Sales Discounts, Returns and Gift Cards

 

Sales Discounts, Returns and Gift Cards are all a fact of life with a lot of small businesses. Even the most simple bookkeeping system needs to have a way to reflect these items.

I’ve worked with manufacturers and retail businesses, and you just have to accept that some merchandise is going to be brought back to you, either because of a defect or just a change of mind on the customer’s part. Even in a service business, a customer may change their mind on you, and cancel your services. And a lot of businesses are now using Gift Cards, too.

So how do you reflect Sales Discounts, Returns and Gift Cards in your simple bookkeeping system?

Let’s go thru each one and take a closer look.

sales discounts, sales returns, gift card accounting, bookkeeping service

Sales Discounts

The first item in this section on Sales Discounts, Returns and Gift Cards is Sales Discounts.  Discounts are reductions to the sales price of an item. It could be for paying within a certain time frame, buying a discontinued product, etc.

For example, let’s say we give a 2% discount for paying an invoice in 10 days. In other words, you’re willing to lose 2% of the invoice amount to get your money quicker, and have less of a chance of having a past due or potentially noncollectable account. This also helps the customer, especially if the invoice amount is rather large.

You want to recognize the entire Sales amount as revenue, then deduct the Sales Discount from it.

Journal Entry:

Debit: Checking Account $90.00
Debit: Sales Discount        $10.00

Credit:Sales Account                                  $100.00

 

Sales Returns

The second item in the category of Sales Discounts, Returns and Gift Cards is Sales Returns.

In accounting class we called these Returns & Allowances. The Allowances part reflects the process of large retail establishments in estimating an allowance of a certain percentage of sales that would be returned, and booking that right up front. Let’s say a large store had sales of $100,000 this month. They would automatically book like 2% of that amount as Sales Returns. Then at the end of the month, they would adjust the Sales Returns account to the actual amount of returns.

In a simple bookkeeping system for a small business, however, just reporting the returns as they occur should suffice.

Let’s say a customer returned a vase to your pottery store. Maybe when they got home they realized it clashed with their drapes (or whatever).

Journal Entry:

Debit: Sales Returns          $50.00

Credit: Checking Account                              $50.00

On your Income Statement, Sales Discounts and Returns would be deducted from your Sales, and called Net Sales.

 

Gift Cards

This brings us to the last installment in this category of Sales Discounts, Returns and Gift Cards.

Not just for the big guys anymore, lots of small businesses use Gift Cards to reward regular customers, and to bring in new customers and increase business.

According to what I’ve been reading lately in the Accounting World, this seems to be an area without direct guidance from FASB – the Federal Accounting Standards Board.

Simple bookkeeping thought tells us a Gift Card is a lot like a Sales Discount, except you never know when, if ever, the Sale will occur.

But I did find some guidance in an article in The CPA Journal. So here’s the skinny on accounting for Gift Cards.

When a customer buys a Gift Card, you record the cash received, and post a liability for that unearned revenue.

When the customer uses the Gift Card, your record the Sale, and decrease your liability, as you’ve paid the customer, as it were.

What if they’re not used right away?

If the cards have an expiration date, and are never used, you can recognize the income (Sale) at the time they expire. However, check with your state as you may have to report that money as unclaimed property.

If the cards do not expire, it seems like you may be carrying that liability on your books forever. It’s estimated that 10% of Gift Cards are never used. Be sure to check with your state’s unclaimed property laws about this first. If there are none, try to estimate the life expectancy of your Gift Cards.

Track the usage, and develop some numbers. For example, maybe 80% of cards are used within 2 months, another 10% used by 6 months, another 5% used within the year, and the last 5% never used.

Document that, and use it as your reasoning to recognize revenue on that last 5% of the value of your Gift Cards sold after a year, instead of leaving that liability on your books forever.

Journal Entry:

Recording the sale of the Gift Card and the corresponding unearned revenue:

Debit: Cash Received                            $50

Credit: Gift Card Unearned Revenue                    $50

Recording the usage of the Gift Card:

Debit: Gift Card Unearned Revenue     $50

Credit: Gift Card Sales                                               $50

 

So, in summary, Sales Discounts, Returns and Gift Cards is of importance to all small businesses.  Sales Discounts and Returns are decreases to Sales, and are posted separately from the Sales Amount. Gift Cards, on the other hand, are different from Sales Discounts and Returns, because they are booked as a liability, then when used, booked as a Sale.

5 hints that your small business accounting system, or lack of one, is hurting your business.

