ones where you have no choice, you just have to do them.

The things that you SHOULD do sound like they are important and have to be done but you may not have to do them.  You could do some and delegate others

And the things that you COULD do are optional.   You may do some of them or better delegate them but you are more likely to try to stop doing them.

By actually analysing the various items you are doing you will get visibility and you will better insight into where your time is going and you will start to prioritise things, and then you will start to spend time better.

Play around with the tools and decide which you prefer.  Then each of the elements, put plans into place. When you are putting plans in place it is important to be realistic. There is no point in sitting down and putting plan into place if you don’t intend to do or if it is not possible to do it.

2.     Be accountable

The third tool that I find very helpful is try and find a way to be accountable. It might be your life partner; it could be another colleague or business partner; it could be your coach.  Pick someone and tell them what you are going to do and then set up maybe a weekly call or an email to review how you have been spending your time and to review this.

Put it out there and make yourself accountable for it. Phase the implementation, don’t try to do everything at once, but have a phased plan on how you are going to implement things and set a time to review it. Give yourself 4 weeks, 8 weeks something and go back and see whether this is working and whether you are making progress.

Conclusion

If you are in a situation where your work/life balance is a problem, step back from what you are doing, look at where your time is going and for each and single one of those elements put a plan together.

Seek help from outside, a family member, business colleague, mentor or a coach to help you with your planning.  You will find that things will improve and it will make a difference.

If you have any questions, or items needing clarification, feel free to drop me an email.  Remember, we’re available if you want to bring an external perspective to your situation.

How to prepare financial projections

Scanning the horizon

Feedback I get regularly from the clients is that they don’t know where to start with the financial projections. So in this article I want to give you a framework and an overview of how I go about doing projections.

My approach is something that has built up over time.  To help myself remember the framework I use the acronym ‘ARC’ which stands for – Activities, Resources and Costs.

Activities

Firstly, sit down and ask yourself what activities do you expect to do, or to be working on, in your business over the next period – a year, three years, maybe as little as three months, depending on what you are doing.

Now when I say activities, the obvious one is sales and everyone sits down and puts down what they think they are going to sell. But there can be other activities. For example, if you’re planning on opening a new office somewhere, say Dublin – that is also an activity.

There might be a new product that you are planning on launching in the next year – that is also an activity.

There might be other initiatives that you are planning to implement which might be a new computer system or you might want to refurbish your premises or you might want to renew your fleet of vans.

Any of those things are activities, but you need to decide what activities you are planning on achieving in the next period.

Resources

Next thing you need to decide on what resources are those activities are going to consume?

When I think about the resources I use a framework that we used to have on lean projects.  We consider the 5 Ms  – Materials, Methods, Manpower, Machinery and Money.

Sit down and ask yourself ‘if I am going to be making sales, what materials will I be using, what manpower, what overhead etc will I use?

If I am going to be setting up a new office in Dublin, what resources will I need? It might not be materials, but it might be a certain amount of my time or somebody else’s time.  Who is going find the office space. I might use an external resource, for example an auctioneer or some sort of real estate professional, to help me find the office and no doubt there’ll be a cost somewhere for that.

If I am going to be working on a new product, I might have to use materials to make prototypes, I might have labour – engineers working on it, production staff, and I may have quality control staff. So what sort of people would be working on the new product? Where will they be working? Do I have the space? Will there be incurring any extra overhead? Will they be using any machinery or equipment?

You need to review the categories – Materials, Methods, Manpower, Machinery and Money and ask yourself how much of those will you be using.  That will help you to develop a list of the resources that you are going to need, and the resources will typically be materials, labour and something to do with overheads.

You then need to collate all the information that you have. Typically you will put them into something like a spreadsheet and you schedule them out by a time period – preferably monthly but sometime quarterly can be enough to start with.

Costs

Then I put costs on those resources and I schedule the costs out by month or quarter.

Typically, you will have sales quantities and prices.  You will have materials purchases and costs.  You will have headcount and the related labour costs.  For some overhead items, you may be able to estimate the costs easily.  For other overhead items, you may need to create tables to build up the costs.

For example, if I have sales reps on the road and I am going to take on one more.  That rep may need a car, a phone and laptop, a travel expenses allowance and an entertainment allowance.  You can identify an average for each cost and build up the costs based on the number of salesmen that you have.

Do this for any other costs that need to be built up in this way.   Check against your annual accounts to make sure you are picking up everything.  If you are just starting up, look at standard business plan templates from support agencies or the internet and use those to prompt you to include everything.

When complete, you will have identified your sales figures and the associated cost figures.

Summarise into your key Reports

Organise your sales figures, your product cost figures and your overhead figures by month to give yourself a profit and loss account.    This will show what you are going to sell each month and will summarise the costs of the activities you will be undertaking each month – materials, labour etc.

You should also look at that profit and loss from a cash flow point of view.

