Are you in control of your company's accounting? For many small business owners, accounting is a frightening concept. It's unusual and it's foreign. The temptation is to outsource it: to bring in a friend or a family member, or to hire a third-party bookkeeper or accounting service. Unfortunately, accounting is also an intrinsic part of a business, and separating yourself from your accounting is an easy way to lose control.
There is a danger inherent to not understanding your accounting and your accounting processes. When you offload your bookkeeping to another business or service, you can't prioritize the information that you receive. You may hire a bookkeeper, but you'll request specific things from that bookkeeper. Over time, they'll start to give you those specific items, neglecting to give you the information that you don't deep pertinent.
The problem is, without true interest and curiosity into your financial infrastructure, you can't know what's pertinent. You won't have a complete understanding of where you should be looking in your accounting reports, and you'll gradually find yourself knowing less and less about your business. Any bookkeeper, even the best or most trustworthy bookkeeper, isn't going to know about your business as much as you, nor are they going to care as much about your business as you.
To really pare down to the important numbers of your accounting — the story of your accounting — you have to build a firm foundation and gain an understanding of your company's books.
How does anyone learn anything? It all comes down to the fundamentals. As a business owner, you probably didn't begin your business with everything included right out of the gate. Instead, you built your business up slowly from the most important components, securing those components before moving on to the next.
What creates the foundation for a healthy accounting department? There are four things you need to focus on: accountability, team work, work flow and technology.
Through accountability, you set expectations regarding what your bookkeeper needs to give you. Bank reconciliations, general ledger reports or full financial reporting: if they don't come, you're asking for them. Accountability is what drives accuracy and care. If your accounting team isn't accountable for anything, the bookkeeping will quickly spiral out of control.
Accountability further tells your team what elements of your accounting and bookkeeping are most important to you. Are you doing a deep dive into your expenses every month? Are you focusing on your accounts receivable? Are you primarily interested in your gross revenue? The information you ask for tells your accountant and bookkeeper where your priorities are.
You need to have a team. Yet most small businesses don't have a big budget. In the SMB market, it's $1 to $30 million: that doesn't always leave space for a full-time accountant. Many small businesses will utilize the services of a bookkeeper instead, and it may be a part-time bookkeeper at that. But a bookkeeper is not an accountant.
A bookkeeper handles the day-to-day processing of transactions. While that's important, it isn't accounting. Accountants aren't just for taxes: they are financial mentors and a critical part of a team-based approach. The accountant needs to understand your bookkeeping, and your bookkeeper has to be able to execute the accountant's suggestions. Even a part-time accountant is important to have, not for the day-to-day operations, but rather the knowledge and experience.
Accounting works the same as any other business process. Everything needs a workflow and a process. It may be difficult to get started. But these are the key things that you need to start thinking about, and your team is what's going to bring that together for you.
Having regular, consistent accounting workflows is what controls the accuracy of your books. If you don't have a workflow for cutting checks and making vendor payments, those payments are going to go out late. Likewise, if you don't have a complete process for booking profit and income, you won't have a complete revenue picture.
Periodically, your workflow has to be explored, optimized and revised. The more efficient your business processes are, the less administrative time you'll spend on them... and the more accurate the results will ultimately be.
Today, the cloud is everywhere: everyone talks about the cloud and the associated computing technology. And there are a lot of advantages to the cloud for businesses that are willing to work with it. Through the cloud, you can leverage advanced accounting solutions that are used by big players, elevating your small business's accounting without having to increase your costs.
Modern cloud platforms can provide you with real-time information about your company's finances from anywhere. It can improve the efficiency of your operations, as well as the accuracy and depth of your reporting. By implementing new technologies and moving away from the "paper way," you can automate many of your processes and bring your books together faster and more accurately.
These are the four things that you want to think about when building your company's financial foundation. It's these things that will give you the best picture of your company's books and accounting. But they aren't the complete story.
What is accounting, really? Is it just a sequence of numbers? Far from it. Accounting is best seen as the story of a company. If you're looking at the right reports, your accounting should be able to tell you how your business is doing: the current trends, potential risks and future growth. Understanding accounting as a story is what enables you to really connect to your business and its performance.
