Many small business owners make financial decisions based on how much cash they have in the bank. Unfortunately, there are a number of pitfalls to managing this way. Let’s explore some ways that business owners manage by bank balance, the problems associated with these practices, and some alternatives that will help you stay in great financial shape.
1. You pay bills as they arrive, based on your bank balance.
When you receive a bill, do you check your bank balance to determine if you can cover it, and if so, pay it right away? There are two problems with this method:
- You’re not accounting for checks you’ve issued but which have not cleared. The obvious risk here is that an outstanding check will clear, resulting in costly bad check and overdraft fees, as well as damaged vendor relations.
- You’re not planning for other obligations that could impact your payment decisions. You might pay some bills well before they’re due and unnecessarily deplete cash you later need.
Instead, implement and use a cash flow forecast and track accounts payable. A cash flow forecast starts with your reconciled account balance and predicts your incoming and outgoing cash. It tracks when you expect your revenue to come in and your bills and payroll to go out. You’ll have a complete picture of what bills are coming, when they will be due, and how much you’ll have left over after they’re paid. You can predict cash shortfalls and adjust your payment schedules accordingly.
2. You send invoices out and wait for the money to arrive.
Failing to follow up on your outstanding receivables in a timely manner has a negative impact on your cash flow and skews your financial forecast.
Instead, use your accounting system to track accounts receivable, implement a collection policy, and follow up on overdue invoices. You’ll increase your cash flow by getting paid sooner. If you find out when a customer with a past due invoice will actually issue payment, you can update your cash flow forecast so that it remains accurate.
3. You make decisions on big purchases or new hires based on whether you “feel” like you can afford it.
When you’re managing by your bank balance, it’s difficult to know what you can or cannot afford. Are you currently cash-rich because of a windfall, or can you reasonably expect to maintain that income level?
Instead, review your historical income statement and balance sheet to see if you’ve been consistently making enough money to cover the new obligation. Next, create an income statement budget, using past data to predict your future income and expenses. If you are still profitable after adding the items you want to purchase to the budget, create a long-term cash flow forecast. Does the cash balance stay positive? If you’re profitable, cash flow positive, and your debt to equity and other performance ratios remain healthy, you can afford the purchase.
4. You assume projects are profitable because you have cash in the bank.
Cash in the bank doesn’t mean that all of your projects are profitable. Some jobs may be profitable while others are not, or you may have debt that obscures your financial picture. The real question is: could you have MORE cash in the bank?
Instead, track all of your time and expenses against jobs in your accounting system. If a job is unprofitable, find out why. If you track this information throughout the project, you can make corrections to stay on budget where possible. You can also use that information to more accurately bid new jobs.
These relatively simple accounting practices provide a great foundation for making smart decisions that keep you on the right financial track.
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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.
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Balance Sheet
Ask any accountant and they’ll spout off the balance sheet equation (Assets = Liabilities + Owner’s Equity). Ask most everyone else, and they’ll either look at you blankly or have a hard time remembering what goes where in that equation. It’s simple, really, if you just picture it.
The balance sheet is nothing more than a pie graph where half is always “assets” and the remaining half is divided between “liabilities” and “equity”. The proportion of equity to liabilities will change, but the total of the two must be equal to the dollar value of your assets.
Now you know how to visualize the balance sheet. If you can hang on for a few more minutes of reading, I’ll tell you what it means to your business. First let’s define the terms:
Assets will be divided between current and long-term assets on your balance sheet. These are either cash or items you own that have cash value. Examples include: accounts receivable, investment accounts, inventory, equipment, etc. You’ll also find things like “prepaids” in your assets. Prepaids are simply expenses you have paid in advance, so they don’t belong on your income statement yet (theoretically you could get them refunded if you don’t actually use them…hence cash value).
Liabilities are things you owe. Like assets, liabilities are divided into current and long term liabilities. The most common liability accounts are: accounts payable, credit card debt, loans, lines of credit, etc. Similar to prepaids, you’ll also find deferred taxes, deferred wages, accrued payroll, etc. Customer deposits are also liabilities. Revenue is recognized when it is earned, not when the customer pays you. So, if the customer pays in advance, you record it as a liability until you have actually earned the revenue.
Equity is essentially what your business is worth. Equity is reduced by dividends and distributions and increased by your net profit, capital investments, etc.
Now that I’ve defined what’s on the balance sheet, let’s review what that means to your business. Essentially, the balance sheet holds the keys to how well your business has functioned throughout its lifespan. The income statement covers a period of time, while the balance sheet is an accrual of your business history. Bankers are more concerned with how your balance sheet looks because it shows how well you’re running your business.
Don’t get me wrong, the income statement is important too. The balance sheet and income statement together tell the story of your business. Too often, I see owners concerned only about the profit and loss and there are many problems with that approach.