If you are using materials today, when will you buy those materials and when will you receive it into my warehouse? Once you know when you buy it, when will you pay for it? Will you get 30 days credit, will you have to pay up front or will you get 60 days credit?

In this way, you take each of your items and you start to break them down and schedule when the money is going to flow.  Look at sales – you will have a projection of when the sales will happen and based on that you should have a reasonable idea of when the money is coming in.  If you are buying any new machinery, if you are going into a new office, when is the money going to flow for that? And then your overheads, when is the money going to move, or when is money going to flow for each of those various overheads.

This work is essential to help to build your cash flow projections.

This work will also help you build your balance sheet. When you are identifying the timing of sales receipts, you will also be able to determine how much is owing from your customers each month.  To do this you will start with your opening customer balances, then add sales, the deduct whatever is going to come in – this is going to give you your closing customer balances.

You should be able to work something like that out for every month, and you should be able to do that for your suppliers. By doing this you should be able to build a rough-cut balance sheet.

Getting Help

I know that when I start mentioning profit and loss and the balance sheet people are going to pull back a little bit, but there are tools to help with that.

You can have somebody to build a spread sheet for you, a simple spreadsheet that would do some of this for you at the start. You could get help from your accountant to do that or you can buy business planning software of the shelf such as – Business Plan Pro, which costs about $150 dollars. There are other pieces of software that could link into your accounts, and will integrate with your accounts – i.e.  software that take the figures from your accounts and move those forward.

And finally, you can simply outsource it, you can ask your accountant to do that for you. That is something that I do for a lot of clients, where they have all the knowledge and insight, and I sit with them for as long as it takes to complete the projections.  This can be as low as a half a day, but depending on business size and complexity it can take a day or two. It might take a short bit of time to get started, but what I find is that once they get the first pass of the numbers, and they see what the numbers are like, they start to want to start to do the various ‘what ifs’ – if I change it and do this what will happen or if I change it and do that what will happen.  You need to allow time for that exploration and fine tuning.

Summary

Doing the projections is a fairly straight forward process.

Ask yourself what your activities are, and when doing that take a broad view of what your activities are.  Don’t just limit it to sales.

Once you are done with activities, move on to resources that you are going to have to have to deliver on those activities.

For each of those resources – put a cost on them.

Take all that information and collate it, or put it into some sort of document. Typically a spreadsheet or a business planning software and that is going to be your projection.

Take that projection and run your business, run your accounts. Go back and look at your projection, learn from the differences that arise between these projections and the actuals. Tweak the projections and tweak how you are doing them.

And this, as I said in another article, is how you are going to learn about your business and how you build your knowledge.

If you have any questions, or items needing clarification, feel free to drop me an email to jim@accountsplus.ie.   Remember, we’re available if you want some external assistance in developing projections.

 

Do you know much it costs you to open your doors? Predicting Business Costs.

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A friend of mine, a retired banker with lots of experience dealing with owner managers, has a phrase he uses about those business owners that he feels are in control of their business.  What he says is that ‘they know exactly how much it costs them to open their doors in the morning.’  Are you one of those businesses?  Many people think that this is a very difficult thing to be able to do, but in fact it’s not.

Overview

To know what it costs to open your doors, your first need to know what you will be doing when you open the doors.  So you need to have a good sense of what the activities will be like the day or week.  In the short term – ie next few weeks.

In most cases that will not be too difficult.   You may have an order book that will tell you what will ship the next few weeks.  If its retail, you should have data over the last few years that will give good guidance on what happens at this time of year.

Once you know what’s going to be happening, then you should be able to put costs on that.

The importance of a budget

A good business will prepare a budget of some sort at the start of the year.  When preparing that budget, the business will develop assumptions or rules about the various costs.  You will use those rules throughout the year to help you anticipate what will happen and to convert the expected activity into reasonable cost estimates.

Direct Costs

If it’s a factory making products, the cost of the product will be made up of direct costs and indirect costs.

Direct costs are those costs that are easily linked to the product.  If I am making a chair for example I can see the timber that went into that chair, I know how much timber was needed and I know what it cost. The cost of timber in the chair can be directly linked to purchases of timber.

Similarly, if it’s a convenience store, I can say that for every item that I sell, eg a litre of milk, then I must buy in a litre of milk in order to have it to sell.  So the cost of the litre of milk is a direct cost.  If I sell 10 litres I have to buy 10 litres.  If I sell 200 litres then I have to buy 200 litres.

Labour can also be a direct cost.  Even though, we can’t point to a chair and see the labour that went into making it, we might know that a workman might make 10 chairs a days.  So if we have to make 100 chairs then we can calculate that we will need 10 workmen to do that.  As we know what a workman costs, we can predict our labour cost.

Indirect costs or Overhead Costs

These are costs where it is harder to make the link between the individual item sold and the costs that the business incurs. For example, if I have a convenience store and I pay €1,000 rent per month.  I cannot link the rent to any particular sale – there is not a direct relationship.  I may sell € 5,000 worth of goods on a Monday and € 15,000 worth of goods on a Saturday but the rent cost for each day is the same.

