Cash Flow Analysis

Cash flow analysis is very important as a business tool. Cash flow is the lifeblood of any business, whether you have a small one-person business run from your home or a large business with multiple locations and many employees. If there’s not enough cash coming in, there’s not enough cash to pay the bills or pay employees or to invest in your business.

Do you need additional small business financing or do you have money to invest back into the business?

Do you have slow periods throughout the year that you need to save for?

You will know if you keep track of your cash flow.

cash flow analysis

To a lot of business owners, though, financial statements are very intimidating, so they don’t take as much of an interest in them as they should.  Some small business owners just use a checkbook as their accounting system (gasp!).

Even so, just looking at the cash balances on your balance sheet (or your checkbook) is only a snapshot of a moment, really, not a look forward. Looking at two or three balance sheets together, say for three months in a row or three years in a row, will give you a better indication if your cash is growing or decreasing, but that too is only seeing the surface.

So how do you figure all this out?

Let’s keep things simple.

You’re going to need a calculator and some ledger paper or graph paper if you feel better with pen and paper, or if you’re comfortable using Microsoft Excel (or some other spreadsheet software) just open a new file.

At the top of the sheet, title the first column “description”, then head one column for each of the next 6 weeks. For our purposes here, we’re going to use this time line. If you want to use 4 weeks, or 6 months, or some other time frame, feel free. If you’re doing this to obtain bank financing, you’ll want to use each month for the next year. But that’s a little more involved.

On the first row, enter your current cash available, which you can get from your current bank statements. This is the starting point.

On the next few rows, list out each revenue stream your business has. For example, if you run a video store, you may have dvd rentals, dvd sales, late fees, etc. Then you’ll want a row for Total Cash In.

The next section is for expenses, or Cash Out. Here list everything you have to pay out every month, like utility payments, mortgage or rent payments, employee payroll, etc. Again, you’ll want a row labeled Total Cash Out.

Skip a line and title the next row Total Cash Available. This will be the difference between your Cash In and your Cash Out. Hopefully it’s a positive number!

Next in your cash flow analysis begin filling in your columns for each week in the appropriate row. To estimate your cash inflow, estimate your sales for the next 6 weeks.

A good way to do this is pull out your bank deposits for the last 3 months, and add up your weekly receipts for each of these months.  Next, see if there is a pattern, or take an average.

For your cash outflow, list your bills in the appropriate weeks based on the date you would make the payment.

For example:

Sample Cash Flow Analysis

cash flow forecast

To start off our cash flow analysis, we have $1000 in Week 1 listed as Beginning Cash. This amount is in this storekeepers bank account right now. That’s our starting point.

The next step in our cash flow analysis is to add up our expected revenues for the first week, which in this case are weekly dvd rentals, dvd sales, and late fees received. Add those together for each week to get the Total Cash In. For the first week this would be $3175.

Add to the Beginning Cash of $1000 and you get $4175. This is your Total Cash Available for this week.

The next step in our Cash Flow Analysis is to add up all your bill and loan payments for this week. This is your Total Cash Out.

Take your Total Cash Available and subtract your Total Cash Out for this week. This will give you your Cash Over/Short.

If it’s a positive number that is cash over, meaning you will have cash left over after paying everything for that week. If it’s negative, obviously you won’t have any cash left over, and you won’t be able to pay everything that week.

The next step in our Cash Flow Analysis is to take your Cash Over/Short from the first week, and place at the top of the next week’s column as Beginning Cash. Then go thru the process again until you have all your columns filled in.

This little exercise shows this store owner many things.

First of all, it shows a cash gain of $990 for this 6-week period.

However, this cash flow analysis also shows that one of those weeks, Week #4, has a negative cash flow for that week, so they won’t be able to pay all their bills for this week.

It also shows that one week out of each month has higher sales.

The store owner can now make some informed decisions to positively influence their cash flow. It might be possible to lower the payroll cost for Week #4 to lower the expenses for that week, or to place an ad or have a sale to increase rentals in that week, etc.

Now the owner is more informed about the business, and can make detailed decisions to better manage this business. They might want to buy more dvd’s to rent out, for example, or run some advertisements, and this cash flow analysis will show them if they have the resources to do so.

This process should be updated regularly, so you can see how your decisions affect the business, either positively or negatively.

As you can see, cash flow is indeed the lifeblood of every business, and a cash flow analysis is an important tool for any business owner to use for decision-making.

If you’d like to see a 12 Month Cashflow Projection, click here.

 

How to Prepare Cash Flow Statement

If you want to dig a little deeper than profit and see how your business operates on a financial level, prepare a Cash Flow Statement.

