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The Difference Between Your CPA and a Controller – Part 2

Posted on August 26th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Our firm is unique in that, unlike most accounting firms, our initial focus (as the name of our firm implies), is on the client’s internal accounting (The Difference Between Your CPA and a Controller: M1).  We offer a full spectrum of accounting services all “under one roof,” ranging from bookkeeping services, to CFO and Controller Services, to year-end tax preparation.  In this way, the client’s internal books are always accurate and consistent with their year-end tax return.

However, from time to time we (my wife, Marianne, and I) each work with our own clients with whom the other person is not involved. Marianne is a CPA and her primary role is income tax preparation. As such, she has some clients who prefer to do their books themselves and just want her to do the taxes at year-end.

In contrast to Marianne’s role, my background and experience is as a controller and CFO.  As such, my primary focus is on the client’s internal (“book”) accounting.  And I have some clients who have their own tax accountant and came to me for their bookkeeping services only. They were either referred to me by their CPA who prefers not to get deeply involved in the client’s internal accounting and bookkeeping; or, they found me some other way not wanting to do their bookkeeping themselves, instead preferring to focus their time and effort on their own business.

As mentioned above, a few of Marianne’s clients prefer to do their own bookkeeping (against our advice). The occasional problem, however, is that her client doesn’t understand either accounting OR QuickBooks.  Consequently, they are making numerous bookkeeping mistakes throughout the year that Marianne has to clean up.  Plus, they are not receiving the ongoing financial explanations and tax planning they need as a small business owner.

One such client was surprised to learn that his business realized a significant net profit for the year upon which he now owes taxes. And why was he surprised? Because he had drained all of the cash out of the business either as payments to himself or for his personal expenses, and paying back loans. Consequently, his business was continuously starved for cash.  So to him, the business didn’t “feel” like it was profitable. In addition, he had not paid in any income or payroll taxes during the year, a big red flag for the IRS, especially for S-Corporations.

In short, this client (despite our best efforts) didn’t understand the difference between “profit” and “cash flow,” a subject about which I’ve written numerous articles. In fact, in one way or another, just about every article we’ve written would apply to this client. But rather than listing them all here, browse through our blog, including in the archives to the right of the page that are listed by month.

To sum up, this article from Entrepreneur Magazine addresses my main point perfectly: Getting the Most From Your Accountant Means More Than Just Doing Your Taxes.


What is My Monthly Breakeven Point of Sales?

Posted on August 21st, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Assume you would like to know your monthly profit. However, you’ve recently discovered that your largest vendor accidentally over-charged you over a period of several months.  In addition, you are recording the payments to your vendors in QuickBooks via a “check” transaction in the month following their related sales, rather than as a “bill” or check transaction in the same month as their related sales. In other words, you are using QuickBooks primarily on a “cash basis” for tax purposes.

This scenario brings to mind another article I wrote a while back, “How You Use QuickBooks Can Distort Your Company’s Profitability.” This is just another variation of the kind of things I mentioned in my article that can distort profitability. But what they all come down to in accounting terminology is the principle of “matching costs to revenues.”

To illustrate, let’s ask this question in a different way: “What is my monthly breakeven point of sales?” The way this is determined is by dividing your company’s total fixed costs by its Contribution Margin after all variable costs (or Gross Margin if all costs in cost-of-goods-sold are variable).

To illustrate the math, assume that a company’s total fixed costs are $100,000, and its contribution margin is 50%. Based on the above formula, this company’s breakeven point of sales would then be $100,000 / .50 = $200,000. But now let’s assume that the company is recording its costs (payments for purchases) directly to cost-of-goods-sold in the month following the sale, such that its contribution margin is now showing as 30% in a month where it had lower purchases. It’s breakeven point of sales in that month is then (theoretically) $100,000 / .30 = $333,333.

So which of the above breakeven sales numbers is correct?  That’s a rather important question if you want to know what your monthly sales need to be in order to make a profit, don’t you think?

To further illustrate the above, now look at the below sample company in which I assumed in the projections that the company’s material costs are being recorded as described above (i.e., cash basis). I assume that the check (or credit) from the supplier is recorded all in one month, in this case May. Then, due to the monthly payments being recorded in the month after their related sales, I assume that material costs fluctuate up and down by 5% from month-to-month:

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First, notice the graph on the last page, particularly the Breakeven Sales line. Next, look at the monthly volatility in its bottom line Net Income Before Taxes. Then look at the fluctuation in its Contribution Margin at the bottom of Monthly Breakeven page, and the Operating Breakeven Sales above it.  The breakeven sales fluctuate up and down from $194,000 in May, to as high as $368,000 in subsequent months.  So the question is, exactly what is this company’s “monthly” breakeven point of sales that it must surpass in order to make a profit? Who knows?