These costs that are hard to link to a product are often called overhead costs. I think of them as costs that are hanging over the business and that vary little for different levels of activity.

Indirect or overhead costs will include marketing costs, premises costs, office consumables, staff travel, professional fee and financing costs.

In some businesses, eg a convenience store, labour costs are more of an overhead.  I will have to staff my shop to a certain level even though sales for can fluctuate.  For example, a restaurant will have wait staff on in anticipation of trade but the level of trade may vary significantly.  For these businesses, we have to plan on having staffing levels that will not vary much will activity.

When you are doing your budgets or projections at the start of the year, you list down all the different types of overheads that you have and you put in your best estimate of what is going to happen. In that way, you pull together some sort of projection of your P&L as to what your costs are going to be.

Applying this understanding of costs

As you progress through the year, you know from your order book, or from your activity plans, what’s likely to be happening in the weeks ahead. With this awareness, you are likely to start asking yourself- “if my sales go up – what is going to happen to my materials?”

You can then predict that if your sales are going to go up by 20%, your materials might go up by 20%. If your sales go up by 20%, but the mix of sales differs, your materials mightn’t go up in exactly the same way, but if you understand your costs and you understand your sales, you will have a very good idea of what is going to happen to your materials.

Similarly, if your sales are going to go up and your activities are going to go up, you are going to have a very good idea of what is going to happen to your labour.   Think back to the example about the chair making factory.

So as a good business owner/manager, you will have a sort of sense of what is coming at you and you will be quickly able to turn that sense into rough and ready figures – but reasonably accurate rough and ready figures.

Finally, you will be able to run through your overheads – certain overheads will not vary at all – rent for example. Other overheads, such as electricity, may vary.  If you are running machines for longer, then you are likely to use more electricity.  While some overheads are reasonably constant, there are other overheads that you will need to tweak.

You know what is happening in your business and you should be able to estimate what is likely to be happening to your overhead from that. You can do that very quickly, you can do rough numbers or you can do it a bit more precisely. For most people, it is enough to be able to do this roughly.

Building your knowledge of the business

But how do you develop this knowledge? – That is the question I am most often asked. There is definitely an element that comes from experience, but even with the experience, it all goes down to understanding the accounts and the information that you already have about the business.

If you prepare accounts every month and you spend some time understanding those accounts, and even better, if you have what I call a feedback loop, or a feedback control, you will quickly improve you understanding of what is happening in the business.

The feedback loop

The feedback loop can be summarised as Plan – Act – Review – Adjust.

We’d say that at the start of the year you make a PLAN for the business, and then you go ahead and take ACTION to deliver on that plan.

Out of that action you’re going to get results, so you look at the results, you REVIEW these results. When reviewing, you ask yourself – ‘Did what I expected to happen, happen?’, ‘Was it different?’, ‘Why was it different?’.  As you review these results you’re going to get learnings. You absorb and apply those learnings and then you ADJUST your  plans for the next period.

Applying Feedback Loop to Management

Putting all this together, you start off with a budget or a projection (PLAN)  , you run your business (ACTION), you prepare your accounts and then you go back and see how do my accounts compare to my original budget. What was different? Aah, I misunderstood that or something changed. (REVIEW).  Through this review process you develop your experience.  Then you take that learning and revise your projections (ADJUST).

And that is how you develop your learning.

And that learning helps you develop a good understanding of the costs of your business, and how they relate to the activities of your business.   Then you will be one of those business owners who knows how much it will cost them to open the doors of their business.

If you have any questions, or items needing clarification, feel free to drop me an email.  Remember, we’re available if you want to improve your financial control expertise.

 

 

Decision-making and the importance of understanding cash flow

As I said in my last blog post, one of the most common areas where my business clients want advice is around decision-making – knowing which of the options they’re faced with will be most beneficial for their business.

Whether you’re a brand new start-up business, or an established family business, it’s vital to make the right decisions over the course of your business journey. Make the right move, and you’re on the pathway to profits and success. Make the wrong move and you’re likely to miss opportunities and reduce your overall profitability.

So how do I help my business clients to improve their decision-making and make the very best of every situation?

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A clear focus on cash flow

I originally qualified as an engineer and that systematic, rational approach is something that informs my approach to decision-making and the assessment of financial options.

To know which outcome produces the most financial benefits, I focus on the cash flows in your business. Once we know the different options, and the cash flows that relate to them, we can compare and contrast the various financial outcomes.

 With the cash flows noted down, I enter this information into a table with three columns:

  • The first column is for the cash flows in the current situation.
  • The third column is for the cash flows in the alternative situation.
  • The middle column is for the difference in cash flow between the two options.

Here’s an example of how this table will look, using the example of ‘John’, a painter/decorator who’s looking to buy a new van for his business – you can read more on this example in the previous blog here.