The Cash Flow Statement is one of the 3 basic accounting financial statements. The other two are the Balance Sheet, and the Income Statement.

A Cash Flow Statement can be one of a couple different varieties, but I’m going to focus on this simple example below, starting with the beginning cash balance for the period.

cash flow statement

This Statement of Cash Flow has 3 sections, Operations, Investing Activities, and Financing Activities.

All that means is we’re analyzing our cash inflow and outflow from day to day business (operations), from buying and selling assets and investments (investing), and from borrowing money and buying or selling stock in our business (financing). Of course, you’ll only have the stock issues if your small business is a corporation.

Cash Flow Statement sections

In the first section, Operations, we look at our cash flow from day to day business.

This statement shows us our cash inflow was receipts from customers of $693,200.

Our day to day uses of cash were buying inventory, paying for general expenses (rent, utilities, etc), paying payroll, and paying interest and taxes. This left us with $147,900 in cash left over, so we have a net inflow of cash from operations. This is good. It means our small business is paying for itself and then some.

If the final number in this section was negative, then we’d know our small business was not covering the basic expenses. Some decisions would have to be made on how to improve the situation. For example, cut expenses or increase sales.

The next section is Investing Activities.

Cash inflows would be sales of assets or investments. Here in this example we have a sale of equipment.

The cash outflows (or uses of cash) in this section of the Statement of Cash Flows is a purchase of equipment.

What probably happened here is this company sold an old asset and purchased a new one. This has caused a negative cash flow from investing activities.

The last section is Financing Activities.

In this section, you might see receipts from selling some of your company stock or borrowing funds from a bank, and payouts for things like buying back your company stock, paying down a loan, or paying one off, and issuing dividends. Again, if your small business is not a corporation, you won’t see this type of activity. You would see borrowing or paying off of loans, though, just not the stock activity.

So, to summarize the Cash Flow Statement above, this company started out their year with $15,700. Throughout the year, the business contributed $147,900 in cash from day to day business, used $41,400 to purchase equipment, and used $87,000 paying down loans and issuing dividends. This all left them with $19,500 in cash at the end of the year. Which is better than they started with, and that’s a good thing.

What does that mean to you?

You might say, I only run a small business, how would this help me?

Well, a Statement of Cash Flows tells you how much cash your business has, how it’s used, and how you can improve your cash situation.

How, you ask?

Do you have a lot of cash on hand? Nice problem to have, right? Well, the Cash Flow Statement shows you some options. Look at the operations section. You could pay off some bills. Look at the investing section. You can buy some equipment or invest in securities, or maybe even a side business or new location. Look at the financing section, you could issue dividends or pay down a loan.

Have a negative cash flow? The Statement of Cash Flows can also give you an idea of how to improve that flow. Cut expenses, sell some equipment, borrow some money, sell an investment, etc.

Not sure where your cash is going?

The Statement of Cash Flows is a great way to find the answer. Right here in one report you’ll find where your cash went. Maybe it went to pay bills and payroll or make loan payments.

So, you can now see that the Cash Flow Statement is very useful for your small business.

 

Are you having cash flow troubles?  If you need help finding out where the trouble is, I can help.  I can analyze your financial situation and help your business be more profitable.  Use the contact me form here.

The Income Statement

An Income Statement is a very important resource for the small business owner.  You should prepare and analyze your every month.  If you’re unfamiliar with this tool, read on.

What is an Income Statement?

An Income Statement is a financial report that lists all the revenue (Sales and other income) and expenses for your small business for a stated period of time. This time period could be a month, or a year, or several years. You may also hear the term ‘Profit & Loss Statement’ or “P&L” for short. This is referring to the same report.

It may seem intimidating to look at a corporate Income Statement showing several years worth of financial data, but luckily most small businesses require only a modest statement of earnings and expenses, culminating in a bottom line figure of net profit or loss for the time period.

 

Income or Profit??

These two words sometimes seem to be used interchangeably, and this can be confusing, but I’ll try to make it simple.

INCOME means revenue, which means sales dollars.

NET INCOME means profit. The “NET” means after subtracting expenses.

PROFIT means a positive figure left after you subtract your expenses from your income. It means you made something on your investment of time and money put into your small business, as opposed to a LOSS, which means your expenses are greater than your income. That’s not a good thing.

Let’s look at a couple very simple examples.

Here’s the first simple example:

sample income statement

This is an Income Statement for an attorney. Take a good look at it.

Revenue is listed first. She only has one stream of income, her legal fees. If you have more than one stream of income, such as lawn mowing and tree removal, or food and liquor, you would list each income stream on its own line on your Income Statement.

