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The Role of Cost Accounting In Planning Your Business’ Success

Posted on January 29th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Can you point your car in the direction you want to go, step on the gas, and then sit back and wait to arrive at your destination?

Not quite. You can’t let your business run on autopilot either and expect good results. Any business owner knows you need to make numerous adjustments along the way – decisions about marketing, pricing, hiring, investments, and so on.

So, how do you handle the array of questions facing you?  A critical part of the decision-making process is financial planning, of which a major component is cost accounting.

Cost Accounting Helps You Make Informed Decisions

Cost accounting reports and determines the various costs associated with running your business. With cost accounting, you track the cost of all your business functions – raw materials, labor, inventory, and overhead, among others.

Note: Cost accounting differs from financial accounting because it’s only used internally, for decision making. Because financial accounting is employed to produce financial statements for external stakeholders, such as stockholders and the media, it must comply with generally accepted accounting principles (GAAP). Cost accounting does not.

Cost accounting allows you to understand the following:

  1. Cost behavior. For example, will the costs increase or stay the same if production of your product goes up?
  2. Appropriate prices for your goods or services. Once you understand cost behavior, you can tweak your pricing based on the current market. (Sample Price/Volume Analysis.)
  3. Budgeting. You can’t create an effective budget if you don’t know the real costs of the line items. (Sample Budget.)

Is It Hard?

To monitor your company’s costs with this method, you need to pay attention to the two types of costs in any business: fixed and variable.

Fixed costs don’t fluctuate with changes in production or sales. They include:

  • rent
  • insurance
  • dues and subscriptions
  • equipment leases
  • payments on loans
  • management salaries
  • advertising

Variable costs DO change with variations in production and sales. Variable costs include:

  • raw materials
  • hourly wages and commissions
  • utilities
  • inventory
  • office supplies
  • packaging, mailing, and shipping costs

Cost accounting is easier for smaller, less complicated businesses. In QuickBooks, you have the ability to perform “Job Costing,” which is a fairly simple method of associating the related costs to specific customer sales.  This is great for service based companies, or those buying and reselling a single product or products.  The trickier part is getting the costs and revenues into the same accounting period, which QuickBooks does not do FOR you.  At this point manual accounting adjustments are required.

If your product has component parts that make up the final product, you have “Inventory Assemblies” which is a quite a bit more involved in QuickBooks.

Either way, you first need to understand these costs before you can plan your business and make informed business decisions. The more complex your business model, the harder it becomes to assign proper values to all the facets of your company’s functioning. If you’d like to understand the ins and outs of your business better and create sound guidance for internal decision making, consider getting help from a financial professional to set up a cost accounting system that fits your business model.

 


Analyzing the Components of Cash Flow

Posted on January 22nd, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In our previous article, “Cash Flow Management: The Secret to Success,” we provided a broad definition of cash flow and stressed its importance: the sooner you learn how to manage your cash flow, the better your chances of survival.  Furthermore, you will be able to protect your company’s short-term reputation as well as position it for long-term success.

The first step toward taking control of your company’s cash flow is to analyze the components that affect the timing of your cash inflows and outflows. A thorough analysis of these components will reveal problem areas that lead to cash flow gaps in your business. Narrowing, or even closing, these gaps is the key to cash flow management.

Some of the most important components to examine are:

