It’s common for small business owners to measure their financial health based on their income statement or bank account balance and deem their business “fit” if the bottom line looks good.  To reveal why this approach can be deceptive, let’s apply a dieting metaphor.

Only looking at the bottom line is the equivalent of “sucking it in” when you look in the mirror.  Sure, it looks like you’ve lost some weight, but what happens when you exhale? You might appear skinny for a moment, but that version of the situation isn’t accurate.

In terms of your business’ health, the balance sheet is the “real” you.  Think of the income statement (also called the profit and loss statement) as your diet log.  It tells you how well you did in a specific time period—last week, last month, or last quarter.  We all know that there are good weeks and bad weeks on a diet.  If you only look at one week or month, are you getting a true picture of your overall health?  Of course not.

The balance sheet, on the other hand, is based on everything you’ve ever done.  In our diet metaphor, it accounts for how much you’ve exercised and what you’ve eaten over your entire lifetime.  The sum of all that information is what you see when you stop sucking it in.

To understand this metaphor, you need to understand what the balance sheet is and how it relates to the income statement. Your income statement contains information about what has occurred in the current period.  Revenue, cost of goods sold and expenses are some of the account types found on the income statement.

To get an accurate picture of what’s happening in your business, you must adhere to the matching principle.  That means you record expenses and cost of goods sold when you have earned the revenue that they are related to (if an expense is not related to revenue, you record it during the period it is used). The balance sheet accounts hold these revenue and expense items until the period in which they are earned or used.  We use accounts such as prepaid insurance, customer deposits, and accrued payroll to classify these things on the balance sheet.

Income statement accounts only reflect transactions in the current accounting period.  At the end of the period, the net profit or loss is moved to the equity section of your balance sheet (to retained earnings).  This means that the balance sheet reflects all prior period revenue, cost of goods sold, and expenses in the form of retained earnings.  The equity section also shows how much you’ve invested in and drawn out of your business.  The equity section, therefore, shows what the company is worth to you.

So, how do you know if your business is “over weight”?  Take a look at your debt to equity ratio (total liabilities divided by total equity).  Compare that to your industry average and you’ll have a pretty good indicator of your business’ weight.  Too much debt and not enough equity means your business is, in fact, overweight—even if your current period income statement looks healthy and you have money in the bank. Because everything shows up on the balance sheet, you can rely on it to depict the financial health of your business.

~Kelly

Do you manage your business by the bank balance? Many busy entrepreneurs do but what we know is that managing your business by your checkbook is like managing your personal health by the scale. While the number on the scale is a helpful indicator, it certainly doesn’t mean you’ll get a clean bill of health from your doctor. Join us to learn about other financial tools to help you see, understand, and manage your business’ financial health.

Topic: Beyond the Bank Balance – Create a Dashboard to Manage Your Business for Profit & Growth!
Date: Wednesday, June 9th
Time: 11:30am-12:30pm PDT (2:30-3:30pm EDT)

Click here for more info

]]> http://www.crackerjackaccounting.com/2010/05/bank-balance/feed/ 0 http://www.crackerjackaccounting.com/2010/04/barter/ http://www.crackerjackaccounting.com/2010/04/barter/#comments Thu, 29 Apr 2010 17:00:23 +0000 Kelly Totten http://www.crackerjackaccounting.com/?p=802

The difficult economic climate of recent years has led more businesses to utilize barter transactions, in which they trade their products and services for other products and services. Many businesses wrongly assume they don’t need to account for these transactions. Accounting for bartering transactions is required by the IRS and is essential to accurately determining the financial health of your business.

When you barter for other goods and services, you are still investing time and resources to sell the item you are trading. You are simply receiving a commodity other than cash in exchange for your product or service. Not accounting for barter transactions is equivalent to not accounting for revenue and expenses. It’s impossible to determine how well your business is doing if you can’t generate accurate financial statements.

Recording these transactions is quite simple if you break them down into individual pieces. When you barter, two transactions occur: 1) you sell something and 2) you buy something. The most confusing factor can be determining the value of the transaction. IRS guidelines dictate that you must value the transaction at the fair market value of the item you are receiving. In most cases, the fair market value is already known-it’s the normal sale price of the item. The sale of your goods or services is valued at the purchase price of the goods you are receiving.

Of course, you also have to record the receipt of the item. If the item you are receiving is a valid business expense, you will record it just as you would if you had paid cash. Instead of cash, you paid with your goods or services. If the item you are receiving is for your personal use, you need to record it as if you took cash out of your business (draw, payroll advance, etc). Let’s look at an example to see how it works in practice:

A designer is trading his website design services for two months of free rent. His rent is normally $800/month. The designer would record the transaction at $1,600, the value of two months’ rent. Since the rent is a business expense, he would debit “Rent Expense” and credit “Income” for $1,600.