Expenses are listed next. You see the usual small business expenses here, rent, salaries, phone, etc. These are totaled and subtracted from Total Revenue.

The result of the calculation is a Profit, or Net Income. Had expenses been more than income, this would be a loss.

Look a little deeper, and we can see more about this business.

If there were any strange expenses, we would see it here. If she had been sued, for example, we’d see a large figure for legal fees expense. Also, note that her profit is about 50% of her income. That’s awesome!

Now let’s look at another example.

This Statement is for a dry cleaners. Note again that revenue is listed first, then the expenses. This small business is earning a Profit too, but notice it’s smaller. There is a smaller profit margin for this industry.

WHAT IS PROFIT MARGIN?

Profit Margin is the Net Income (aka Profit) divided by Total Revenue, in this case it’s $15515/$51690 or 30%. Remember in the other example it was about 50%.

Also note the depreciation expense. This alerts you to the fact that they own their building and cleaning equipment.

These statements are very quickly computed for you if you’re using Quickbooks or another small business computer software program.

They are also fairly easy to prepare if you have, let’s say, a month of deposit slips and check stubs.

Add your income together from the deposit slips. Then separate the information from your check stubs by expense, and list your expenses out and total them up. You should have a list of, say, rent, utilities, phone, insurance, supplies, etc. Then just subtract the Total Expenses from your Income, and there you have a Profit or Loss figure for that month.

If you’d like to learn more about preparing an income statement without using accounting software, check out my manual accounting system ebook.  It’s free.

 

The Balance Sheet

How to Read one
How to Prepare One

The Balance Sheet is one of the 3 basic Financial Statements.  These are the Balance Sheet, the Income Statement, and the Statement of Cash Flow.  It is an important tool to help you manage and run your small business.

The Balance Sheet is prepared as of a certain date, for example, as of December 31, 2017, and tells you what your business owns, what it owes, and what it is worth, as of that date in time.

 

There are 3 basic pieces or sections of a Balance Sheet:

1) What your business owns – these are your Assets.

2) What your business owes – these are your Liabilities.

3) What your business is worth – this is your Equity. Also called Net Worth or Capital.

Assets are always listed first, then Liabilities and Equity, and they are listed together.

sample balance sheet

As you can see from the sample above, the Assets are listed first, and totaled (Total Assets).

Then the Liabilities are listed and totaled (Total Liabilities).

Then the Equity is listed, totaled (Total Equity).

The Liabilities and Equity are added together (Total Liablities and Equity), and that should equal your Total Assets.

OK, but what is included in each of these sections, right?

 

Assets

Assets are things your business owns, like cash, receivables, buildings, and vehicles.

There are 3 different types of Assets:

1) Current Assets – cash or things that can be quickly converted into cash, like receivables, cd’s or money market accounts, inventory, etc.

2) Plant & Equipment – buildings, equipment, vehicles, these are longer in life than Current Assets, and are depreciated.

3) Intangible Assets – these are more subjective things, like Goodwill or a Customer List, that are mainly used when you purchase a business. For example, you purchase a business for $100,000, when the assets purchased equal $80,000, but you paid more for it because it’s a popular restaurant, for example. The $20,000 extra you paid is for “goodwill”.

 

Liabilities

Liabilities are things you owe – payroll taxes, loans, etc.

And there are 2 types:

1)Current Liabilities – things you need to pay within a year, like payroll taxes, short-term loans or lines of credit.

2)Long-term Liabilities – things you will be paying on more than a year, like a vehicle loan, or building loan, etc.

 

Equity

Equity is a quick way to see how much your business is worth, but there are many factors, so don’t panic if your Equity is kind of small.

Equity is the most confusing of the 3 parts of a Balance Sheet, but only because it changes with the type of business, be it a sole proprietorship, a partnership, or a corporation.

For a sole proprietorship, Equity will consist of:
Owner’s Capital

For a partnership, Equity will consist of:

Owner 1 Capital
Owner 2 Capital

For a corporation, Equity will consist of:
Common Stock
Retained Earnings
Dividends Paid

 

Now you know the basic sections of a Balance Sheet. But how do you read one?

Reading a Balance Sheet is quite simple.

Take a quick look at the Assets.

What kind of Assets does this company own?  How much cash do they have? Are they carrying a lot of Inventory? Do they have a lot of Receivables? Maybe they’re not too good at collecting? Do they have Equipment or Buildings?  In the sample here, you can see this company has quite a bit of cash, and has more Current Assets than Plant & Equipment, and no Intangibles. That may be good or bad, depending on the industry.