If you ignore that balance sheet and work under the assumption it is correct, you are setting your business up for failure. The accuracy of the balance sheet is directly tied to the accuracy of your income statement. The asset and liability accounts on the balance sheet hold income statement account items until the period they impact the income statement. If you don’t move things to/from your balance sheet from/to your income statement in a timely manner, then you’re managing an incorrect income statement too.
Once you have an accurate balance sheet and income statement, the next step is to set up a dashboard and monitor your financial ratios (things like debt to equity, current ratio, receivables turnover, etc). Ideally, you’ll determine the right ratios for your business in your industry and start utilizing all of this data to make decisions.
Personally, I like to set up visual dashboards for the income statement, ratios, and other trend data. The whole idea here is to become proactive with your financial data and keep (or make) your business healthy. I find the easiest way to understand what is happening in a business is to make it visual.
]]>Unfortunately, I’ve worked with many business owners who were victims of embezzlement prior to my engagement with them. It’s really not all that uncommon. Why? Because we want to trust our employees.
I’m not saying your employees aren’t trustworthy; I don’t know them. What I can tell you is that’s always the story I hear. “I thought I could trust her”, “we’ve been friends forever, I can’t believe he did that to me”, “she worked for a bank! I thought I could trust her”. I’ve heard all of those from owners who were cheated by that “trusted employee”.
I don’t want to scare you and I don’t want you to lose faith in your employees. I want you to set up some simple internal controls, so you don’t ever have to question your employee’s trustworthiness.
I’m put in positions all the time where the business owner will put me on the checking account or try to leave me a blank signed check. Each time, I take the opportunity to explain that I would never, ever steal from them, but it’s not a good idea to put anyone in the position of being able to steal. Then, I advise them in ways we can solve the problem (usually their unavailability to sign a check) and maintain a system of controls that protects their hard earned cash.
Here’s a list of simple controls you can put in place to protect your business and your bookkeeper:
- Open the bank statement yourself (or view them online), review the cleared checks (invest in getting copies of cleared checks if you don’t automatically get them).
- Review the bank account reconciliation with the bank statement. Ensure the bank account is reconciled in a timely manner.
- Require checks to be written sequentially. Review the check register and ask to see any missing check numbers. Voided checks should be kept on file and marked VOID.
- Have someone who doesn’t issue checks or handle cash reconcile the bank account
- Check Signing
- Do not give signature authority to anyone who reconciles the bank account or issues checks. Require duplicate signatures if you must have one of these persons on the account.
- NEVER sign blank checks.
- Do not use signature stamps.
- Request to see invoice copies for checks submitted for your signature, ensure there is a paper trail and know what you are signing.
- Have someone other than the bookkeeper check the mail, open customer payments, and list the receipts.
- Make sure you have a fidelity bond included with your business insurance package that will pay in the event of employee theft.
- Petty cash
- Set a limit on the petty cash fund and treat it like a bank account (someone who doesn’t have access reconciles it).
- Use an imprest petty cash system: require signature on a petty cash receipt for taking cash from the till and receipts/change returned to match the petty cash receipt.
- Require vacations and cross train. Have someone else perform the bookkeeping functions while the bookkeeper is on vacation.
While these controls don’t guarantee that you’ll never be the victim of embezzlement, they certainly will reduce your risk.
~Kelly Totten, Top CrackerJack
]]>I really don’t want to be a banker and I’m guessing you don’t either. The harsh reality is that any business with accounts receivable is acting as a banker.
With the current economy and banking situation, it’s important to realize that you are a banker…and you should act like one. In times when banks are failing and loan sources are drying up, your clients will be leaning on you more heavily to act as their banker. It’s critical to be careful when lending your money to your clients.
Fortunately, you can take steps to discourage the use of your cash by your clients. You need to put together a credit policy that is fair to your clients and consistent with your industry, but has enough teeth in it to protect your business. If you have employees administering the policy, you’ll want to make sure that the policy is clear and you have an escalation path for potential exceptions to the policy.
Some things you should be thinking about when you develop your credit policy include:
Who will you issue credit to? Does the company have to be a certain size? Maintain a certain D&B score? What gate will you put in place to lower your risk?
How much credit will you issue? When do you shut off the credit line? How much are you able to risk?
What are your payment terms? You’re giving a free loan to your clients. How long will you make that free money available?
What happens when they don’t pay within terms? Will you assess finance charges? (If you have to borrow money to cover the cash shortfall in your business, your client should have to cover that cost.) Will you send them to collections?
What are the alternatives for those who don’t qualify for the credit line they need? If you have a good credit policy in place, you will have customers who don’t meet the criteria for using your money. You should have some policies in place to help those customers. Some of the options here might include:
- Collecting a deposit – all or a portion prepaid
- Provide a very small credit limit, so the customer will have to pay any old invoices before accessing the line
- Accept a credit card and preauthorize the amount of the purchase
Of course, you’ll also want to consider your current client base and past payment experience. You’ll want to make sure that your current good paying clients do not suffer from your new policy. You should also take a look at your customer agreements and update them, as needed, to reflect your new terms.