Current Van Difference New Van Comment
Investment 0 -10,500 -10,500 As I’m only looking at what will happen from now, I don’t consider the cost of the current van.
Fuel -10,800 1,500 -9,300 This is fuel cost over 3 years, based on the info supplied.
Maintenance -6,000 3,000 -3,000 Maintenance cost over 3 years. based on the info supplied.
Van Hire -1,500 1,500 0 5 days pa for 3 years at 100 per day
Lost Earnings -2,400 2,400 0 2 days a year for 3 years at 400 per day
Tax -900 150 -750 Info as supplied
Insurance -1,500 -300 -1,800 Info as supplied
Resale Value 0 4,000 4,000 Info as supplied
Net Cash In/(Out) -23,100 1,850 -21,350  

 

The important number here is the final figure in that middle ‘Difference’ column. Using the cash flows we know, and estimating things like costs and wear and tear, we can reliably say that John will save €1,850 over the year by buying the new van he’s looking at.

For a small, one-person business, having €1,850 more in your pocket will have a positive impact on the company’s overall cash flow – giving you more scope to invest in other areas, like marketing, or new equipment.

Putting the cash flow approach into practise

My previous post mentioned two examples of businesses that were at a crossroads with their decision-making.

  • The dentist – One was a dentist friend of mine, who many years ago asked me if refurbishing his dental practice was a sound financial move.
  • The food manufacturer – The other was a food manufacturing business who came to me recently to ask whether they should keep production in-house or outsource it. 

Lets look at both these scenarios and see how the systematic cash-flow approach helps us to choose the best option for each business owner. 

For the dentist, the decision looks a little easier. He already had a quote for the cost of the refurbishment. This would be a tax-deductible cost, so we could say that the after-tax cost to him was 50% of the quote – all sounding pretty rosy so far!

Then I asked what would happen to his practice if he didn’t do it up. He replied that he wasn’t sure but he would expect to see a slight decline in the number of patients. He considered the quality of dental care would be most important but having a rundown surgery could lead patients to think he was not doing so well and maybe he was not so good – in other words, a shabby surgery could have an impact on the perception of his brand.

Finally, I asked him how he would feel working in a somewhat tired, run-down surgery. He was very strong about that and replied that he would hate it. So, he decided to do it up.

I think that was the right decision and was what he’d really wanted form the outset – he just wanted some reassurance that he was making the right decision.

An important lesson here is that not everything can be quantified. Yes, I know that is heresy for an accountant to say. But some factors in decision-making just can’t be expressed as hard numbers, even though these factors could be vital to the outcome of the decision. Always keep that in mind and consider these less quantifiable factors, even though it is hard to do so.

The right decision for the manufacturer

 Let’s look at the more recent example of the food manufacturer and the thorny question of whether to outsource production, or keep it in-house.

The business owner looked at the costs of producing in-house vs outsourcing to a contractor, and this was what we found:

  • The contractor had much bigger buying power and was able to save on the cost of raw materials (applying the benefits of economies of scale).
  • Labour costs for both alternatives were similar.
  • Overhead costs were lower for the contractor as he had a much larger operation with economies of scale again.
  • There were going to be additional costs for freight and for quality control as the outsourcer wanted to ensure the contractor would maintain standards.
  • By way of intangibles, the outsourcer was concerned that the contractor might gain his production know-how which could lead to contractor becoming a direct competitor – but they put agreements in place to deal with that.

I put my table in place for the food manufacturing decision. As I said already, it’s not always about the numbers. Reviewing the table gave rise to a series of discussions about the various elements to be considered, about the reliability of the numbers and particularly about the intangibles or the less quantifiable factors.

By having both the tangible numbers AND the intangible considerations all worked into the decision-making process, we came to an informed (and ultimately more profitable) conclusion – outsourcing production would be cheaper, more efficient and used all the outsourcers’ buying power and economies of scale to improve margins and profit. [I’m making an educated guess that this was the outcome as it’s not expressly stated, but it seems like the outsourcing option makes most sense]

The importance of process and good information

A key point to remember is that while having a good process is important, having good information to feed the process is vital. That information comes from having reliable and insightful management information available – something that I, as your accountant, can help you refine and make into an efficient management reporting system.

With up-to-date business information, a systematic approach to assessing your cash flows and a healthy consideration of the most intangible elements, you’ll make the best possible decision-making for the future of your business. It’s a framework and approach that will let you address most of the decisions that are likely in your business.

If you have any questions, or items needing clarification, feel free to drop me an email.  Remember, we’re available if you want to bring an external perspective to your decision.

 

Making the best business decisions – how to evaluate your opportunities

One of the questions that I get asked most often by business owners is how to decide between one or more options – when faced with path A or B, how do you know which fork to choose and what the potential outcome may be?

These sorts of question arise for businesses of all sizes and they’re just as important for the small business owner as for the large business owner. In the past three months, I’ve helped a painter/decorator decide if he should change his van and I’ve helped a large food manufacturer decide whether to outsource production, or keep it in house. For both of them, their decision was important and could have an impact on their business.