Solution: First, understand that QuickBooks is a “transaction-based,”(i.e., “easy-to-use”) accounting software, so it will not (automatically) give you an accurate accounting picture of your business. In order to accomplish that in some situations, you’ll have to make some manual adjustments, usually via journal entries, which means you have to have some idea of the effect on your reports you’re trying to achieve, and the accounting procedure necessary to achieve it.

In the case of this sample company, first a journal entry would be necessary to reallocate the credit for material costs over the applicable accounting period that was affected. I didn’t do that here as this is a spreadsheet model which would require several modifications to get the “Actual” balance sheet data back in balance; however, this could very easily be done in QuickBooks.

Second, the costs recorded in the month after the sales month would need to be journaled back into the previous month by debiting Material Costs and crediting Accrued Expenses (in Other Current Liabilities). Then the journal entry would be “reversed” so as to offset the accounting effect of the checks that were previously posted, but without disturbing the previous check transactions and your bank reconciliations themselves. (Again, this could have very easily been done in QuickBooks, but for purposes of illustrating the accounting effect, I did it here in the projected months only.)

The result end of the above would then look like this:

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Note the consistency in the monthly Breakeven Sales that’s now calculated (in the projection period from May on), and the smooth Breakeven Sales line on the graph.

Then going forward, in this example, a “Bill” transaction should be entered for the material costs dated in the same month as the sales (assuming that’s when the supplier’s invoice is also dated), which is then paid via a “Bill Payment” the following month in the Pay Bills window.  The Bill transaction in this example then records the cost in the same month as the sale (i.e., “accrual accounting”).  See the following for a quick overview of how the QuickBooks accounting process works (in the absence of manual journal entries):

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Of course the point of all of this is, the importance of accrual accounting in managing your business, and understanding that QuickBooks does not automatically perform that FOR you. It first has to be set up correctly, and even then sometimes also requires further manual adjustments, both of which require a fundamental understanding of accounting.  So if you are not comfortable with accounting, and your financials mean anything to you (which they should or you shouldn’t be in business), then seek proper accounting help.

 

Related Articles:

Winging It in QuickBooks

Profit vs. Taxable Income

Which is More Important, Profit or Cash Flow?

The Role of Cost Accounting in Planning Your Business’ Success

Why Outsource Your Bookkeeping?

The Opportunity Cost of Being Your Own Bookkeeper

The Difference Between Your CPA and a Controller – “M1”


I Hate Debt! Should I Pay It Off?

Posted on August 14th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Of course you hate being in debt.  Who really likes it?  But in business, sometimes it’s appropriate to borrow money to purchase equipment that will increase revenues or lower costs, and thus, produce greater profits; or, to borrow money to finance sales growth, and again, increase profits (“The Effect of Sales Growth on Cash Flow“). So you’ve gone ahead and incurred the loan.

But now you’re eyeballing those monthly payments, and worse, the amount of interest you’re paying over time.  You’ve got some surplus cash sitting around and you’re thinking about paying off the loan, and wondering, “Should I, or shouldn’t I.? What is my risk if I do this?”

A client came to me recently and asked me this very question, which in her case was loan on a vehicle. My initial response was, “Well, coincidentally, I wrote an article just recently on “The Effect of Funding Fixed Assets Out of Cash Flow,” and suggested they first read this article (the underlying premise of which is the importance of funding fixed assets with long-term sources of funds). They did, and then asked, OK should WE do it?”

In order to answer this question, you cannot merely look at what’s in your checking account today, you have to look further down the road at your future cash needs, and the potential consequences of paying off the loan in question. Here’s an example of what can happen:

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Note first on the Projected Income Statement that this business IS projected to be profitable, showing a projected Net Income Before Taxes of $324,000 for the year. Next look at the Monthly Cash Flow Statement under the month of July when they forecast paying off this loan. And finally, look at the immediate cash “over-advance” below.

The over-advance occurred because first of all, its  short-term line of credit is structured to fund short-term uses of funds, namely, accounts receivable and inventory, and the credit line’s use is restricted by the lender to this type of funding need (i.e., sales growth). The over-advance in this case thus represents the amount of long-term financing required to pay off the equipment loan, and if not from this equipment loan, then from the owner’s personal funds (Larry’s Fairy Godmother Strategies, Inc.).