Next, take a quick look at the Liabilities.

What’s the amount of Total Liabilities compared to Total Assets? Do they have a large debt load? In the sample, you’ll see an amount labeled “Accrued Expenses” – this means they have expenses due in the future that they have already incurred, the best example of this is payroll taxes due at the end of the quarter.

Also notice that Total Current Liabilities is less than Total Current Assets. This is good, and it is called the Current Ratio. What it means is that if you had to, you could convert your Current Assets to cash, and pay off your Current Liabilities.

Take a look at Equity.

The sample shows us a corporation, so the Equity section consists of Common Stock, and 2 other items we haven’t covered. Additional Paid-in Capital is used when someone pays more than stated value for their Stock. Retained Earnings simply is an accumulation of net incomes (profit) or losses for the years this small business has been in operation. A positive number tells you this business has had more profit than loss.

 

If you want to know more about a company, yours included, take a look at two or three years of  Balance Sheets.  Compare year to year.  Is cash increasing or decreasing? What about Inventories and Receivables?  If they are increasing due to increased Sales, that’s to be expected. Are liabilities increasing or decreasing?  If Equity is increasing, the business should be making profits.  But it could also mean the owner is putting money into the business.  You can learn a lot by comparing a couple years of Balance Sheets.

7 simple tools for a basic accounting analysis of your business.

 

Here are 7 simple, commonsense ways to keep your business healthy.

A basic accounting analysis will show you what kind of shape your small business is in.  There are a lot of ways to do this. Some business owners use their checking account balance as a guide. Others let the bottom line on their Income Statement do the talking. The truth is, you should monitor several accounting basics to keep your business on track.

accounting analysis

Here are 7 basic accounting analysis tools to use to monitor your business.

1. Balance Sheet
Let’s start our basic accounting analysis with the Balance Sheet. This financial statement gets ignored by a lot of small business owners, but it’s a very important tool.

What is on a basic accounting Balance Sheet? Assets, Liabilities, Equity. Remember this equation:

Assets – Liabilities = Equity

Put simply, this means what you own minus what you owe is your business net worth. If you owe more than you own, you end up with a negative net worth. Not good.

But there’s more to a simple accounting analysis then just looking at this equation.

The Balance Sheet also shows you more details, like how much cash you have, how much customers owe you (accounts receivable), how many bills you owe (accounts payable), how much you owe in loans, and how much your business has earned up to now (equity or retained earnings).  It also shows you if those figures are increasing with time or decreasing.

2. Cash Balance

Your cash balance is on your Balance Sheet, but it bears digging into.  How much is in your checking and savings accounts? Cash is vital to your small business health. You can’t survive without it.  If you have to keep borrowing, your debt will overtake your assets, and your net worth will disappear. And banks don’t like negative cash flow. So monitor your cash balance.  Reconcile your bank statement every month. Know when your business cycles up and down, and plan ahead to make sure you have the cash you need to move ahead.

3. Income Statement

The next step in your basic accounting analysis is to take a look at your Income Statement each month. Your Profit is your bottom line. But it’s so much more than that. Your basic accounting analysis should dig deeper than just your Profit or Loss number.

Look at your total revenue and total expenses. Are they increasing or decreasing? Ask your accountant for a comparative Income Statement. This shows the comparison of this month and this year to date with last year, this month, and last year, year to date.

That way you can see at a glance what expenses are increasing, for instance. If you’re doing financial statements yourself, just keep copies of your Income Statements, and lay last years next to this years, and compare.

4. Statement of Cash Flow

This financial statement is another step in your basic accounting analysis. It takes the change in your cash balance for a time period, usually a year, and dissects that change into 3 areas – operations, financing, and investments.  From this statement you can see whether your business is holding its own just from operations, or needs influxes of cash from sources outside day to day operations to keep afloat.

Let’s say you have a $50,000 increase in cash for the year. Great, right? Maybe. Maybe not.  Look deeper. If most of that increase came from operating activities (day to day operations), that is great. But if it came from financing activities (loans) or investing activities (liquidating investments) then it’s not so great. Your operations should provide your cash flow.  So this statement should be prepared at least at the end of every year. Make it part of your accounting basics.

5 – Employee Turnover

Another part of your basic accounting analysis is taking a look at your employee turnover. Do employees stay a while or leave right away?  Certain employees are a very important part of your business. They may be the ones greeting customers, or helping customers on the phone, buying your materials, or selling your product. The longer they work for you the more wealth of knowledge they have, the more your customers count on them, and the harder they’ll be to replace. Each new employee needs training. That takes time and money. In some businesses, your employees are your business.

