Selling Your Small Business: Winging It In QuickBooksPosted on September 5th, 2020
Outsourced Accounting Department, Inc.
As I tell prospective clients for our services, “QuickBooks has done a remarkable job of marketing its product as ‘easy to use’ — but that is also what makes QuickBooks easy to abuse.” The truth is, QuickBooks will allow you to do just about anything you want, whether is it is correct from an accounting standpoint or not. So you can be going along thinking everything is working just fine, when the reality is your financial statements are a total mess. And your tax accountant is not going to clean all of this up at the end of the year either. That’s too much work to do during tax season. Instead, they’re going to extrapolate from QuickBooks only what they need for tax purposes, and instead rely more heavily on your reconciled bank statements.
As a QuickBooks ProAdvisor, we are often contacted to clean up a client’s QuickBooks file, and for the above reasons, their books are a total disaster. Then one day the small business owner wishes to sell his business, and all of a sudden, the historical accuracy of his or her books has become urgent.
As a case in point, our firm was recently engaged by a small business owner’s CPA to clean up his books, as she had reached a point where she was no longer able to “work around” his massive mistakes. Just about everything he was doing in QuickBooks was the wrong way to do things, and his financial statements and reports reflected this. Normally when we receive an engagement like this, our approach is to tie the client’s books to the CPA’s most recent tax return, usually the previous year, and then start the QuickBooks clean-up from there. In this case, however, after only a short period of time working on his books, the owner informed me that he had a prospective buyer for his business who needed certain information as soon as possible. The information they requested, after their preliminary view of his file that he had sent them, is shown here in their Due Diligence List.
Since the inception of the business, this client had been using QuickBooks mainly to enter supplier invoices and record inventory purchases, and to create customer invoices to send to his customers for payment. He knew nothing else about QuickBooks, leaving everything else to his CPA who, as described above, was mainly concerned with reconciling the bank accounts to prepare his tax return on a cash basis. This ignores most of the accrual accounting information requested in the due diligence list.
Selling a small to medium-sized business is a complex venture, and many business owners are not aware of the the things prospective buyers look at. So if you’re thinking about selling your business, the first step is to be able to provide accurate financial statements going back three or more years. That is what will be needed to prepare an accurate business valuation to determine how much your business is worth. And rest assured, potential buyers will scrutinize every aspect of your business. Not being able to quickly produce financial statements, current, and prior years’ balance sheets, profit and loss statements, tax returns, equipment lists, product inventories, and property appraisals and lease agreements, may lead to loss of the sale.
Suffice it to say in this situation, the clean-up process suddenly turned in a whole new direction, the timing was critical, and much of it could not be recreated at this late stage. Even if the sale goes through, you may not be able to get the price that the business would otherwise be worth if you had been able to produce an accurate financial history as requested by the buyer. Thus, it’s important to maintain your books properly from the start, as someday you’re going to be asked to produce that information, whether it be to sell your business, or simply to obtain a bank loan. And if you’re not comfortable with doing this yourself, then outsource it to someone who does have the expertise.
Three Tips for Getting an Accurate Business ValuationPosted on August 8th, 2019
Outsourced Accounting Department, Inc.
If you’re conscientious about financial reporting, you may already have a sense of your company’s worth, but in some instances, you might need a formal business valuation, such as:
- Certain transactions: Are you selling your business? Planning an IPO? Need financing?
- Tax purposes: This includes estate planning, stock option distribution, and S Corporation conversions.
- Litigation: Often needed in cases like bankruptcy, divorce, and damage determinations.
There isn’t a single formula for valuing a business, but there are generally accepted measures that will give you a valid assessment of your company’s worth. Here are three tips that you can use to give your business a more accurate valuation.
- Take a close look at how your business operates. Is your business profitable, and do your internal financial statements reflect that? Does it incorporate the most tax-efficient structure? Have sales been lagging or are you selling most of your merchandise to only a few customers? If so, then consider jump-starting your sales effort by bringing in an experienced consultant who can help.
Do you have several products that are not selling well? Maybe it’s time to remove them from your inventory. Redesign your catalog to give it a fresh new look and make a point of discussing any new and exciting product lines with your existing customer base.
It might also be time to give your physical properties a spring cleaning. Even minor upgrades such as a new coat of paint will increase your business valuation.
- Tangible and intangible assets.Keep in mind that business valuation is not just an exercise in numbers where you subtract your liabilities from your assets, it’s also based on the value of your intangible assets.