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The value of good advice

I wasn’t long qualified as an accountant when an old school friend, now a dentist, asked me if he should refurbish his dental surgery. He’d already asked his accountant, who replied “that’s up to you”. That answer wasn’t very helpful. We know it was up to him to decide but his accountant wasn’t providing him with any advice as to how to make that decision.

To put it bluntly, he wasn’t adding much additional value as an accountant.

But (thankfully) times have changed, and most good accountants now realise that a large part of their role it to help with this kind of decision making – whether it’s supplying the right numbers, forecasting the potential outcomes or looking at the strategic implications.

So how do I go about making financial decisions?

I focus on the cash flows in your business and compare the different cash flow relating to all the options.

The simplest way to explain my approach is to imagine that the business has a large barrel of cash and ask what will happen to the cash in each of the scenarios. What money will come in and what money will go out? Once I identify the cash flows, I enter them into a table with three columns.

  • The first column is for the cash flows in the current situation.
  • The third column is for the cash flows in the alternative situation.
  • The middle column is for the difference in cash flow between the two options (I’ll show you an example of a completed table shortly).

Before you do that, you need to decide what sort of a time period you’re going to consider.  Its common to look at a decision over the life of the relevant item – so if it’s a van and you plan on changing again in three years, then you might evaluate it over three years. If you’re looking at outsourcing production, you might just look first at one year and then consider whether you need to review a longer period.

So, let’s look at the van example.

How much will a new van cost?

Let’s say John is currently running an 8-year-old van. His garage has a good 3-year-old van for €12,000 and will give him €1,500 for the old one. John wants to know if he should change.

The first thing I will ask is what the current van is costing him. He tells me his current van works up the following costs:

  • €3,600 a year in diesel to fuel the van.
  • €300 a year to tax and €500 a year to insure it.
  • Repair costs as the van had been giving him trouble which needed repair
  • €100 per day to hire a replacement van while his own was off the road – he expects this to continue and suggests that I allow 5 days a year for being off the road with maintenance work.
  • 2 days a year in lost earnings while he is dealing with the van – where he normally earns €400 per day on average.
  • Overall the van is costing John about €2,000 a year in maintenance, €1,000 of which is normal wear and tear, the other €1,000 is due to breakdowns.

Next, let’s look at the costs of buying a new van:

  • The new van John has his eye on will cost €12,000
  • We can then subtract the €1,500 trade-in on the old van.
  • John reckons he’ll sell the van on in 3 years for €4,000.
  • He estimates that it will cost him about €3,100 a year in diesel.
  • It will cost him €250 a year to tax it but €600 a year to insure it.
  • He’s not expecting to have any breakdown days or van hire.

So, overall the new van should cost about €1,000 a year in maintenance, which is all for normal wear and tear.

Note – these are not real numbers. They’re my best guesses to develop a reasonable example for you.

I put my table together, taking three years into account.

Current Van Difference New Van Comment
Investment 0 -10,500 -10,500 As I’m only looking at what will happen from now, I don’t consider the cost of the current van.
Fuel -10,800 1,500 -9,300 This is fuel cost over 3 years, based on the info supplied.
Maintenance -6,000 3,000 -3,000 Maintenance cost over 3 years. based on the info supplied.
Van Hire -1,500 1,500 0 5 days pa for 3 years at 100 per day
Lost Earnings -2,400 2,400 0 2 days a year for 3 years at 400 per day
Tax -900 150 -750 Info as supplied
Insurance -1,500 -300 -1,800 Info as supplied
Resale Value 0 4,000 4,000 Info as supplied
Net Cash In/(Out) -23,100 1,850 -21,350  

 

Positives in the cash flows are ‘cash in’ and negatives are ‘cash out’. In the difference column, positives show where the new option is better than the current option; i.e. cash in, or less cash out.

So, what the above table tells us is that a new van looks like it will save about €1,850 over the three years. We need to be careful and remember that we’re making assumptions, albeit reasonable ones, about the performance and reliability of the new van. We need to be confident that we are aware of, and considering all of, the costs.

We’re not taking into account intangible elements like the effect on his business profile of driving in a newer van. Also, we’re not taking into account the effect on customers of cancelling work because the van let him down. And we’re also not taking into account the effect of having a reliable van and less stress and worry on John himself. We can allow for those in our decision but it’s hard to quantify them and put them in the table.

The bottom line is that the new van looks like it will save him €1,850 over the three years but there are some intangibles that might also be worth a lot to John and only he can put a value on those. I think most of us would change the van based on the info above.

The time value of money

Another factor to take into account is what accountants call the ‘time value of money’.

If I ask you which would you prefer – €1,000 now or €1,000 in 1 year – you’ll all intuitively know that if I get €1,000 now I could invest it somewhere and maybe make another €10 to €30, say €20, in that year. That means that €1,000 now is really worth €1,020 in 1 year. This is what we call the time value of money.