If you have trouble keeping people, find out why and rectify the problem. You’ll save money in the long run. And remember, you’re employees are out there talking about you. Make sure it’s positive!

6 – Supplier Relations

How well do you get along with your suppliers? When you need something in a pinch, are they willing to work with you or do they not return your phone calls?  No basic accounting analysis would be complete without looking into the strength of your supply chain. Make sure you pay on time, and take a little time to develop a personal relationship. You don’t have to be buddies, but make some time for those sales reps. If they know you, they’re more apt to go to bat for you in a pinch to get what you need.

7 – Customer Relations

Last on my list, but certainly not any less important, is customer relations. How are your customers? Do they come back for more? Do they send their friends to you? Are they angry or happy with you?  This is an important part of your basic accounting analysis because there is no business without customers. There is no sales income without customers.  Again, word of mouth is the greatest advertising. Make sure your customers are happy and giving you the thumbs up to their friends and business associates.  Keep in touch with them, and let them know how important they are to you.

 

These 7 tools are simple, commonsense things, but if handled well, they will help your business grow and be successful.

If you have positive net worth, a decent amount of cash in your checkbook, a profit, great employees that stick with you, suppliers ready to back you up, and customers raving about you, how can you go wrong?

And if you don’t have all these things? Find out why.

It’s a good idea to take a good look at all these items on a regular basis. Nothing about business is static. It’s always changing.  Spot problems when they’re small and more easily and quickly fixed.

How to properly use a Petty Cash Fund.

petty cash fund, using petty cash

Do you have any cash around the office for quick lunches or buying supplies?

Most businesses can benefit from having a little cash in the office for small incidentals. The trick is to account for everything and keep it safe.

  • get a nice metal LOCKING cash box
  • put a pen and small notebook inside
  • decide on an amount to initially set up your fund. Depending on the size of your business, you may want $50 or $100 in there.
  • keep the box locked at all times, and put in a safe place, either an out of the way drawer or cabinet.
  • Keep your key in a safe place as well. You may want to give a trusted employee a duplicate key if someone else will need access, and you may want a duplicate key to keep elsewhere, in case your gets lost.

Now your petty cash fund is set up – and ready for use.

Make sure your petty cash fund is used for actual business expenses.  This is not for personal use.

As an aside, any business lunches should be documented as to date, persons attending, and business purpose.  A business is allowed to supply a meal for employees if they are in the business location and working.  These meals would be 100% deductible.  Other business lunches are 50% deductible.  You grabbing fast food while out servicing customers is not a business expense, and is not a deductible business expense.  Keep this in mind.

Things I’ve seen clients use petty cash for are a trip down the street for batteries or office supplies, window cleaning or snow shoveling, and a holiday lunch for the office.

Here’s the steps to take when using your petty cash.

  • when you take cash out, use a slip of paper and write down the date, the amount, the reason. For example, June 20, $10, cleaning supplies.
  • put the slip of paper and the receipt back in the cash box.
  • once a week (or month if you don’t use it often) count all your cash and receipts. If you initially put $50 in the box, your cash and receipts should add up to $50. If not, a big red flag pops up! Possibly someone took cash and didn’t put in a slip. Start asking. If it adds up, the system is working.
  • write a check to yourself, go to the bank and cash it. Put the money into your cash box. You have just replenished your petty cash fund.

Then you’re ready to go again!

As you keep using this process, it will get to be second nature to you.  And you will be able to back up each business transaction with a receipt.  Remember, if there’s no paper documentation, it didn’t happen.

Accounting Glossary

 

Do you ever read thru some accounting instructions and wish they’d explain what all the terms mean?

Well, here is an accounting glossary of some basic accounting terms and concepts that are applicable to most standard accounting systems.

standard accounting system

The basic accounting terms I’m listing here are the ones I think most small business owners would need to reference.

If you find a term you think I should add here, let me know by visiting my contact page!

Accounting Glossary Terms

Accounting – The process of recording, classifying, reporting, and interpreting financial data of an organization.

Account  – An accounting devise used to record and summarize increases and decreases in revenue, expense, asset, liability, and equity items.

Accounting equation – An expression stating the equality of assets and equity, stated as such: Assets = Liabiilites + Owner’s Equity.

Account Payable – A debt owed to a creditor for goods or services purchased on credit.

Account Receivable – An amount due from a debtor for good or services sold on credit.

Asset – A property or resource owned by an individual or organization.

Balance Sheet  – A basic accounting financial report showing the assets, liabilities, and owner equity if an organization on a specific date.

Bookkeeping  – The record making phase of accounting. Entering transactions into journals. Paying bills. Preparing sales invoices.