It’s easy to figure out the numbers for the value of your real estate and fixtures, but what is your intellectual property worth? Do you hold any patents or trademarks? And what about your business relationships or the reputation you’ve established with existing clients and in the community? Don’t forget about key long-term employees whose in-depth knowledge about your business also adds value to its net worth.
- Choose your appraisal team carefully.Don’t try to do it yourself by turning to the Internet or reading a few books. You may eventually need to bring in experts like a business broker and an attorney, but your first step should be to determine the level of business valuation certification that will be required.
Planning for Rapid Sales GrowthPosted on May 14th, 2019
Outsourced Accounting Department, Inc.
What if your company has an opportunity to grow fast? That’s every small business owner’s dream, right? But if you don’t plan for it, you may quickly find that cash flow is strained, and you’re having a difficult time keeping suppliers current, or making payroll, or both, even though your business is profitable. So how do you avoid this financial catastrophe?
To start, your method of accounting is critical here. If your books are maintained on a cash basis, that will tell you if you have a positive or negative cash flow, but it won’t tell you WHY? In order to get to the root of the problem, your books need to be maintained on an accrual basis of accounting.
Under accrual accounting, your sales include uncollected invoices (accounts receivable), and unpaid bills (accounts payable). Your material costs are recorded first to inventory, then “matched” to related revenues at the time you invoice your customer. And that last point is extremely important, as that’s the only way you know if your business is truly profitable.
Assuming then that your books are maintained on the accrual basis, the next step is to look at the various components on your cash flow statement to see what may add to or take away from your profit, and then look at the underlying causes. These may include:
- Your projections show losses: Profit is a critical component of cash flow (as defined above regarding matching of costs and revenues). If your business is losing money, this will eventually drain all of the cash out of your business until it can no longer operate.
- Increases in accounts receivable: Higher sales mean higher accounts receivable, and some customers may also pay slow.
- Increases in inventory: As sales increase, so does the amount of inventory you must purchase so support the higher level of sales.
- Increases in accounts payable: As inventory increases, so do accounts payable, and thus is a source of cash.
- Fixed-asset purchases: Capital expenditures typically produce revenues (cash flow) over the long-term, and thus should not be funded out of short-term cash flow.
In a growth stage, the above increases in receivables and inventory represent “permanent working capital.” The increase in accounts payable provides some cash relief. But the permanent portion of accounts receivable and inventory, as well as the fixed-asset purchases, must be financed with long-term sources of funds such as long-term bank debt, financing of the receivables and inventory portion through a commercial finance company (asset-based lender), or owner equity.
Funding any of the above cash requirements out of your day-to-day cash flow will quickly eat up your checking account balance. Then at that point, you will not be able keep suppliers current, and you risk being put on payment terms of cash-on-delivery (C.O.D.). Or worse, you may be completely cut off by suppliers from new inventory purchases.
Now that you know what might cause your company to have cash flow issues, how can you plan ahead to avoid a financial crisis?
In addition to traditional cash flow forecasts, my firm developed a tool that expresses cash flow in terms of borrowing availability against accounts receivable and inventory, which I refer to as “Asset-Based Credit Facility — Borrowing Availability.” Beyond borrowing availability, it forecasts the company’s total funding requirements, as well as helps to identify the most appropriate sources of funds based on the company’s financial structure and circumstances.
To illustrate, the below wholesale distributor is expected to experience significant sales growth. If you refer to the Cash Flow Statement, projected sales are assumed to be accompanied by major increases in accounts receivable and inventory of $123,288 and $99,669 respectively, ultimately resulting in a $76,030 cash requirement. This is then met by a $53,268 advance on its line of credit, and a $22,762 reduction in the company’s cash balance, leaving a (forced) minimum cash balance of only $1,000. However, if you then look at the Asset-Based Credit Facility, the company still has $46,434 available under its line of credit (i.e., in this case, limited to 75 percent of eligible receivables as defined by the lender).
In the above example, if the company’s growth rate is too fast and it did not arrange adequate financing ahead of time; or, if receivable and inventory turnover is projected to be slow; and/or, if projected profits are too low — then an “over-advance” occurs in the forecast. If so, most lenders will not fund that gap, and therefore, it represents a potential bank overdraft and a serious cash crisis. For that reason, it’s not enough to look only at your annual statements. To avoid any surprises, you need to forecast your cash requirements on a monthly basis.