There's no one way for a business to complete its accounting, but there are a few bookkeeping elements that business owners are likely to ignore that really need to be understood to get the full picture. These are: the Chart of Accounts, Accrual-Based Accounting, P&Ls and Balance Sheets.
At the start of every business is a Chart of Accounts. Your Chart of Accounts is like the plot outline for your company's story. Yet most businesses start with a formulaic, by-the-numbers, template and then they just start adding things. For most small businesses, the Chart of Accounts has no consistency and cohesion. It's just a set of random categories that have grown organically over time.
To take control over your Chart of Accounts, you really need to use numbers. Numbers are necessary. If you have a Chart of Accounts without numbers, it's going to be alphabetical. It won't tell a story. If you have numbers, you can organize your Chart of Accounts in the best way that makes sense to you, grouping things in a logical fashion.
Many small businesses prefer cash accounting: booking transactions as they come in, rather than for the time period they were for. It's easy to see why: cash accounting is simpler, easier and more direct. The problem is that it's not accurate. Cash accounting is fine for a very small business, but as that business grows, its books are going to become less accurate. Accrual accounting is necessary to tell a complete story.
Under cash accounting, you might pay your insurance for 12 months in January. In cash accounting, you'll see all of that 12 months of insurance in January, and you won't see any insurance costs for the rest of the year. Obviously, that's incorrect. Under accrual accounting, that insurance cost will be distributed correctly throughout the year, giving you the correct picture of your costs and your profit and loss.
Over time, cash accounting introduces static: incorrect transactions that are scattered across your calendar year, because they aren't being booked in the most accurate time period. Gradually, this makes your accounting less accurate and less useful. With this type of static, your gross profit numbers are eventually thrown off: they become meaningless and they can no longer be used to make functional decisions about your business.
If a business owner looks at one report, it's likely to be the Profit & Loss statement. And that's understandable: it's a useful financial report. Unfortunately, a business owner is also likely to only be looking at a one-dimensional P&L: one column, many rows. While it's useful as a snapshot, it doesn't tell you the full story of your business.
Rather than having a one-dimensional P&L, consider adding columns. Rather than a P&L that just reports back the entire company's operations, set up departments, profit centers, and locations: anything that could be relevant to your business. This lets you drill down into the profitability of specific sectors of your business, enabling you to make better decisions about your company's operations.
Through this, job costing can also be achieved. For many, job costing means contractors and HVAC. But anyone in a service business, where labor is a key component to what you're investing in, should be thinking about job costing. Job costing enables you to break down that client or customer relationship into smaller pieces, looking at the jobs that you might do wtih someone, and being able to analyze the profitability and drill into what you can improve upon in your processes.
As mentioned, most business owners look at the P&L first and that's understandable. However, there's an issue: many of them only look at the P&L. Most people consider the Profit and Loss Statement the quintessential accounting report. Yet the balance sheet is also incredibly important, because the balance sheet is a hedge against inaccuracy.
There's no magic in accounting. There are only two places you can put numbers: it's either the P&L or the balance sheet. If your balance sheet is wrong, if you have things on your balance sheet that belong on your P&L and you don't fix them, then the P&L is wrong. So, the importance of the balance sheet lies in driving the accuracy of the P&L.
These are the most important aspects of really understanding your company's story, but of course, it also isn't everything. As you grow more comfortable reviewing your company's books, you'll gain a deeper and more thorough understanding of your business.
Financial reports are used to grow and manage your company. If you don't have control over your company's financial reporting, you don't have a true picture of your company's profitability. And it's true that you don't know what you don't know: if you avoid your company's accounting, over time, it will become more dysfunctional and out-of-control.
Yet just like a new language, it's possible to gain further understanding of your company's accounting and financial processes by immersing yourself in it. The more you interact with your accountant and bookkeeper, the more you review your company's books and the more interest you show in the process, the more you'll understand about your company and its inner workings.
For some business owners, accounting is frightening. It's foreign, and it's very tempting to try to avoid the accounting and the bookkeeping, delegating other staff members to its maintenance. But the accounting of a business is what truly drives informed business decisions: a business owner who doesn't understand their accounting, doesn't understand their company.
By creating a course of action and paying attention to your company's financial story, you can learn more about your business and take control. But that also means working with the right partners: trustworthy bookkeepers and accountants who are able to provide you with the information that your company needs to thrive.