Budgeting  – The phase of accounting that deals with planning the activities of an enterprise and then comparing actual performance to those plans.

Business Transactions – An exchange of goods, services, money, or the right to collect money.

Capital Stock – Ownership equity in a corporation, the result of selling shares of corporate stock to its shareholders.

Chart of Accounts – A list of all accounts being used in a particular standard accounting system, in this order: assets, liabilities, equity, revenue, expenses. See a sample Chart of Accounts here.

Controller – The top accounting officer of a large enterprise. Would be responsible for the entire accounting function, and would report directly to the owners, or possibly to a VP of Finance.

Cost accounting – The part of basic accounting that focuses on collecting and controlling the costs of producing a certain product or service.

Cost of Goods Sold – The cost of producing a good to sell, or the cost of offering a service to your customer. It includes materials to make the goods, labor costs to manufacture the goods (not administrative labor), subcontracted services costs, and freight or postage costs to deliver – whatever specific costs you have to buy to make a good or provide the service.

Equity – A right, claim, or interest in a property. As it pertains to Owner’s Equity, it would be an interest in the organization.

Expense – Goods or services consumed in operating an enterprise.

Income Statement – A basic accounting financial statement showing revenues earned by a business, the expenses incurred in earning that revenue, and the corresponding net income or loss.

Invoice – An itemized statement of goods or services bought and sold.

Journal – Book of original entry in your standard accounting system, in which business transactions are first recorded, and from which transactions are posted to ledger accounts. (think checkbook)

Ledger – A group of accounts used by a business to record its transactions. (like summarizing your checkbook entries into separate lists by name or type of entry)

Liability – A debt owed by the organization.

Posting – The act of transcribing amounts from a journal to a ledger account.

Purchase order – A standard accounting system form. This business form is used by a purchasing department to place an order. It authorizes the supplier to ship the merchandise ordered.

Trial Balance – You probably won’t use this, but you may here it from your CPA. It is a list of your ledger accounts with the balance in each account, and the total of all debit and credit balances, which should equal zero. This is a Chart of Accounts with balances.

Voucher – A business form on which a transaction is summarized, its correction verified, and its recording and payment approved. I think the most widely used voucher is a bill received for goods or services purchased. The bill would be compared to the purchase order, if applicable, verifying that the bill is correct, then the information would be entered into an accounting software system as a voucher, to be paid at a later date.

 

Hope that helps. If you still have questions on certain terms, send me an email, I’d be glad to explain.  When you run a small business, it’s important to understand the mechanics of accounting so you can run your business more profitably.

Having trouble finding the time (or the desire) to do your own bookkeeping?  Give me a call.  I provide bookkeeping and accounting services via my company, Small Business Accounting Solutions.  Spend your time growing your business and let me take care of the books.

What paperwork to keep, and for how long.

This is a question many small business owners ponder.  What to keep and for how long?

Documentation is a word we accountants use that means paper backup for each sale or expense that you report.  It could be a receipt from a store, an invoice copy, or an email receipt for a purchase.  Whatever the business transaction, you need documentation.  This is a very important piece of small business accounting.

If the IRS ever came calling, any expense without proper documentation could be denied. So, yeah, it’s important.

In a previous post, I discussed setting up files for your small business.  Check out that post here.  I talked about Current Files and Reference Files.  Current Files are things you work with every day, or at least weekly, like payroll information, quotes, purchases, deposits, sales invoices, etc.  Reference Files are for information you only need occasionally, things like loan paperwork, contracts, employee files, vendor files, etc.

It’s important to keep your business paperwork together, and in some kind of order where you can find it as you need it.  So whether you’re just starting a business or have been in business a while, an organized office will help you focus on your business.

small business accounting

 

The main thing to remember when thinking about what paperwork to keep and for how long is that you want to prepare accurate, well documented financial statements, and you want backup (documentation) for all revenue and expenses for your tax return.

That’s the point of a good office management system. When your office runs smoothly, and everything you need is at your disposal (meaning you don’t have to root around for days looking for something) you will feel freer to focus on actually running your business, not your desk.

This is also a good argument for using a bookkeeping service.  Letting someone who knows accounting handle your books will take that load off your shoulders and free you to spend more time bringing in revenue.  If you need help, give me a call.  Or check out my website here.

So here’s a list of what you should be keeping in your files, and how long to keep it.

 

Keep the following for 3 to 7 years:

**sales invoices, deposit slips and receipts

**copies of bills or receipts for purchases, as well as credit card statements. Remember that many receipts are made with heat transfer paper, and fade over time. Consider photocopying them for longevity.