Barter exchanges are also becoming more common. When you trade via a barter exchange, you trade for “points” through a third-party organization. You can accumulate points by selling your goods and services to other members of the organization and apply those points when you find something you want to buy.

If you trade with a barter exchange service, it’s important to understand that barter income is cash basis. When someone “buys” your services with trade credits or points, you have generated reportable income. The fact that you haven’t spent your trade credit is not relevant. When you do spend your trade credit, you record the expense just as you would with a direct trade (normal business expense or personal draw).

The easiest way to account for barter exchanges is to set up a “bank” account on your books called “Barter Exchanges”. When you sell something through an exchange, make a deposit into the “Barter Exchanges” bank account, crediting “Income”. When you purchase something from the exchange, you can simply “write a check”, debiting the appropriate expense account. Using this method, you have a complete record of all transactions running through your barter account and you’ve properly recorded your income and expense. You can also make reconciling your barter account a part of your normal monthly close process.

Properly accounting for both types of barter transactions is essential to accurately representing your revenue and expenses. When recording direct barter transactions, you are essentially recording a sale and a purchase. Instead of recording two transactions-one in which you sold something for cash and one in which you purchased something with cash-you record one transaction and skip the cash. Barter exchange transactions are similar to cash transactions; you just need a barter bank account to record them. Remember to keep a paper trail in either case and note it as a barter. For more information, see the IRS document “Record Keeping for Barter Transactions.”

Time tracking is a subject that causes many a manager’s eyes to roll.  The concern is understandable.  Most of us have experienced the negative consequences that occur when bad time tracking practices are employed.  Time tracking can be a major headache, if you get too granular and it can make employees feel like “the man” is watching their every move.  There are ways to implement time tracking that minimize the commonly quoted reasons for hating the policy, but first you need understand why time tracking is important (even if you bill on a fixed fee basis).

When you track time, you are gathering data that will allow you to do project costing.  This is especially important when you’re working on a fixed fee.  I once had a client who bid a project low because it was a good publicity piece.  Since they knew it was going to be a loser, they didn’t bother keeping up with the project cost reports.  When the project was finished, they finally took the time to review the time data they had gathered.  Guess what?  The project was over budget by 400%!  The designers went crazy trying to make it the best piece ever. Why?  Because no one gave them a limit.  When you actively monitor your project time and budgets, you can give your employees a sense of the project scope and keep scope creep under control.

Project costing information also helps you price future projects.  Take the above situation, for example.  With the time and cost information on that project, the client is armed with useful information for a similar quote request.  Sometimes a project is over budget because of poor project management and sometimes it’s just a bad quote.  Managers will have to do their own due diligence to determine why the project went south. The time tracking information will help them figure out the problem on current projects and will be a great resource for future project pricing.

A major benefit of time tracking is the ability to value work in process.  When you bill on a fixed fee basis, it’s difficult to match your revenue to the expenses in any given month, if you aren’t tracking time.   Using the time applied to various projects will allow you to calculate the value of the work performed during the month, whether or not you invoice it.  The matching principle is a fundamental of accounting and for good reason.  When you can match revenues to expenses, you get an accurate profitability picture.  The sooner you see accurate financial reports, the sooner you can make better business decisions.

In addition to accurate financial statements, monitoring the value of your work in process will allow you to see potential cash flow problems in advance.  For example: A client who was tracking work in process, but wasn’t monitoring it, came to me with cash flow concerns.  They didn’t understand why their sales were fantastic, their revenue was good, and collections were going well, but there was no cash in the bank.  A review of their balance sheet trends revealed a rapidly growing work in process account.  They were doing a lot of work through the months, but there was a break down in the invoicing process.  Projects were either not invoiced after completion, or they were stalling out before completion.  If they had been monitoring the work in process, they could have seen this problem and made corrections before they had a cash crunch panic.

Now that we’ve reviewed some excellent financial reasons for time tracking, let’s take a look at some other benefits that will help everyone feel better about the policy.  One way that time tracking helps your employees is it allows you to “right size” your staff.  I’m sure you’re thinking: “My employees are NOT going to like me hounding them about productivity and laying off their co-workers, if we don’t have enough work to keep everyone productive.”  You’re right; your employees won’t like that.  But, let’s flip that around.  Instead of looking at the negative side of right sizing, let’s look at the positive side.  I had a client whose employees were constantly complaining they were overworked.  With the time tracking information, we were able to finally see, in real numbers, that they were overworked.  Not only could we see areas of the business where they were over-staffed, we could also see where they were under-staffed.  The overworked employees were very happy to have some of their workload shifted to others.  Keeping your staff from burning out is just as much a productivity concern as having too much capacity.