  • Accrual profit or loss. As was explained in our article, “Which is More Important, Profit or Cash flow” and other articles, your profit or loss is a critical component of cash flow, and if it is a loss, over time it will act as a cash drain and threaten your company’s survival. Thus your (accrual) profit is the lifeblood of your business, NOT “just what you pay taxes on.” Do not ignore this number.  Is your mark-up too low?  Is your overhead too high?  Whatever the cause, if you are showing a loss, get to the root of it and fix it.
  • Accounts receivable. Accounts receivable represent sales that have not yet been collected in the form of cash. An accounts receivable balance sheet is created when you sell something to a customer in return for his or her promise to pay at a later date. The longer it takes for your customers to pay on their accounts, the more negative the effect on your cash flow (see “The Relationship Between Turnover Ratios and Cash Flow”).
  • Credit terms. Credit terms are the time limits you set for your customers’ promise to pay for their purchases. Credit terms affect the timing of your cash inflows. A simple way to improve cash flow is to get customers to pay their bills more quickly.
  • Credit policy. A credit policy is the blueprint you use when deciding to extend credit to a customer. The correct credit policy – neither too strict nor too generous – is crucial for a healthy cash flow.
  • Inventory. Inventory describes the extra merchandise or supplies your business keeps on hand to meet the demands of customers. An excessive amount of inventory hurts your cash flow by using up money that could be used for other cash outflows (see “The Relationship Between Turnover Ratios and Cash Flow”). Too many business owners buy inventory based on hopes and dreams instead of what they can realistically sell, and ultimately, must sell it at a loss or simply write it off. Keep your inventory as low as possible.
  • Accounts payable and cash flow. Accounts payable are amounts you owe to your suppliers that are payable at some point in the near future – “near” meaning 30 to 90 days. Without payables and trade credit, you’d have to pay for all goods and services at the time you purchase them and prior to selling your product and receiving payment from your customer. For optimum cash flow management, examine your payables schedule.
  • Matching sources and uses of funds.  The general rule in corporate finance is that long-term assets should be financed with long-term sources of funds, and short-term assets should be financed with short-term sources of funds.  Long term uses of funds include plant and equipment purchases, “permanent working capital” requirements, such as that required to fund sales growth (see “The Effect of Sales Growth on Cash Flow”), or to expand its line of business.  Short-term uses include temporary or seasonal increases in inventory, accounts receivable, etc.

Some cash flow gaps are created intentionally. For example, a business may purchase extra inventory to take advantage of quantity discounts, accelerate cash outflows to take advantage of significant trade discounts.  For other businesses, cash flow gaps are unavoidable.  Take, for example, a company that experiences seasonal fluctuations in its line of business.  This business may normally have cash flow gaps during its peak season and then later fill the gaps with cash surpluses when sales (and therefore, receivables) come back down from the peak part of its season.   These types of cash flow gaps are short-term in nature, and are often filled by external financing sources. Revolving bank lines of credit, and obtaining extended terms on trade credit, are just a few of the external financing options available that you may want to discuss with your bank or suppliers.

The type of cash flow need described under “Matching sources and uses of funds” above, should always be financed with long-term sources of funds such as long-term debt, intermediate sources such as “asset-based” (accounts receivable and inventory) credit facilities, or an equity infusion. To ignore this rule by trying to support these kinds of long-term investments out of cash flow is to potentially create a severe strain on accounts payable causing them to become past due, inviting almost certain financial disaster.

Finally, do NOT take your operating losses or any of the other cash mismanagement symptoms in the above list to your bank and ask them to fix it.  Why?  Because banks are looking to your profit and cash flow in the first place to repay their loan, and an astute business lender will see right through it (see “Larry’s Debt Repayment Strategies, Inc.”). Consequently, your business management skills may become tainted in the bank’s eyes for a long time to come.

 


Cash Flow Management: The Secret to Success

Posted on January 16th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Cash flow is the lifeblood of any small business. Some business experts even say that a healthy cash flow is more important than your business’s ability to deliver its goods and services.

While that might seem counterintuitive, consider this: if you fail to satisfy a customer and lose that customer’s business, you can always work harder to please the next customer. If you fail to have enough cash to pay your suppliers, creditors, or employees, you are out of business!

What is Cash Flow?

Cash flow, simply defined, is the movement of money in and out of your business; these movements are called inflow and outflow. Inflows for your business primarily come from the sale of goods or services to your customers but keep in mind that inflow only occurs when you make a cash sale or collect on receivables. It is the cash that counts! Other examples of cash inflows are borrowed funds, income derived from sales of assets, and investment income from interest.

Outflows for your business are generally the result of paying expenses. Examples of cash outflows include paying employee wages, purchasing inventory or raw materials, purchasing fixed assets, operating costs, paying back loans, and paying taxes.

Note: An accounting professional is the best person to help you learn how your cash flow statement works. He or she can prepare your cash flow statement and explain where the numbers come from. But for a quick overview, here’s a simplified illustration: “Profit vs. Cash Flow Made Easy.

Cash Flow versus Profit

While they might seem similar, profit and cash flow are two entirely different concepts, each with entirely different results. The concept of profit is somewhat broad and only looks at income and expenses over a certain period, say a fiscal quarter. Profit is a useful figure for calculating your taxes and reporting to the IRS, but more importantly, it’s a gauge for monitoring the health of your business: “Which is More Important, Profit or Cash Flow?”