**bank statements

**inventory counts

**basic accounting reports you print out for each month. You should be printing or storing a copy of your cash receipts journal, cash disbursement journal, payroll journal, sales journal, accounts payable and receivable journals, and your general ledger and financial statements.  If you aren’t sure what these journals are, you should definitely think about hiring a bookkeeping service.  Give me a call and let’s see how I can help your business be more profitable.

 

Keep the following as long as you are in business:

**tax returns – as well as any correspondence with your tax preparer, and any taxing authorities, too, be it the IRS or your state and local tax department.

**dealings with attorneys, and any legal documents or lawsuits.

**payroll information, including payroll taxes and W-2 forms – you never know when you’ll need something in there, trust me.

**employee benefit information

**loan agreements, lease agreements

**receipts and paperwork on any asset purchases , including furniture, computers, cars, buildings, or equipment, as well as any building improvements.

 

When setting up your office filing system, I suggest you keep your current year and last year paperwork somewhere within arms reach. I try to keep the current year in my desk or close by, and last year in a file drawer nearby. Get some file boxes and keep previous years in another file cabinet or a closet or storage room. You may need to access it but not often.

office management

 

With a firm idea of what small business accounting info to keep and for how long, you should be all set.  If you’re keeping paper files, be sure they’re in a secure location, preferably in a locked filing cabinet.  If you keep stored documents on your computer, make sure you back up often and have your computer set up with a strong antivirus and malware protection.

 

 

How to Calculate Payroll

how to calculate payroll

How to calculate payroll is the next step of how to do payroll.  This is where you actually see how to pay your employees.

If you didn’t start at the beginning of the payroll discussion, check out these pages:

Payroll

Employer Payroll Taxes

Employee Payroll Forms

 

This is a simplified example of small business payroll, for learning purposes, but you will easily learn from this example how the process of calculating payroll is done.

We’ve gone over all the taxes, and the difference between hourly and salary wages, gross pay and net pay. Let’s calculate a sample payroll.

Let’s say we’ve started a vending business, and we’ve hired two kids to fill the machines, Ricky and Dave.

What do we do first?

 

The first step in how to calculate payroll is gathering the necessary information.

  1. We have them fill out an Employment Application Form. This will tell us their full names, birth dates, home address, work history, if any, and someone to call in case of emergency. (also make sure if they are minors they have the right paperwork to be able to work)
  2. We need to have them fill out a Federal Form W-4, and a similar state form, which tells us how to calculate the amount to withhold when we file taxes. Also find out what locality they live in. Is it a city or a township, for example, then find out if there is a local tax.
  3. Have them fill out a Form I-9, from the Department of Immigration. This tells us they are legally allowed to work in the U.S.

 

Revisit our page on employer payroll taxes if you need a refresher.

 

Okay. So we have all the necessary forms, and information we need to calculate payroll on these two.

The next step in how to calculate payroll is to decide how much and and how often to pay them.

Be aware of the Federal and State Minimum Wage, and make sure you pay them at least the minimum required. Go to the website for your state or the Department of Labor to find the latest.

 

Let’s pay them $8.50 per hour, and let’s pay them bi-weekly. That’s every two weeks.

We could pay them weekly, biweekly, semi-monthly (twice a month for example), or monthly.

Let’s say each boy worked 6 hours each week filling our vending machines. And we’re paying them every 2 weeks.

 

To calculate Gross Wages for each boy we calculate it by multiplying the hours by the hourly wage.  In this case that’s $8 x 12 hours.

sample payroll gross pay

 

The next step in calculating payroll is employee payroll taxes.

So what taxes do we need to withhold from each boy’s wage?

  • Social Security Tax of 6.2%
  • Medicare Tax of 1.45%
  • Federal Withholding Tax – use the Federal Withholding Tables
  • State Withholding Tax – use State Withholding Tables
  • Local Withholding Tax – calculate based on percentage for that locality.

For the withholding tables, go online at IRS.gov and your state website and search for ‘tax tables’.

For this example, let’s say we’re operating in Toledo, Ohio. The local tax for Toledo, Ohio is 2.25% of gross wages.
To look up Federal Withholding in the federal tax tables, we need to know the gross wage, whether the employee is single or married, and the number of exemptions claimed. We also need to know the frequency of payment.

We’re paying them biweekly. And we know the gross wages from the calculation above, and we can find the other two tidbits on the employee’s Form W-4 that we had them fill out.

Both boys are single, and are claiming “0” exemptions.

So, look at the Federal Withholding Table for Single – Biweekly. Go down the column on the left, and look for the wage spread that includes $96, then slide over to the column that shows “0” exemptions. This is your federal withholding for that pay.

