How detailed, thorough, and complete are your small business accounting practices?

Many people outside the small business world, and too many inside it, often confuse record keeping and small business accounting. Record keeping is a subset of your small business accounting operation. So, in that sense they are related, but nevertheless completely different entities. In an ideal company, record keepers would be mainly responsible for the “recording” of data and information. It takes a fully-qualified small business accounting expert to do the work of not just amassing and organizing all the data and information that goes into the “books” and financial statements, but can also expertly analyze and interpret all the information and data. This is necessary for two reasons. First, only a qualified small business accounting professional is able to determine both the short-term and well as long-term financial health of the company. Second, only a fully-trained small business accounting professional is qualified to correctly know and follow all of the complex tax laws when it comes to end-of-year tax filings.

Cash Flow
The company’s cash flow is generated by three fundamental components through which cash flows in and out. They are: Operations, Investing, and Financing. The cash flow measurements derived from the business’s every day core operations include, but are not limited to: how much money is generated from the sale of a company’s products or services, the money paid to vendors, wholesalers, suppliers, equipment and its depreciation, accounts receivable, accounts payable, inventory control, etc. They are all part of a SMBs core business operations and are reflected in the Cash flow Statement.

Financial Statements
Financial statements provide records of all the financial activities of a business. These written reports quantify the financial health and performance of the company. They include Statements of Cash Flow, Balance Sheets, Income Statements, and others. Company owners and small business accounting consultants use them to get a realistic sense of the profitability and overall success, or financial failings, of SMBs as well as the status of actual cash flow. Financial statements provide a detailed quantitative analysis of the company’s financial activities, for both tax submissions as well as any audits required by government agencies.
The Financial Statement germane to our purpose here is to explain the Statement of Cash Flows, or the Cash Flow Statement. Think of your cash flow like you do your checking account and checkbook. All of the recordings made to your checkbook represent money that enters your checking account, as well as all of the money that is deducted from it. Your checkbook, which carefully records every transaction that involves money flowing either into or out of your checking account, is analogous to an SMB’s Cash Flow Statement. A Cash Flow Statement is the financial statement that accurately and represents all cash flows moving through the company’s financial holdings and dealings, for a given time period. Some small business accounting consultants consider the company’s Cash Flow Statement to be the most important of all financial statements, given the assumption that cash flow is king, and the necessary “grease” that keeps every aspect of the company’s functioning smoothly and powerfully.

Income Statement
Skipping over explaining the Balance Financial Statements, let’s move onto the Income Statement, often referred to as the “Profit and Loss Statement.” It is the summary of a company’s profits and losses during a given time period just like the Cash Flow Statement. It is an important indicator of a company’s profitability—the potential to make money selling its services or products. If the ending Balance Sheet reports that profits have exceeded losses since the beginning Balance Sheet shows, the company is successful making money. There is one important issue necessary to understand because failing to lead to cash flow problems. The issue has to do with understanding the difference between the Income Statement and the Cash flow Statement, an issue many are confused about, even some SMB owners, because it can give them a false sense of the cash flow available to them.

Cash Flow Statement
While the Income Statement is a detailed reflection of the company’s revenues, expenses, gains, and losses—how much money it has made or lost—it is not an accurate reflection of all cash money actually in hand. It is the Cash Flow Statement that is the record of the actual monies that the company has in hand or has paid out in real time. This is different than the Income Statement, which shows an accurate account of present and future incoming and outgoing cash, either in the form of recorded credit or accounts receivable, but not yet actually received, as well as accounts payable, which are not yet paid because usually deferred according to terms established between you and your vendors, suppliers, etc. This means that only paying attention to the Income Statement, which small business consultants, especially small business accounting specialists find many SMB owners do, can mislead them into thinking that what they actually have literally on hand in terms of cash flow is not what they actually have.
Such false readings are partly due to “accrual accounting,” which takes into account receivables and payables, meaning that the revenues reported and reflected in the Income Statement many not have been collected or disbursed yet. The expenses reported on the Income Statement may not have actually been paid at the time the owner is looking at the Income Statement, while at the same time ignoring the Cash Flow Statement. Each company sets up its own terms of payment scheduling. Owners make arrangements with customers they sell products and services to, and there is a given time period, depending on the terms of the account, between when the goods are delivered or the services rendered, and the customer actually pays for them. Due to the common and often necessary usage of accrual accounting methods, the Income Statement may show a sale, which will be recorded as income/profit for the company, but will not yet show up on a Cash flow Statement because it does not represent actual hard cash.

Profit versus Cash
Confusion arises because owners confuse profit with cash. A company may be profitable, yet have little cash on hand. It works both ways. A company’s cash flow may be positive, yet it still may be unprofitable. Positive profitability does not equal positive cash flow and, likewise, positive cash flow does not equal profitability. Once this is clear, you can see the potential for financial disaster if the unwary SMB owner, thinking she is cash rich, spends money during the time that payments have been deferred, so what cash she thought available isn’t. Or, because cash flow is positive, an owner may seek a bank loan, only to be rejected because their Income Statement shows poor profitability. An SMB’s inability to turn a profit is a red flag to any creditor. What happens if a loan is desperately needed at this time to pay bills, taxes, or whatever? The loan not forthcoming means that the incautious SMB owner will not have the funds for whatever pressing issue they face. The bottom line is, failing to understand the detailed and complex interpretations and interactions between the Financial Statement and the Cash flow Statement may result in unsounded cash flow problems.
The following three best record-keeping and small business accounting practices can help to mitigate deadly cash flow problems.

Carefully Manage Accounts Payables
• Practice prompt billing.
• Always have a courteous follow-up.
• Make sure your checking deposits are made in a timely manner.
• Issue invoices promptly.
• Keep careful track of accounts receivable.
• Identify and avoid slow-paying customers.
• Follow-up immediately if payments are slow in coming.

Aggressively Manage Accounts Receivables
• Remain current with suppliers, while retaining the use of funds as long as possible.
• Take full advantage of creditor payment terms—if the payment is due in 30 days, don’t pay in 7 days.
• Use electronic funds transfer to make payments the last day they are due.
• Consider vendors’ offers of discounts for early payments.

Have a rigorous and robust planning policy
• Have, and regularly use, one of the excellent cash management tools available.
• Have a clear sense of cash flow forecasts and be able to identify spikes in cash flow positioning—this will enable your small business to make the best operational, investment, or financial/borrowing decisions.
• Consult a professional accountant, unless you have one in-house, to create, analyze, and interpret the company’s Financial Statements, and then to follow a comprehensive cash flow statement, in order to analyze, and keep track of, all of the sources and uses of cash. This is invaluable for understanding how cash flows in and out of small businesses.

Story by Mark Joseph Manion

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