Lending money is expensive and risky, but you can limit the risk. Set a credit policy that works for your business. Once you have a policy established, review it regularly to make sure it continues to work with your ever changing business, client base, and the economy.
For more information on writing credit policies, see Michelle Dunn’s Ultimate Credit and Collections Handbook.
]]>The 2009 versions of QuickBooks are due out soon and the mac version gets an upgrade this year too. Unfortunately, they didn’t include networking (multi-user) in this release. I’ve been working in both the pc and mac versions lately and it’s quite frustating that the mac version lacks a lot of the features of the pc version. Some of that is changing with this release.
Here is the list of changes noted by Intuit:
We made some big improvements in QuickBooks 2009 for Mac. The new version is much closer to functional parity with QuickBooks Pro 2009.
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New look and feel with “SuperNavigator” Homepage
Makes it easier to manage your business.
Makes full use of new Mac features like Spotlight and Coverview.
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Key business information all in one place
More visibility into the performance of your business with a new dashboard.
On one screen, you can see an income and expense graph, customer balances, and reminders
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IMPROVED! Online Banking
Save time on data entry and increase the accuracy of financial records by securely downloading bank and credit card transactions directly into QuickBooks.
Bonus: Now clients can use either WebConnect as before or use new DirectConnect access.
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IMPROVED! Batch E-Mail
Send out invoices in batches as convenient
Flag invoices and other forms to e-mail later
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IMPROVED! iCal Integration
Less likely to miss payments due from customers.
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IMPROVED! Performance and usability in Forms and List Views
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IMPROVED! Built for the Leopard Operating System
Makes full use of new Mac features like Spotlight and Coverview.
The new version should be out in October; I was told that I could download it on September 29th. I’ll post an update after I’ve seen the new version.
~Kelly
]]>I am no stranger to businesses with cash flow problems. The lack of cash to pay the bills is pretty common among small businesses. It’s no secret why it happens… promises haven’t been kept by customers, you expected sales that didn’t materialize, you expected funding that didn’t come in, the list goes on. What I find most often is business owners don’t know what to do when it happens to them. Here’s my advice:
1) Figure out what went wrong and take steps to fix the problem or at least limit the impact. This is easier said than done and you might need some outside advice to help you figure it out. Here are some things every business should do:
- Review your budget vs actual report – is anything out of line? (If you don’t have a budget, you need to get one. Budgets help you keep things under control and see when they aren’t)
- Review your trends – Look at your operating cash flow ratio, debt to equity, etc. What’s the trend? Is this a one month blip or has your problem been brewing for a while? (note, your financials must be accurate or your ratios mean nothing)
- Build a cash flow report. I like to use 2 cash flow reports. The first is a high level cash flow that turns the budget into a cash flow forecast so you can see potential problems with your budget and figure out how to make your plans work well in advance. The 2nd is the one you’ll need immediately. It’s a very tactical report that details out what you’re expecting in receivables over the next 4 to 8 weeks (as far out as you can accurately predict) and the bills you’ll need to pay.
2) Take a look at your tactical cash flow report. Make sure you’ve got payroll covered. If not, immediately figure out how you’re going to make payroll. Once you’re 100% satisfied you’ve made payroll, prioritize your vendor payments. Try to get an idea of when you’ll be able to pay vendors.
3) Collections. Call your clients – be persistent. ALWAYS ask for a date of when they’ll be able to pay. Offer to take payments on their account if they too are suffering cash flow issues. If you take credit cards, ask if they would like to use that option. If the client hasn’t given you a date of when they can pay, ask them when you should follow up with them. I like to suggest a date – “should I follow up with you next Tuesday?” Document the day, time, who you spoke with and mark them for follow up. Remember the squeaky wheel? It is true, persistence will pay off.
4) Vendors. Call your vendors (at least take their calls!). I know first hand that you don’t want to take those collection calls. No one does. I also know that what every vendor wants to know is that they’re important and you do want to pay them. You’re a lot less likely to be thrown into collections if you talk to your vendors, explain that you are having cash flow problems and see what they can do to work with you. Make sure to prioritize your vendors and don’t make promises you can’t keep. Being a liar will never work in your favor. If you simply can’t make any guarantees, tell them when your next decision point is. “I’ll be reviewing payables again next Tuesday, you can follow up with me on Tuesday.” Almost every business has had a time when they experienced cash flow problems. Most vendors will understand as long as you’re communicating and making an attempt to get them paid.
5) Paying the bills. When you finally have money to pay the bills, of course, pay the most important first. If you don’t have enough to pay everyone, try to share the love. You’ll be better off getting several people closer to current, than making one person completely current and avoiding the rest.
Of course, every situation is unique and I can’t possibly comment on all the possibilities for getting through a cash flow crunch. If you take nothing else from this article, take my advice on talking to your vendors. I see people make the mistake of not keeping an open and honest dialog with their vendors far too often. It’s the professional thing to do, so take those calls! You need to manage the situation; avoiding it won’t solve anything.
~Kelly, www.acclaroaccounting.com
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