Then look at the Ohio Withholding Tax Table for “bi-weekly”. Find the wage spread down the right, then slide over to find “0” exemptions. That is your Ohio withholding tax for that pay.

 

how to calculate payroll taxes

Notice that the Net Pay is the Gross Wages less all the payroll taxes.

We would now write the boys checks for $85.86 each.

That’s how you calculate payroll.

However, that’s not the end of the process.  You then have to remit the taxes that you’ve withheld to the proper authorities.  You send the Social Security and Medicare tax x 2 (1 for the employee and 1 for the employer), along with the Federal Withholding taxes to the IRS, and you send the state and local withholding taxes to your state tax department, and you local tax office.  You do this on a monthly or quarterly basis, depending on the size of your payroll.  The taxing authorities will tell you which category you fall in.

 

 

If this all sounds a bit too much for you, send me an email.  I provide payroll services as well as accounting services.

Employee Payroll Forms

 

If you’ve decided to hire employees, you’ll need employee payroll forms.  But which do you need?

Payroll Forms are the forms you have your employees fill out upon hire. These forms are to prove eligibility for employment, to set up their employee payroll taxes and to set up their employee benefits.  This is the next step in learning how to do payroll.

 

Employment Application Form

The first payroll form you need is an Employee Application Form. This form can be purchased or downloaded, and contains an employee’s personal information, employment information, and references.

 

Form W-4

Available at the IRS website, the IRS Form W-4 tells you how much federal withholding tax the employee wants taken out of their pay. This employee payroll tax is based on wage and number of exemptions. On this form your employee will mark Single or Married, and then fill in the number of exemptions they have.

For example, most Single people enter S for Single, and 0 for no exemptions, or 1 for one exemption. Single-0 is the highest level of withholding. Single-1 would be a little less tax withheld. If they are unmarried with children, the number of exemptions would increase by number of children. Beware when you see Single-8. Question that. Keep this form in your employee’s file.

 

Form I-9, Employment Eligibility Verification

This payroll form is available at the website for the U.S. Citizenship and Immigration Services. This form is required to show proof that the employee is authorized to work in the U.S. Make sure you read this form before handing it to someone to fill out. The employee fills out the first section and signs, then you fill in your company info and sign.

You will need copies of documentation, such as a driver’s license and social security card along with the completed form. There is a complete list of acceptable identification with the form. This form is not to mail anywhere, keep it in your files. There is a penalty if they come knocking and you don’t have the form.

 

State Withholding Forms

This employee payroll form will vary by state. In Ohio, we use a Form IT-4, Employee’s Withholding Exemption Certificate. Go online for your state, and find the area on the site for Employers. You should find a comparable form that the employee will fill out and tell you how much state tax to withhold.

Actually, they enter how many exemptions they want to claim. You will be looking on a tax table provided by your state under that number of exemptions to find out how much tax to withhold. More on this later.

You should also find Withholding Tax Tables on that website, too. Print out a copy.

 

Benefits Application Forms

Your benefit providers, such as your medical or dental insurance provider, disability insurance provider, life insurance provider, or the firm that handles your 401k-retirement plan, will give these payroll forms to you. If you don’t have any of these benefits yet, don’t worry about it until you do.

If you engage a firm to provide these benefits, and they talk to you about a Sec. 125 cafeteria plan, say for disability or sick pay benefits or a medical savings plan, think twice about it. A cafeteria plan is a benefits plan that is set up with the IRS to be a pre-tax deduction for your employees.

It requires a year-end tax return, and has to be monitored by someone who knows what they’re doing, which means you pay fees to a firm to handle this. Some people feel these plans are great for the employee. But you need to weigh the costs of setting up and maintaining the plan against the small tax benefits to the employees.

 

Since you’re collecting all these forms for each employee, now is the time to set up employee files.

 

Payroll Forms to keep in your Employee Files

 

Employee Files

This is an important step in learning how to do payroll. These files are very important, both from a tax standpoint, and a legal standpoint.

  • employment application form
  • payroll tax withholding forms
  • employee benefit application forms
  • non-compete agreements
  • testing results

Keep these files up to date.

Regarding benefits, you may want to print out information on your company and keep these in a folder to give new employees.  Things like:

  • vacation/sick pay rules
  • hours of operation
  • medical/dental/life insurance information
  • 401k pension plan info
  • any disability insurance
  • credit union affiliation

Give your employees one of these packets when you hire them. Sort of a ‘welcome to the firm’ packet.

In the next blog post in this series of how to do payroll, I’ll talk about actually calculating some payroll.