A small business accounting system should help you be more profitable.  How?  You should have at your fingertips the information you need to help you make informed business decisions.  You should know at a glance how much you’ve invoiced this month, who owes you money, and which bills are due this week.  Does your system do that for you?

Or are you still keeping track of your business income and expenses in your checkbook?

And please don’t tell me that’s your personal checkbook, just let me wonder…

If you expect your small business to grow and prosper you need to keep track of all income and expenses, and track your profit and costs as you go along.  Don’t wait til the end of the year and frantically search for deposit slips and receipts so you can get your small business tax return done.  You’ll never make it that way.  My motto is, you need to plan to profit.

One small business owner came to me with a shoebox full of receipts and deposit slips.  He was running a side business helping small companies with their computer problems.  He was just using his personal checkbook to buy what he needed for the business, and putting any money earned in, yep, you guessed it, his personal checking account.  He was very disappointed and alarmed to find out his business had used over $2000 of his personal funds in a year.  He had lost money on his side business and had no inkling of this until year end.  All his business transactions were lost in his personal finances, so he had no way of knowing whether he was making a profit or a loss.

So, whether you’re currently using your checkbook, or an excel spreadsheet, or a combination of online tools to keep your books, there are some telltale signs that your small business accounting system is not cutting it.

  1. You find out at year end that you lost money last year.  This goes along with what I just said above.  You should know throughout the year if you’re making a profit or not.  If your small business accounting system is not giving you that information, it’s not sufficient for your needs.
  2. You don’t always pay your bills on time, because you don’t know what bills are due when.  If you’re paying bills online, that’s fine, but you should have a system that tells you what bills are due by a certain date.  This could be a system of folders by weeks and months, or a software system like QuickBooks or Xero where you can print a payables report.
  3. Customers send you checks and you didn’t know they owed you anything.  Or vice-versa, they owe you money and you don’t know they do, which is much worse.  You should have a system that shows you at a glance which customers you’ve sent invoices to, when the invoice is due, and who hasn’t paid yet.
  4. You want to buy a piece of equipment, but don’t know if you can afford the payments or not.  In a proper accounting system, you know at a glance how much money you have available, and you know from month to month how much profit you’re earning.  If you consistently make a profit of at least $3000 each month, you know you can afford a payment of $400 a month, for example.
  5. You have a great opportunity that falls into your lap – a company wants you to clean out all 30 of their rental homes, and they want a proposal now.  Do you know what your costs are so that you can give them a price that earns you enough to cover costs plus overhead plus profit margin?

Those are just 5 signals that your accounting system is not serving you properly.

If you want your small business to grow and prosper, you need to do more than just deposit the checks and pay the bills.  You should track due dates for your receivables and payables.  You should monitor your income, expenses, and profit each month or quarter, depending on the size of your business.  You should keep track of your direct costs and overhead rate.  And you should price your products or services to cover those costs and your profit.

If your accounting system is not helping you with these things, you need to find a better system or outsource your accounting.

If you’d like help in either area, I can help.  Send me an email or give me a call.  I can help you find a system that fits your needs and gives you the information you need to run a profitable business.

 

Using a Premium Trust Account

In an Insurance Agency, you should be using a Premium Trust Account to hold all your customer premium payments.  These should not be deposited into your normal agency checking account.

This is one reason why accounting for insurance agencies is different than normal accounting procedures for, say, a retail firm.  In a retail organization, customer payments are deposited directly into the normal business checking account, and those payments are considered income.  But insurance agency accounting requires that customer payments be held in trust. And only the commission earned on the premium payment is income.

There are two types of billing in insurance accounting – direct bill and agency bill.

Direct bill is when the insurance carrier directly bills the customer.  The customer then pays the carrier, and you the insurance agent receive your commission after the carrier gets paid from the client.

Agency bill means you the insurance agent invoice the customer, who then pays you, then you pay the carrier for the premium less your commission amount.  For example, if Specialty Brokerage sends you a premium invoice for a customer of $100 at 10% commission, here’s what you would do.

1. Invoice the customer for $100 premium.

2. Deposit the customer’s $100 check into your Premium Trust Account.

3. Send a check from your Trust account to Specialty Brokerage for $90 ($100 less 10% commission).

4. Transfer $10 commission from your Trust account to your regular checking account.

 

If you’re using an insurance agency software, like TAM (The Agency Manager) for instance, the journal entries for using the Trust Account are automatically posted for you.  You then have reports at your disposal like the Premium Trust Report, which lists all the client transactions that affect what must be kept in the account.