For owners and salaried employees, time tracking can also lead to a better work/life balance.  The very act of tracking how you are spending your time will make you more productive.  It’s very sobering to see the inefficiencies in your day.  If you see it, you can do something about it.  This information will help you justify the need to delegate or outsource tasks that you are taking too much of your time that would be better spent elsewhere.  You’ll also see areas where you can adjust your work habits to get more out of your workday in less time.

The bottom line…. Time tracking is a pain, but there are many benefits. You don’t have to track every single moment of the day to get measurable results. Strive for capturing at least 80% of the workday.  When you implement the new time tracking policy, speak to your employees in terms of the benefits they’ll see, like keeping their risk of burn out at a minimum.   Also, a better bottom line for the business means more opportunity for bonuses and salary increases.  The whole company should benefit from better performance.

~Kelly

It’s time to start preparing 2009 1099 forms. Every year the question arises: Who gets a 1099?

For the complete answer, see: http://www.irs.gov/pub/irs-pdf/i1099msc.pdf

In general, service providers you have paid $600 or more in 2009 need to be issued a 1099.  Service providers include: independent contractors, accountants, public relations firms, janitorial services, etc.  Payments to service providers are reported in box 7, non-employee compensation. Sales commissions paid to non-employees are also reported in box 7.  This does depend on the type of entity you paid:

• Sole proprietors, partnerships, and LLC’s taxed as sole proprietors or partnerships DO get a 1099.
• C Corporations, S Corporations, and LLC’s taxed as C or S Corporations DO NOT need to be issued a 1099.

In addition, payments for rent are issued in box 1 and follow the same corporation/non-corporation rule.   Rents paid to real estate agents do not need to be issued on a  1099.

Payments to attorneys are always issued on a 1099 (regardless of corporation/non-corporation status).  These payments will either be reported in box 7 as non-employee compensation or box 14, gross proceeds paid to an attorney.  See 1099 misc instructions for further information.

If in doubt, issue the 1099.  There is nothing wrong with issuing when you didn’t need to to, but you will face penalties if you don’t issue a 1099 when it is required.

No one likes tracking their time, but it is important, even if you bill on a fixed fee basis. Here’s why…

1. It allows project costing of your fixed fee projects which can help you stay on budget and profitable.
2. It gives you the information you need to price future projects.
3. You’ll know how much time and money you’ve spent on R&D projects, so you can take advantage of any available tax credits.
4. Your bookkeeper/accountant will be able to generate more accurate financials because you’ll have the information to value work in progress.
5. The accurate financials will allow you to view your financial trends. Watching your trends allows you to make decisions early, so you don’t end up in a cash crunch panic.
6. Time tracking for business owners and salaried employees can lead to a better work/life balance. You’ll see any areas where you aren’t being productive and you can adjust your work habits to get more out of your work day in less time.
7. You can value the time you’re spending on tasks outside of your expertise and make an informed decision about outsourcing those tasks.
8. You can right size your staff. By gaining visibility in how time is spent, you will see when your staff is in danger of burning out. On the flip side, too large of a staff means lower profits and bonuses, so you’ll be able to see the need to downsize as well.

The bottom line…. Time tracking is a pain, but there are many benefits. You don’t have to track every single moment of the day to get measurable results. Strive for capturing at least 80% of the work day. Also, explain the benefits of time tracking to your employees before implementing the policy. Speak in their terms…what it means for their life (work/life balance, bonus potential…).

~Kelly

There are a couple of ways to handle customer deposits in QuickBooks.

Method 1: Receive Payment Without Applying to an Invoice

If the customer hands you a check you, can simply receive the payment without applying it to an invoice. This will create a credit on their account. While this method will allow you to apply the credit to the project invoice, it usually isn’t the best way to handle the situation.

Method 2: Utilize Customer Deposit Liability Account

I prefer the customer deposit liability account method. The correct accounting treatment of a deposit is to treat it as a liability (you haven’t earned the revenue yet, so you’re just holding their money for now).

To use this method you’ll need to:

• Setup a current liability called Customer Deposits
• Setup an “Other Charge” item called Deposits that points to the “Customer Deposits” account you just setup.

If the customer hasn’t paid you yet, you can issue an invoice using the Deposits item (Result: Debit Accounts Receivable, Credit Customer Deposits). If the customer already paid you, you can issue a sales receipt to skip the receive payment step (result: Debit Cash, Credit Customer Deposits)

When the revenue is earned, generate another invoice. On the first line(s), you’ll use your normal item for billing your customers. This line will be for the full amount of earned revenue. On the next line, use the Deposits item. Enter the amount of the deposit as a negative (only up to the amount of the revenue being invoiced). (The Result: Debit Customer Deposits, Credit Revenue, Debit Accounts Receivable for the difference between the deposit paid and revenue earned).

You can always run a transaction detail report for the Customer Deposits account and total by Customer/Job to see what the remaining balance on hand is for each customer. Reconciling this account should become a part of your monthly close process.

~Kelly