For some decisions, it can be worth taking this time value of money into account.  If you have high interest rates and two options with very different cash flow patterns then it may be worth looking at. But for most day-to-day investments, it’s not worth the additional work – and in any event it will involve other assumptions.

A systematic approach to decision-making

So, that’s how I recommend that you approach decision-making – by systematically breaking down those cash flows and seeing which scenario works out best for your business.

  • Identify the options available to you.
  • Note down the cash flows for each option.
  • Put them into a table and see which one looks best.

Put a little bit of time into challenging your assumptions and into thinking through the options to make sure you have considered everything that is relevant. And armed with your outputs you can be confident you’re making the best decision for the future.

Next time we’ll look at some more practical examples of how this can be put into practise.

If you’d like any assistance with your business decision-making, please do get in touch to see how we can help

 

 

Why a good budget is vital for every business owner

In one of my recent blog posts, I mentioned the need for a business to create an annual budget.

One of my readers contacted me, saying “I don’t really know why I’d need a budget if I’m already doing the basic bookkeeping”. So, in this post, I’m going to set out why I think budgets are so important for every business owner, whatever the size of your venture.

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Feedback for improved decision making

However complex or simple your business model may be, you still need to be constantly monitoring progress and adapting your processes as you go. I come from an engineering background, and in that world we often talk about an ‘engineering feedback loop’, where outputs of a system are monitored and used to help the system operators decide how to respond and adapt to what is going on in the system.

 

It’s not just engineers who exploit feedback. Pyschologists use an approach called Test-Operate-Test-Exit (TOTE), which is a process to apply the same approach to people. With the first Test of the TOTE, we consider what’s happening and make a plan. Then we move on to execute the plan – Operate. After operating, we Test again to get some data or information on what happened. Was the outcome what we expected, or did something different happen? In the final step, Exit, we use the data to decide whether to continue what we’re doing or whether to make changes, possibly even terminate the exercise.

Your annual budget should be understood as part of a feedback loop for your business plan. We start off by creating a plan, which we express in financial terms as a budget. Then we operate the business, getting feedback from our management accounts. We use that feedback to make decisions – whether to continue as is, or to make some changes. So we are going about improving our understanding of performance and feeding that into our management – in short, we’re tracking how well you’re performing against that all-important budget, and then acting if change is needed.

Prompting a review of the business

In the normal running of a business, it’s very easy to get caught up on the treadmill and not take time out for important reviews. But there’s real value in making the time to focus on your budget and to make proactive use of it.

To prepare a budget, you must start with some key assumptions. These include:

  • What will we be trying to achieve in the budget period?
  • What will be happening with our key inputs – raw materials, labour, overhead, distribution etc?

Your budget provides, indeed prompts, a forum for these key discussions about the direction of the business. And the budget process forces you and your management team to formalise those discussions, reducing them to a set of guidelines that will be used in developing the budget to make it work comprehensively for your company.

Helping to anticipate what might happen.

In the western films that I watched when I was younger, the wagon trail or cattle drive would send someone ahead to scout out the land coming up, identify obstacles and find the best path to be followed, while the main train or drive remained behind – in other words, they never put the whole wagon train at risk, only the poor scout who’d pulled put the short straw!

We can’t really do that in a business – running a business comes with inherent risks that impact on the whole ‘wagon train’. But what we can do is to build a model of what we think is going to happen and use that to identify obstacles and make plans for how to deal with those obstacles.

For example, when we prepare a budget, comprising profit and loss, balance sheet and cash-flows for a business with peak sales at Christmas, we might see that it’s necessary to build up a substantial stock in the run-up to Christmas. This means we’ll need to buy raw materials from our suppliers to build this stock up, but we won’t have sold the product yet and won’t have received the sales proceeds. So we’ll be spending, without recouping any revenue and that’s going to put pressure on our cash flow.

By planning a sensible budget we can quantify the scale of the problem and plan how to address it. We might ask the suppliers for extra credit or we might ask our bank for an extra short-term credit facility – anything that eases the pressure of that increased outlay.

But unless we run some numbers, we wouldn’t be able to quantify the issue – we’d be basing any decisions on estimates and guesses, and that’s never good practise.

Developing our understanding of the business

To prepare a budget, we start by making some assumptions about what will happen in the business and how the different elements of a business relate to each other.

Depending on our experience and our knowledge of the business, the quality  of assumptions can range from very poor to excellent. The only way we know how good these assumptions are is by comparing what actually happened with the budgets and studying the outcomes so that we improve our understanding.

By doing this on an ongoing basis:

  • We gradually increase our understanding of what is happening.
  • We improve our ability to predict.
  • We also learn to identify key predictors of performance.
  • We use these key predictors to make early interventions if things are not progressing as we expected – and keep the ‘wagon train’ on a safe passage through the pass.

Using our budget, we can also determine some key metrics for the business. For example, we should always know the break-even point for the business – the point at which our gross profit will match our overhead costs.