If you’re using QuickBooks, for instance, you will have to work around this.  You would have to invoice the customer for the whole premium.  Remember, you don’t want the customer to see the commission amount that you earn. So you’ll have to do separate journal entries to properly account for the receivable and the commission amount.

Journal entries for using a premium trust account

 

Invoice the customer:

Debit=Accounts Receivable…..$100

Credit=Commission Earned…………….$100

Then post this entry:

Debit=Commission Earned…..$ 90

Credit=Insurance Carrier Payable………$ 90

These two entries effectively post $100 into your Accounts Receivable, $90 into a liability account called Insurance Carrier Payable (the amount you owe the insurance carrier), and $10 into an asset account called Commissions Earned.  This Commissions Earned account is for recognizing the revenue you have earned but not yet received.

The customer pays you:

Debit=Premium Trust Account…..$100

Credit=Accounts Receivable……………….$100

This entry closes out the receivable as paid. You would then deposit the money into your Trust bank account.  Then you would pay the carrier, Specialty Brokerage the net amount of $90, keeping the $10 commission as your income for the sale.

You pay the carrier:

Debit=Insurance Carrier Payable….$ 90

Credit=Premium Trust Account…………….$ 90

Now you can move the commission amount to your regular checking account.

Debit=Agency Checking Account….$ 10

Credit=Premium Trust Account…………….. $ 10

Then recognize the funds received as income:

Debit=Commissions Earned………..$ 10

Credit=Commissions Income…………………$ 10

This is the proper way to account for the commissions received, but you could combine the two steps and just post the $10 commission to your revenue account in the ‘invoice the customer’ journal entry.  This would then eliminate the need for this last journal entry.

These are the steps for proper accounting for customer premium payments in insurance agency accounting.

 

I have over 10 years experience working with insurance accounting.  If you need any help, feel free to use the link below to send me an email.  After you click the link, scroll down the page to the contact link.

Send me an email.

How to Calculate your Overhead Rate

Have you ever contemplated the true cost of a sale for your business?

A good way to do that is to calculate your overhead costs.

Let’s say you provide computer repair services.  Think about all the costs of providing your repair services.  You have your time, and the mileage costs to get you to the customer, and the cost of whatever part or equipment they need installed or replaced.  But what about your overhead costs?

What is overhead you ask?

Overhead is all the costs of doing business that are not directly associated with your product or service. Some examples of overhead costs would be:

  1. Rent
  2. Administrative/office personnel payroll
  3. Utilities
  4. Advertising
  5. Accounting / Legal costs
  6. IT Services
  7. Supplies

Let’s dissect the costs for the computer repair service company.

 

First, there’s the direct costs of providing the service, then there’s the indirect costs, or overhead.

Direct Costs:

  1. Direct Labor – you and/or employees who directly work on the computers
  2. Direct Materials – the parts/equipment you hook up/replace
  3. Freight – travel costs you incur getting to/from the customer

Indirect Costs:

  1. Rent of your storefront/office space
  2. Heat/electric/phone/internet for your store/office
  3. Payroll for any office personnel
  4. Advertising costs
  5. Accounting/legal costs
  6. Dues/subscriptions to trade publications/organizations

 

To figure out your Overhead Rate, you add up all your Overhead costs – estimated – for a year.  Let’s say they add up to $100,000.

Next, estimate the total number of labor hours available to work.  If you are the only worker, and you work 40 hours a week for 50 weeks a year, that’s 2000 hours.

 

Take your total Overhead Costs divided by your total Labor Hours to get your Overhead Rate.

In the example here, that would be $100,000 / 2,000 hours = $50 per hour.  If you have one employee besides yourself who works the same 40 hours for 50 weeks a year, you would add your 2000 hours/year and the employee’s 2000 hours per year to get the total Labor Hours.  The calculation would be $100,000 / 4,000 hours = $25 per hour.

 

Let’s say you send your employee to a customer’s place of business to install a computer and get it working.

You have Direct Costs:

Costs of Computer $600
Labor Costs $  50  1 employee for 2 hours at $20/hour + benefits
Travel $  20  40 mile round trip at $0.50/mile
Total Direct Costs $670

 

And you have Overhead:

2 hours at $25/hour $  50
TOTAL COST OF SERVICE $720

 

 

Add the Direct Costs and the Overhead to get your Total Cost of Service.

 

Now, make sure your billing rate is more than your cost and you will make a profit.

 

The important thing to remember about your Overhead Rate is that costs change.  Prices go up.   Try to keep your costs stable.  It’s also a good idea to periodically recalculate your Overhead Rate to make sure you are charging enough to cover your costs and earn a profit.