To demonstrate, the below manufacturing company, XYZ Company, is expecting a sales increase of nearly 150 percent in the coming year. Notice the over-advance that occurs in January through September, until its cumulative profit begins to enable principal reductions on its $400,000 line of credit, thus freeing up borrowing availability. But then also note in some months that the $400,000 line itself is less than projected collateral availability, thus further constraining cash flow.
And therein lies the importance of anticipating your funding needs before they occur.
To recap, before you blindly launch your business into a period of rapid sales growth, do your projections. Then these are some critical items you need to factor into the assumptions:
- Will new customers require credit terms, and how does that translate into the amount of accounts receivable you will need to carry?
- How much inventory will you need to have on hand to support the projected level of sales?
- What about deposits up front from customers to purchase the inventory? Is that feasible? Are customer deposits even customary in your industry?
- Will your suppliers grant my company extended credit terms?
- Do you have sufficient liquidity personally to support these cash requirements, or do you need to prearrange a larger bank line of credit?
- Is your company even bankable, and exactly what is “bankable,” and how do I get there? Or should you be considering alternative financing such as an SBA loan, or an asset-based credit facility (accounts receivable financing) through a commercial finance company?
To ignore this planning process is almost certainly a plan to fail.
How Much Money Do I need to Operate?Posted on April 28th, 2019
Outsourced Accounting Department, Inc.
Your young start-up business is now taking off. Sales for the current fiscal year are expected to increase from $110,000 to $500,000. Until now, you’ve been able to operate out of your home, purchase inventory as needed, and sell it immediately to customers who have either prepaid, or pay cash on delivery (C.O.D.). So what does this new growth spurt imply in terms of the funds required to operate your business?
Assume your business is a wholesale distributor of some kind, and the following changes in the way you currently operate will occur:
- You now need to stock at least a 30 day supply of inventory, and your suppliers offer 30 day payment terms.
- In order to stock inventory, you need to lease warehouse space, hire warehouse staff, and purchase a delivery truck.
- New customers will insist on 30 day payment terms.
Now further assume that, for whatever reason, you overstocked on inventory so that you are running at a 60-day supply of inventory on hand; and, the reality is that your customers are paying you on average in 45 days. This is what your projected Profit & Loss and Cash Flow now looks like:
Note in particular the amounts highlighted in yellow. Even though your business is projected to be profitable at the higher level of sales (see Income Statement), your cash balance declines by $34,000 (rounded), plus you are required to either borrow another $11,000 from a bank or other outside source, or personally invest from your own funds, for a total of $45,000 (see Balance Sheet and Cash Flow Statement). And what if you had not anticipated this funding requirement, what would you do?
The financial concept I am alluding to is called “Permanent Working Capital,” defined in this article (click on link) as “the minimum level of current assets required by a firm to carry-on its business operations.” In other words, it represents a “permanent” funding need. In contrast, a “seasonal” working capital requirement, wherein increases in inventory and accounts receivable, and the funds required to support these increases, would be of a temporary or “short-term” nature.
The distinction between “short-term” and “permanent” working capital is critical for planning your company’s cash requirements. The difference it makes determines not only how much money your company needs to operate, but also when and where it must come from. Banks typically do not lend money for permanent working capital unless they have some tangible collateral to secure the loan with, such as your house. So that leaves: commercial finance companies that lend on receivables and inventory at a much higher rate of interest; an SBA (Small Business Administration) loan; a private investor such as your rich relative; or, your own personal savings account.
For more information, see also below articles.
“Profit” is Not a Dirty WordPosted on December 17th, 2018
Outsourced Accounting Department, Inc.
In the news recently, General Motors announced the closing of several plants causing an uproar in Washington, especially after the government bailed them out only a few years ago (which in truth was to rescue the economy, not just “GM”). So what’s the problem? Is GM just being greedy, or unappreciative, or what?
At the risk of over-simplifying the matter, a while back I worked for a company as its Vice President of Finance. Due to the loss of a major contract the company had been counting on, the owner of the company was forced to cut expenses, which included among other things, temporarily halting some employee benefits such as matching contributions on the company’s 401(k) plan. Shortly after these measures were announced, a disgruntled employee left a note on the bulletin board accusing the owner of being “greedy.” When the owner saw this note, he called me into his office to show it to me, and he was visibly heartbroken.
The truth of the matter was, despite the company’s losses and tight cash flow, and because of the owner’s compassion for his employees, he was avoiding making any staff reductions, even though reductions were warranted under the circumstances. Instead, he invested more and more of his personal funds into the business to fund its operating losses and keep the company afloat, while continuing to attempt to “grow the business” to restore profitability – until, that is, the bank stepped in and put a stop on everything because the company continued to show operating losses. Ultimately, he was forced to sell the company in a distressed sale. So a lot of those employees eventually lost their jobs anyway, and the owner ended up having to pay back a large amount of the company’s debt personally.