If the business is still in its early stage, the budgets can help determine just how viable that business is.

Budgets vs forecasting

Budgets and forecasts are very similar. They’re both financial projections of what’s expected to happen in the business in the future, with the aim of helping you move forward as effectively and profitably as possible.

Budgets are usually annual while forecasts can be run as often as needed. Well-run businesses will prepare an annual budget and then prepare less detailed forecasts during the year. These forecasts will usually incorporate changes that are occurring in the business and help management decide how best to respond to these changes.

Additionally, budgets are often used to set spending limits. In larger companies, the budgets are broken down by departments or cost/profit centres and individual managers are allocated responsibility for their portion of the budget. Usually, they won’t be allowed to spend in excess of a budget without first getting additional approvals from more senior managers – in other words, they place a restriction on the costs that department can incurr.

In smaller companies, the control process won’t be as formal. Usually, an owner manager will hold the purse strings tightly. However, the budget can be used to help them decide on how much they can spend on different types of expenses and, also, if there are better times than others for spending. Once the busines owner know what their limits are, they’ll soon realise if spending is exceeding the pre-defined plan.

Getting product costing right

An area that many businesses struggle with is product costing – working out the amount it costs your business to produce each product or service in your range.

Some businesses use product costs to set selling prices. Even when prices are set by the marketplace, using product costs to understand profitability will help you determine if it makes sense to be trying to sell in the market place.

Most product costs have two fairly distinct components:

  • Direct costs – these are usually the easiest to determine and will include things like labour and raw materials etc.
  • Overhead costs – these can be more difficult, and can include things like building rent, repairs to equipment or utility bills etc.

To determine overhead costs, the first thing we must do is determine the total amount of overhead costs we expect to have – that will be provided by the budget. Then we should figure out the best way of allocating the overhead costs to the products – effectively spreading the overhead costs across our products so that each product gets a fair share of the overall costs.

While all elements of the costing process are important, we must start with a reliable estimate of what the overhead will be and that’s provided by the budget.

The foundation on which your business plan is built

So, there you have it – a number of strong reasons why every business, both small and large, should take the time every year to build a budget and to spend some time comparing actuals with budgets.

Your budget is the financial foundation on which the whole of your annual business plan is built, so the more detailed, the more accurate and the more realistic you make it, the more solid your financial progress and agility will be over the course of the year.

If you’ve got any questions about building a solid 2017 budget for your business, please do get in touch to see how we can help.

 

Putting your accounting knowledge into practice: an engineering perspective

What should a business owner do to make sure he or she has the best possible information at his/her fingertips?

We’ve already discussed how to identify the key transactions of the business and 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

So, with your understanding of the financial basics, how do you start putting this knowledge into action and making your finances work for you?

  • Firstly, you must have systems that are appropriate for the business and decide who’ll be responsible for the recording of information. The methodology for this 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 and what types of information and analysis will help you prepare these reports easily. This involves adapting your accounting system to capture the information needed and 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 as anything else. When someone gives you financial information, you need to know how reliable this information is.

So how do we sanity check your reports? And 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.

To explain why, I will ask you to remember the ‘Wile E Coyote and The Road Runner’ cartoon that used to be on television many years ago…

The road runner 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 travelled 10km in total. However, what if the 15km had been mistakenly put in the wrong place, say at 14km? The roadrunner would think he’d travelled 10km when he’d actually only travelled 9km!

By relying unquestioningly on the miletones, our road runner is misinformed and doesn’t understand his performance correctly.

Accounts are similar. The balance sheets provides the milestones and the profit and loss is a measure of the progress or profitability. If you get the balance sheet wrong then the profit and loss will also be wrong.

I recommend that businesses start by looking at the balance sheet and ask if the figures for the various assets and liabilities look reasonable and reliable.  If they’re reasonable then the profit and loss is also likely to be reliable.

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Checking your balance sheet

So, how do we check the balance sheet?

We check the bank accounts by comparing them to the records that the bank has – the bank statements – and being sure that we understand any differences. The only difference we should have are timing differences; e.g. we pay a cheque but it’s not cleared at the bank yet. Accountants call this checking process bank reconciliation, but 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 that looks dubious and correct when you find something that needs correcting. Remember, if a customer balance is wrong then your sales figure could also be wrong.

Lets move on to the supplier balances. Again, most business owners are very aware of who they owe money to, so they will quickly spot anything that’s wrong and we can fix that. Again, if supplier balances are wrong, then your purchased costs could also be wrong.

Finally, we can quickly look at the other assets and liabilities that might be in the balance sheet and 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 happy 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 shareholders 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 an amount owing to the owners. We think of it as a liability to the owners and we call it shareholder funds (or owners equity) for companies or owners capital for non-company businesses.

Shareholders funds are reduced by moneys taken out of the business as dividends or drawings.  So the difference between any two balance sheets represents the profits made by the business in the period, less any profits taken out in the same period – in other words, the profits kept by the business.

