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How You Use QuickBooks Can Distort Your Company’s Profitability

Posted on November 21st, 2016

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

As I’ve stated in several previous articles, business owners need to set up their internal accounting properly so that they know whether or not their company is profitable. Today, a large number of small businesses use QuickBooks, as it is heavily promoted as being a “user-friendly” accounting software, and you don’t have to be an “accountant” to use it. And both claims are true.  But as I always tell my clients, these “benefits” are also what make QuickBooks easy to abuse.

In QuickBooks, the key to accounting accuracy lies in the proper set-up of your Items List, Chart of Accounts, and Preferences.  How these are set up and managed in turn control how transactions affect not only what your “forms” look like, but also, the behind-the scenes accounting, and therefore, your profit or loss, the taxes you owe, and when.

Here are just a few examples I’ve seen of how companies can grossly distort their profitability:

  • Maintaining their books on a “cash basis” of accounting. In QuickBooks you can switch back and forth between accrual and cash-basis financial statements. Depending on your type of business, cash basis statements can grossly distort your profit margins, as you are analyzing your collections and disbursements which is a timing issue, NOT your profit or loss – apples and oranges.  Set your Preferences to Accrual.  If your tax return is prepared on a cash basis, most CPA firms have tools that can convert your accrual financial statements back to cash for tax purposes, and in their own tax software, NOT yours. (For more details on this subject, see my previous article, “Profit vs. Taxable Income”.)
  • Using “Non-Inventory Parts” to track inventory purchases.  As Non-Inventory Parts are usually pointed at a cost-of-goods-sold account, your costs may be posted in one month and your revenues in another.  This then causes your profit margins to be wrong in both accounting periods so that you can’t tell how you did in either one.  (Note: At times, for various reasons it may be preferable to use Non-Inventory Parts rather than Inventory Parts, but additional accounting adjustments are then required to get the revenues and costs into the same accounting period.)
  • Using “check” or “bill’ transactions to record inventory purchases in cost-of-good-sold, rather than tracking inventory using Inventory Parts.  Has the same effect as described above.
  • Entering a “Bill” to record a supplier invoice, and then paying it with a “check” transaction rather than the “Pay Bills” feature.  The expense has now been recorded twice.  This is a clear indication that the user does not understand how to use QuickBooks properly.
  • Entering a “Bill Payment” without first having entered a Bill – As Bill Payments affect the balance sheet account Accounts Payable, not the Profit & Loss Statement, the expense has not been recorded at all, and the account payable is now negative (which should never be unless your supplier has issued you a credit). This is another clear indication that the user does not understand how to use QuickBooks properly.

So it’s best to manage your books properly right from the start.  With my clients who do their own data entry, I try to make things as easy as possible by setting up “memorized transactions” for them to use on a day-to-day basis.  This helps keeps the accounting accurate and consistent, and removes all of the guesswork – as opposed to my client essentially having to learn “accounting” and QuickBooks’ unique method of accomplishing it (which some people find extremely frustrating and a non-productive use of their time).

There are numerous other examples I could mention, but the point is, many small businesses use their accounting software as a “checkbook,” thinking their QuickBooks accounting software is “miraculously” putting everything where it belongs behind the scenes – NOT TRUE!  As the old saying goes, “garbage in, garbage out.”  Sooner or later, someone has to clean-up the mess, and hopefully before tax time, or worse, the company is out of business.

In my next article, I will talk about various other indicators that your books are in desperate need of a clean-up.

 


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