As I have talked about in several articles, profit is not just a “number,” it’s a critical component of cash flow, and without it, the business will eventually die. To illustrate, the below Profit & Loss, Cash Flow Statement, and Asset-Based Credit Facility – Borrowing Availability, reflects the dramatic impact that operating losses have on cash flow:
Note the large “over-advance” on the line of credit. This reflects the funding requirement from external sources caused by the operating losses. The reality however, is that a bank isn’t going to knowingly fund these losses, as profit is (ultimately) what repays debt in the first place. So in lender jargon, there is no “source of repayment.” Nor will most investors be interested who are also looking to the company’s earnings for a return on their investment.
The point is, when a business is losing money, those funds have to come from somewhere. Those losses represent being drained out of the company to pay suppliers, loan payments, and yes, payroll! When the funds eventually dry up, the business either dies, or makes the expense adjustments necessary for survival. Or, in the case of what large companies like General Motors did a few years ago, allow the government (you and I) to fund their losses. But sooner or later, even tax money can run out (whole different topic).
The moral of the story is, if a business cannot be made to operate profitably, someone is going to end up “holding the bag.” The only question then is, WHO? The bank? As indicated above, not if they can help it, banks are risk averse by design; taxpayers? possibly, whether they like it or not (if the company is big enough to have an economic impact); or, the owner / shareholders – most likely, as they have the most at risk. But (most) business owners and shareholders don’t invest their money into businesses just to lose it, and they are not going to keep pouring money into a losing proposition. They are interested in a return on their investment (“ROI”), or in other words – “Profit,” the motive that led to the creation of those jobs in the first place, .
Difference Between a Bookkeeper, Controller, CFO, and Tax AccountantPosted on December 2nd, 2018
Outsourced Accounting Department, Inc.
Often times I find that many of our clients are a bit confused as to the difference between various accounting roles, and therefore, the various functions our firm performs behind the scenes. In fact, most small business owners I’ve worked with tend to think in terms of “tax,” as that is the first accounting issue they learned they needed to address when they started their business. So the challenge we frequently encounter is one of educating our clients on how all of these roles tie together, and the importance of each role to their particular business.
An excellent “Glossary of Job Descriptions for Accounting and Finance” is published by Robert Half International, an employee staffing agency. The job titles highlighted in yellow in the previous link more or less correspond to the functions we perform. Of course the larger the business, the larger the internal accounting department that is required to perform the accounting function. Conversely, the smaller the business, the fewer accounting positions that are justified.
With very small businesses, many small business owners attempt to perform their own bookkeeping using QuickBooks. But then many often learn that QuickBooks is not as easy as its name implies, and they end up making a mess out of their books that someone has to clean-up, usually their CPA at year-end at CPA hourly rates. And worse, they often find that “bookkeeping” has become a distraction from running their own business, and a task they’ve come to dread. So, eventually, during the early stages of their business’ development, many small business owners discover that they are better off outsourcing the bookkeeping task all together so that they can focus their attention on their own business. This is where our firm comes into the picture, wherein we perform the “accounting department” function on as “as needed,” part-time basis.
In our business, the organization chart would look something like this with the client in the traditional role of “Chief Executive Officer,” and the boxes in red are the services we typically provide:
- Bookkeeper: Performs all data entry including bank and credit card transactions and reconciles same to month-end statements. Provides assistance to some clients who perform some tasks in QuickBooks and need our help.
- Controller: Oversees bookkeeper’s work; performs month-end adjustments and closing. Creates month-end financial statements and various custom reports for client. The emphasis here is on management accounting and financial accounting. Provides assistance to some clients who perform some tasks in QuickBooks and need our help.
- CFO (Chief Financial Officer): As a business grows, its accounting and financial needs becomes more complex. In terms of the functions our firm provides, this would encompass (on an “as-needed,”part-time basis), financial analysis including ratio analysis, and strategic financial planning including budgeting, projections, business plan assistance, and in some cases, communicating the company’s financial results to prospective lenders and investors. In terms of the above chart, the CFO role encompasses the positions of FP&A (Financial Planning & Analysis), and Financial Analsyst down the right hand side of the chart, which are all performed by myself (see Owner and Management.)