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 regularly looking at your reporting, 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 in any business that give feedback, helping you to manage and improve.

  1. The first voice is the voice of the customer, giving feedback on the quality of the service your business is supplying to them.
  2. 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.
  3. 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.

Your accounts should be looked at as a voice of the process. When your accounts are designed and implemented well, they provide extremely valuable information about the performance of the business.

So, rather than thinking of accounts as a compliance-type chore, think instead of the rich information that’s hidden within your accounts – and consider how best to access this.

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 the postive 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 the machinery of your accounts, please do get in contact. We’d love to help you get complete control over your finances and business performance.

Get in touch to arrange a meeting with the AccountsPLUS team 

Turning your financial transactions into insightful information: an engineering perspective

Understanding the nuts and bolts of your accounting really does give you an advantage as a business owner. As we outlined in our last blog post, breaking down your transactions into inputs and outputs (and thinking like a process-driven engineer) is the first step in getting in proper control of your accounts and finances.

The next step is to start thinking about the process that takes the inputs and outputs – the transactions – and organises them in a way that provides information and insights.

Getting genuine insights from your numbers

To get useful business information, we need to group the transactions in a way that makes sense. At its simplest, we can think of sales, expenses, assets and liabilities. However, accounting packages allow us to get even more, and better, analysis.

For example, we can analyse our sales in multiple ways:

  • We can group the sales by product type or by customer type or by customer region.
  • We can group it by salesperson or by selling unit.
  • We can group sales by best-selling product or poorest-performing product.

By thinking this through when we set up our accounts, we can design the system to provide invaluable information about how the business is performing – information that keeps you in control of the future financial path of your enterprise.

For example, one of my clients is a business consultant. When he first came to me, he just had one figure for sales, with no further analysis. As we were speaking, it became clear that he had three very specific, and different, types of sales:

  • One-off projects – where he helped implement improvements for clients.
  • Recurring income – where he was retained by clients on a part-time basis.
  • Training income – where he provided custom in-house training courses for clients.

However, it also became clear from our discussion that he was most focused on increasing the share of sales that was coming from the recurring income. He’d set a goal of increasing that recurring income to be 66% of his business, but at present he had no way of measuring that – and no way of telling if he was meeting that percentage target.

I recommended that he use an accounting package and group his sales into four categories: Projects, Recurring, Training and Other – a final category, to catch anything that was not in the first three.

As he raised his invoices, he could then select the relevant category for the type of sale.  After that, at any time, he can run a report which summarises the sales by category. And, by doing so, he can easily see if he’s on target or not.

By adding these specific categories into your ‘Chart of Accounts’ (the list of different codes in your accounting system), we make it incredibly easy to track and measure every element of your business and its finances.

Magnifying glass, calculator and pen on financial graph, growth concept

Insights into your spending and expenses

We can apply exactly the same categorisation and coding process when looking at expenditure – the cost element of your transactions, where you’re buying from suppliers, whether for resale or for use within the business.

I tend to think of expenses as having a number of main categories:

  • Sales & Marketing costs – creating awareness such as building a website, or producing flyers
  • Building or premises costs – such as rent or maintenance costs
  • Staff costs – such as payroll and bonuses
  • Office-running costs – such as utility bills or software subscriptions
  • Professional costs – such as engaging an accountant, or solicitor
  • Financial costs – such as bank repayments etc.

Within those categories, we can create subcategories to provide additional analysis as we choose. You should choose the categories. The accounts should be working for you – not just for the bank manager, and not just for the Revenue.

Some companies have one ‘big’ expense type in their accounts, while others will chose to break a category down if they think it will help understand what’s happening in the business.   For example, some companies have one category for telephone while others split the telephone cost into mobile and landline. It all depends on what’s most useful for the business. And, crucially, if you have an accounting package then it’s no additional work to simply create a new code in your Chart of Accounts and add a new expense category.

Additionally, many software packages provide a facility to group costs by job or project. While it’s easy to see how this might be useful for a construction company or a project based company, it can also be applied cleverly for other companies.

For example, I have one haulage company who use “projects” to gather the expenses for each truck. In this way, they can easily track fuel, repairs and running costs etc. by truck and can then decide which trucks need to be replaced. It might also indicate if some drivers are more fuel efficient than others.

So think about the type of business that you have and what type of information would be helpful to you in running the business. It’s probably a whole lot easier than you think to code, capture and collate this information.

Putting it all into practice

We’ve outlined how to understand your inputs and outputs, and how to turn this data into insightful reports regarding the performance of the business.

The final step is to combine your basic accounting and financial reporting with a proactive focus on your performance – a topic we’ll cover in the last blog post of this series – “putting your accounting knowledge into practice“.

If you’re looking for assistance with your reporting and business information needs, please do get in contact with us and we’ll show you the ropes.

Get in touch to arrange a meeting with the AccountsPLUS team