How to set up a Small Business Accounting System

How to set up a system to take care of all your basic accounting needs.

Small business accounting systems are relatively easy to set up, once you know what you need.  I’m going to outline those needs here.  There are a few things you’re going to need for a manual accounting system that would be done for you in a computerized system.  I’ll differentiate that for you.

small business accounting systems

I have set up many small business accounting systems, both manual and computerized, and even converted manual systems into computerized systems, so I can help guide you thru the steps to get you started.

If you’re just opening a small business, you’ll be starting from scratch. If you’ve already got a business going, but your records aren’t what you’d like them to be, you can always convert what you’ve got into a system that will work better for you.

So, let’s get started!

 

What do you need to set up your small business accounting system?

 

1. You need a separate checking and savings account. If you like, set up online banking for your business as well. Order checks and deposit slips with your company name and address on them, add your logo if you have one.

2. You will need a cash disbursements journal to track your expenses and other purchases. Please don’t just use your checkbook.  Your checkbook journal may seem to be enough now, but it’s best to set up a separate journal, be it in Excel or in a pad of 13-column accounting paper. For more on this, see my page on the cash disbursements journal.  If you’re using accounting software, the software takes care of this for you.

3. You will need a cash receipts journal, to track your receipts for sales collected. A pile of deposit slips just doesn’t cut it when you want to know which customer you made the most sales to. You can set up a simple Excel spreadsheet or use that same accounting 13-column pad you may be using for your cash disbursements journal. For more on this see my page on the cash receipts journal.

Just a note, accounting journals will automatically generate in a computerized accounting system. When you prepare a check or post a deposit, these are automatically added to the appropriate accounting journal.

4. Payroll files. Do you have or are you planning to have employees? Will you do payroll yourself, or hire a payroll service provider? Either way, you should set up a file for each employee. Go here for a more complete discussion on Payroll, Employee Payroll Forms, Employer Payroll Taxes, and How to Calculate Payroll.

5. For you computer users:
a. You will need to set up your company in your accounting software. Look for a “company” tab. Fill in your company name, address, etc.
b. You will also need to set up your customers and vendors into the system. Fill in name, address, terms (how often you pay…if you pay in 30 days, for example, use net 30), etc. for your customers and vendors. Remember, you can always add new ones later on.
c. Set up your employees as well. Fill in name, address, taxing information, etc.
d. You can individualize your invoices in most software packages. You can add your logo, change fields around or eliminate some if you wish.

6. Set up an initial Chart of Accounts. This is a list of Accounting Ledger Accounts you will be using, such as Cash, Accounts Receivable, Inventory, Equipment, Income, Rent, Insurance, Supplies, and on and on. For more on this, check out Sample Chart of Accounts.  If you’re using accounting software, they have a chart of accounts for you to start with.

7. Put together an initial Balance Sheet. If you are just opening a small business, you won’t have much. Maybe you got a loan from your cousin-in-law for $5000, and bought $1500 in equipment.

Here’s what you’d have:

Assets:
Cash of $3500
Equipment for $1500

Liabilities:
Note Payable of $5000

Pretty simple, but this will be the beginning of your enterprise. This entry will be your opening journal entry in a computerized system.  In a manual accounting system, just keep this initial Balance Sheet on file.  You’ll need it for your business tax return. Also, this will be helpful in preparing a small business plan.

For more on setting up your first Balance Sheet, click here.

8. Set up a filing system. You should have what I call Current Files, for things you need access to regularly, and Reference Files, for things you need, but don’t need often. See my page on Accounting File Management.

9. Invoices – in manual small business accounting systems, you will need to buy ready made invoices, or make your own with Microsoft Word or Publisher, or even go to a print shop and have some made for you. You may also want Purchase Orders, if you plan on using them.  For software users, invoices within the system can be edited as you like.

 

There you have the main steps for setting up a small business accounting system.

After these steps you will be able to buy materials and pay the rent, invoice your customers, accept payments and deposit the monies into your business account. You will then enter the information for your payments to your cash disbursements journal, and your deposits to your cash receipts journal.  This will give you the information you need to prepare an Income Statement (a.k.a. Profit and Loss Statement) at month end to see how your small business is doing.

 

Have questions?  Send me an email.  Not sure if you really want to set up your own small business accounting system?  Would you rather let someone else get things set up for you?  If you’re looking for system set up services, or bookkeeping services, we can help.  We have plans to fit all needs, however large or small.  So whether you have a question or need my services, send me an email here.

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.