- Tax Manager: Converts the company’s books for tax accounting purposes for preparation of the year-end tax return; provides assistance in various other tax related matters such as sales tax, property tax, etc. (In our organization, this function is performed by an outside CPA firm, our affiliate, Kern and Associates CPA, P.A. which is owned by Marianne Kern, CPA (see Owner and Management). Marianne’s primary focus is providing tax assistance to our business clients who do not already have an outside tax accountant.)
- Payroll: While QuickBooks includes a payroll module, in our opinion, it is a tedious process that is more efficiently and economically managed by outside payroll companies. These company’s typically guaranty timely and accurate submission of payroll tax returns and payment of payroll taxes which most CPA firms I know of do not, and at rates that are more affordable to the client vs. what a CPA firm would charge. For this reason, we also see many CPA firms who prefer to outsource this task to a payroll company vs. offering this service themselves.
If you have questions on any of the above, as always, please do not hesitate to give us a call or send us an email. Our contact info is on our website.
The Relationship Between Financial Management and Loan UnderwritingPosted on October 28th, 2018
Outsourced Accounting Department, Inc.
In my previous article, “Securing a Small Business Loan Revisited,” I went over the phases of approaching a bank for a small business loan, wherein I made this observation: “In recent articles I’ve also talked about the importance of using an appropriate method of accounting, budgeting, and strategic financial planning. The reasons these activities are important are twofold: 1) managing your business’ growth, profitability, and cash flow; and 2) obtaining outside financing as and when needed. This article revisits some earlier articles I’ve written on the topic of obtaining bank financing, but the two objectives are very closely intertwined, as banks first and foremost want to know if you are addressing reason number 1.”
What I was referring to above was a section on the topic of Understanding the Lender’s Underwriting Criteria from another article, that concludes with this statement:
“Even a brief examination of these points suggests the need for you to do your homework before making a loan request, because an experienced loan officer will ask probing questions about each of them. Failure to anticipate these questions or providing unacceptable answers is damaging evidence that you may not completely understand the business and/or are incapable of planning for your firm’s needs.” (Securing a Small Business Loan – Part III: the Application)
The point is, the lender wants to know how you manage your business financially, because that has a direct bearing on if and how your loan can be repaid. So exactly what ARE some of the things (experienced) lenders are looking at, and why:
- Profitability: A business that has historically lost money, and is continuing to lose money, is on its way out of business. The lender’s loan cannot be repaid, nor can it prevent the business from failing in the long run.
- Debt Service Coverage: The adequacy of existing (NOT projected) profit and cash flow to fund both existing and proposed loan payments.
- Balance Sheet Leverage: The amount of debt in the company in relation to its net worth. The more debt the company has, the more susceptible it is to swings in sales, profit, and cash flow, particularly for a company that has thin margins to begin with.
- Liquidity and Turnover Ratios: The ability of the company to fund day-to-day operations through internally generated cash flow. A negative net working capital position can jeopardize the business’ ability to meet payroll, pay suppliers when due, make loan payments on time, and fund many other short-term cash needs.
- Sales Growth: The faster the business’ growth, the more cash flow that is consumed by “permanent” increases in working capital. This is due to the cash required to support the related increases in accounts receivable, inventory, labor costs, and so on, that far exceed the company’s internally generated profit and cash flow – until the growth levels off. This type of funding need can bankrupt a company if it goes unchecked, and most “traditional” banks are usually not staffed and equipped to provide this specialized type of financing.
- Funds Management: The proper matching of sources and uses of funds. For example, the funding of major capital expenditures out of cash flow, or with short-term debt, can severely cripple a business financially, the same as poor liquidity can as discussed above.
If you need assistance in better understanding the above issues, see below articles for more information. Or, if you need help with working with a lender, just give us a call.
Three Most Common Budgeting ErrorsPosted on October 15th, 2018
Outsourced Accounting Department, Inc.
When it comes to creating a budget, it’s essential to estimate your spending as realistically as possible. Here are three budget-related errors commonly made by small businesses and some tips for avoiding them.
- Not Setting Realistic Goals. It’s almost impossible to set spending priorities without clear goals for the coming year. It’s important to identify, in detail, your business and financial goals and what you want or need to achieve in your business. And a major category to consider is the impact of sales growth. An unrealistic forecast here will not only give you a false reading of your future funding requirements, but also discredit your business plan with prospective lenders right from the start.
As a case in point, a while back I was working with a client to put together a business plan to assist him in obtaining financing for his company. I started the process by asking him to forecast his sales for the remaining 3 quarters of the year.