Cash flow, on the other hand, is a more dynamic tool focusing on the day-to-day operations of a business owner. It is concerned with the movement of money in and out of a business. But more important, it is concerned with the times at which the movement of the money takes place.

In theory, even profitable companies can go bankrupt. It would take a lot of negligence and total disregard for cash flow, but it is possible. Consider how the difference between profit and cash flow relate to your business.

Example 1: If your retail business bought a $1,000 item and turned around to sell it for $2,000, then you have made a $1,000 profit. But what if the buyer of the item is slow to pay his or her bill, and six months pass before you collect on the account? Your retail business may still show a profit, but what about the bills it has to pay during that six-month period? You may not have the cash to pay the bills despite the profits you earned on the sale. Furthermore, this cash flow gap may cause you to miss other profit opportunities, damage your credit rating, and force you to take out loans and create debt. If this mistake is repeated enough times, you may go bankrupt.

Example 2: Another example is a business that is growing rapidly, such that it’s increased spending on inventory and overhead expenses to support sales growth surpass its incoming receivable collections creating a negative cash flow, which continues until the rate of growth tapers off to a sustainable level of sales (net positive receivable collections). This negative cash flow phenomenon, which I’ll call “permanent working capital,” is illustrated in our previous article, “The Effect of Sales Growth on Cash Flow.” Left unchecked, this scenario can also lead to bankruptcy, even if your Profit & Loss Statement reflects a decent profit.

Monitoring and managing your cash flow is important for the vitality of your business. The first signs of financial woe appear in your cash flow statement, giving you time to recognize a forthcoming problem and plan a strategy to deal with it (“Financial Planning, or Business Turnaround – Your Choice”). Furthermore, with periodic cash flow analysis, you can head off those unpleasant financial glitches by recognizing which aspects of your business have the potential to cause cash flow gaps.  In our next article we will analyze these gaps in greater detail.

 


Earlier Filing Deadlines in 2017 for Forms W-2 and 1099

Posted on January 11th, 2017

Starting in 2017 employers and small businesses face an earlier filing deadline of January 31 for Forms W-2. The new January 31 filing deadline also applies to certain Forms 1099-MISC reporting non-employee compensation such as payments to independent contractors. Also of note is that the IRS must also hold some refunds until February 15.

A new federal law, aimed at making it easier for the IRS to detect and prevent refund fraud, will accelerate the W-2 filing deadline for employers to January 31. For similar reasons, the new law also requires the IRS to hold refunds involving two key refundable tax credits until at least February 15 (also new). Here are details on each of these key dates.

New January 31 Deadline for Employers

The Protecting Americans from Tax Hikes (PATH) Act, enacted last December, includes a new requirement for employers. They are now required to file their copies of Form W-2 submitted to the Social Security Administration, by January 31, as well as Forms 1099-MISC.

In the past, employers typically had until the end of February (if filing on paper) or the end of March (if filing electronically) to submit their copies of these forms. In addition, there are changes in requesting an extension to file the Form W-2. Only one 30-day extension to file Form W-2 is available, and this extension is not automatic.

If an extension is necessary, a Form 8809 Application for Extension of Time to File Information Returns must be completed as soon as you know an extension is necessary, but by January 31. Please carefully review the instructions for Form 8809, and call the office if you need more information.

The new accelerated deadline will help the IRS improve its efforts to spot errors on returns filed by taxpayers. Having these W-2s and 1099s earlier will make it easier for the IRS to verify the legitimacy of tax returns and properly issue refunds to taxpayers eligible to receive them. In many instances, this will enable the IRS to release tax refunds more quickly than in the past.

The January 31 deadline has long applied to employers furnishing copies of these forms to their employees and that date remains unchanged.

Some Refunds Delayed Until at Least February 15

Due to the PATH Act change, some people will be getting their refunds later than they have in the past. The new law requires the IRS to hold the refund for any tax return claiming either the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) until February 15.

Furthermore, by law, the IRS must hold the entire refund, not just the portion related to the EITC or ACTC.

Even with this change, taxpayers should file their returns as they normally do. Whether they are claiming the EITC or ACTC or not, taxpayers should not count on getting a refund by a certain date, especially when making major purchases or paying other financial obligations. Typically, the IRS issues more than nine out ten refunds in less than 21 days; however, some returns may be held for further review.