Then, looking further down the road, note how long the funding requirement continues. If the lender won’t provide this financing under its line (meaning carry the over-advance), and the business owner doesn’t have the cash personally, then the most likely scenario is that the company will be forced to postpone payments on accounts payable causing his or her suppliers to become severely past due, or in other words, use short-term financing to support a long-term funding requirement.

For the above reason, in most cases, paying off long-term debt like this simply does not work, unless there are some unique circumstances in your business that enable you to do it. The latter was the case with my client.  They had a very strong cash flow due to their industry practice of requiring customer deposits up front, and the loan they wanted to pay off was relatively small. But we did a cash flow forecast just to be sure they weren’t putting themselves in a predicament like that of the sample company above.

Related Articles:

The Effect on Cash Flow of Slowing Payments on Accounts Payable

Larry’s Funding Strategies, Inc.

Larry’s Exit Strategies, Inc.

Financial Planning, or Business Turnaround – Your Choice


Identity Theft: What to Watch out for and What to do

Posted on August 6th, 2017

Identity Theft: What to Watch out for and What to do

Tax-related identity theft typically occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. Anyone can fall victim to identity theft. Here is an important reminder of how to protect yourself from identity theft, what to watch out for, and what do if your identity has been compromised:

  1. Protect your Records. Do not carry your Social Security card with you, or any other documents with your Social Security Number (SSN) on them. Only provide your SSN if it is completely necessary and you know the person requesting it. Routinely change passwords for all of your Internet accounts and protect your personal information at home and protect your computers with anti-spam and anti-virus software.
  2. Don’t Fall for Scams. Criminals often try to impersonate your bank, credit card company, and even the IRS in order to steal your personal data. Learn to recognize and avoid those fake emails and texts.
  3. Beware of Threatening Phone Calls. The IRS will never call you threatening a lawsuit or arrest, or to demand an immediate tax payment using a prepaid debit card, gift card, or wire transfer. Generally, if you owe taxes, the IRS will first mail a bill to the taxpayer. Furthermore, The IRS initiates most contacts through regular mail delivered by the United States Postal Service. While there are certain circumstances when the IRS will visit your home or business, taxpayers will generally first receive several letters (called “notices “) from the IRS in the mail beforehand. The IRS will also not:
  • Demand that you pay taxes without the opportunity to question or appeal the amount they say you owe. You should also be advised of your rights as a taxpayer.
  • Threaten to bring in local police, immigration officers or other law-enforcement to have you arrested for not paying. The IRS also cannot revoke your driver’s license, business licenses, or immigration status. Threats like these are common tactics scam artists use to trick victims into buying into their schemes.
  1. Report ID Theft to Law Enforcement. If you discover that you cannot e-file your return because a tax return already was filed using your SSN, please call the office immediately for assistance. Next, you will generally need to take the following steps:
  • File your taxes by paper and pay any taxes owed.
  • File an IRS Form 14039, Identity Theft Affidavit.
  • Contact one of the three credit bureaus (Equifax, TransUnion, or Experian), to place a fraud alert or credit freeze on your account.
  1. Complete an IRS Form 14039 Identity Theft Affidavit. File IRS Form 14039, Identity Theft Affidavit. Print out the form and mail or fax it according to the instructions. Continue to pay your taxes and file your tax return, even if you must do so by filing on paper.
  2. IRS Notices and Letters. If the IRS identifies a suspicious tax return with your social security number on it, they may send you a letter asking you to verify your identity and will provide instructions on how to do so. You may need to call a special phone number or visit a Taxpayer Assistance Center. This is to protect you from tax-related identity theft.
  3. IP PINs. If a taxpayer reports that they are a victim of ID theft or the IRS identifies a taxpayer as being a victim, he or she will be issued an IP PIN. The IP PIN is a unique six-digit number that a victim of ID theft uses to file a tax return. Each year, you will receive an IRS letter with a new IP PIN.
  4. Data Breaches. If you learn about a data breach that may have compromised your personal information, keep in mind that not every data breach results in identity theft. Furthermore, not every identity theft case involves taxes. Make sure you know what kind of information has been stolen so you can take the appropriate steps before contacting the IRS.
  5. Report Suspicious Activity. If you suspect or know of an individual or business that is committing tax fraud, you can report it on the IRS.gov website.
  6. IRS Website. Information about identity theft is available on the IRS website. There is also a special section devoted to identity theft with a phone number available for victims to obtain assistance.