After struggling with it a few days, he came back with a spreadsheet indicating six percent sales growth in the second quarter, nine percent in the third quarter, and twelve percent in the fourth quarter. And my immediate response was, “OK, now write in the margin, ‘ha, ha.’” (we had that kind of humorous relationship).
“Now here is what I really want to know: What are your customers going to buy from you? And if you don’t know, call them and ask them.” (In his line of business his customers would know this). When he finally did obtain this information, the projected sales growth far exceeded his initial guess, having major implications for the amount and type of financing he was going to need to fund this growth. (See Testimonials under “Growth Funding”.)
- Underestimating Costs. Every business has ancillary or incidental costs that don’t always make it into the budget–for whatever reason. A good example of this is buying a new piece of equipment or software. While you probably accounted for the cost of the equipment in your budget, you might not have remembered to budget time and money needed to train staff or for equipment maintenance.
In addition, you also need to make sure you’ve arranged financing for the purchase of the equipment with the appropriate source of funds, usually long-term-debt. If you neglect to do this and instead purchase the equipment out of cash flow, you can jeopardize your company’s ability meet payroll, pay suppliers, or basically, to operate.
- Failing to Adjust Your Budget. Don’t be afraid to update your forecasted expenditures whenever new circumstances affect your business. Several times a year you should set aside time to compare budget estimates against the amount you actually spent, and then adjust your budget accordingly.
In QuickBooks, there is a budget feature that allows you to create reports with such a comparison. You can project your Profit and Loss as well as your balance sheet and cash flow. However, projecting your balance sheet is the tricky part, as changes in accounts receivable, inventory, and accounts payable, are a function of your sales growth and turnover ratios , and QuickBooks does not do this for you automatically (nor do most other business plan and projection software programs I’ve seen).
So, I use the QuickBooks budget feature for the Profit and Loss portion only so that I can compare my actual operating results with my original budget. I then export that to EXCEL to be incorporated into a more advanced projection model I use (sample) that can forecast the above balance sheet changes based on historical or expected turnover rates, and in turn, the funds needed to support those changes. I then update the projected data with actual operating results each month so that I can forecast the company’s cash requirement through the end of the year and beyond.
Budgeting and forecasting is not easy for most small business owners who are usually not accounting oriented and have “better things to do” with their time. So as I’ve stated in previous articles, if you need help with it, consider contacting a financial professional.
The Importance of Cost Accounting in Financial PlanningPosted on October 1st, 2018
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:
- Cost behavior. For example, will the costs increase or stay the same if production of your product goes up?
- 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.)
- 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:
- dues and subscriptions
- equipment leases
- payments on loans
- management salaries
Variable costs DO change with variations in production and sales. Variable costs include:
- raw materials
- hourly wages and commissions
- 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.
Strategic Financial Planning vs. Crisis ManagementPosted on September 24th, 2018
Owner / President
Outsourced Accounting Department, Inc.
In my article, “The Effect of Sales Growth on Cash Flow,” our fictitious entrepreneur, Larry, got himself into quite a predicament by growing his business too fast, and not having sufficient profit or external funding to finance that growth. So now let’s see what his cash flow would look like if he had planned ahead and done things a little differently.
In this scenario, which I now call Larry’s Turnaround Strategies, Inc., I assumed that Larry does a much better job of managing in two areas: 1) payroll, and 2) receivable collections:
Note on the pro forma P&L that his Net Income is now (rounding) $118,000, or 30% of sales, versus only $15,000 previously, and his monthly receivable turnover is reduced from 45 to 30 days, thus producing an additional $37,000 in cash flow as a result of improving receivable collections.
Now, refer to the Statement of Cash Flows to see the impact these two improvements had. The company goes from a cash deficit of about $11,500, to a cash surplus of $129,000.
The point is this: sales growth for the sake of sales growth is dangerous. Yes, there are times when a business can take on aggressive sales growth. But from purely a financial perspective (vs. operational which is a whole different issue), doing so without having either adequate profitability, or outside capitalization in the form of financing from a receivable finance company (or other specialized lender), or investors, or both, is a sure “plan to fail.” At the very least, you may wind up in a highly stressful turnaround situation where you are unable to obtain materials from critical past-due suppliers, and a bank breathing down your neck everyday either pressuring you to restore profitability, or worse, calling your loan and threatening to liquidate your company.
So the moral of the story is, if you’re going to grow the business, focus first on profitable growth, and then plan on how you’re going to fund that growth ahead of time, not after-the-fact when it’s too late.