Understanding Your Business Financials

The Importance of an Accounting System and Chart of Accounts Most business owners, when they think of financial statements, think of the compiled statements that their accountant produces at the end of the year for them.  In some cases, these were created by providing them a box of receipts and in other cases they were produced from your accounting system. In many cases, we find business owners are not looking at them unless they need them for financing or providing to their bank which is insufficient.

Financial statements provide a view into how your business is performing and should be looked at more than at the end of the year, because at that point it may be way too late to react to less than desirable results. This is why it is important that you have a professional accounting system such as QuickBooks, Sage, or even one specific to your industry.  Once you have the system, it is important that you have your Chart of Accounts set-up for your business.  You should want to see a breakdown of your revenue by product or service lines, target markets, sales channels, or maybe even geographies.  The same is true of your Cost of Goods.  It may be important down the road to understand the cost of raw materials, packaging, labour, shipping, or anything else that is included in your costs; especially if you want to understand how each product line contributes to your profit or loss.  Expenses within a business tend to be the same across industries.  Setting up accounts for your balance sheet should be very specific to your business.

If you are not sure how to set a chart of accounts up for your business, ask a professional for help. If you are putting receipts in a box and printing bank and credit card statements at the end of the year along with invoices and providing them to your accountant, you are not managing your financials and this is where we find businesses end up in trouble. Keeping your Bookkeeping Up to Date Once you have an accounting system, it is important that you keep the information up to date on a monthly basis.  Broadly this includes invoices, expenses, and purchases.  For other businesses this can include job costing and inventory as well. Bookkeeping is not a data entry job, it requires someone to understand the chart of accounts and have some understanding of accounting principles.  Most small businesses do not need a full-time bookkeeper and in many cases they can get by with a few hours a month based on the number of transactions their business has.  Speak to your accountant, as many firms have bookkeepers on staff and for smaller ones, we find they usually have one or two bookkeepers that they have worked with and can recommend. A good bookkeeper can be a business life saver.

If you are not keeping on top of your bookkeeping, this is where we find businesses run into trouble with paying GST / HST (depending on province)  and payroll taxes.  You may be small enough now to pay annually for GST/ HST, but at some point you are going to be required to pay quarterly and if you do not know what you have earned, if you are not tracking this closely, you may not have the funds to pay which paying late can result in fines and interest. The CRA (Canada Revenue Agency) are very unforgiving when business owners and operators borrow their HST funds for other business purposes – this is considered “trust funds” and should be allocated to any other use than remitting to the CRA.

The Importance of Finding a CPA As a business owner, you want to make sure that you find an accountant for your business that has a CPA designation and has experience in performing assurance exercises and filing taxes. Just as with any professional that you hire, you want to make sure that you feel comfortable with the individual and are able to sit down and talk to them about your business. Just like with any professional you hire, you need to perform due diligence.  Different firms will have different focus areas and designations of accountants with specific expertise.  Make sure you find one that meets the needs of your business. In some cases, there might be accountants who focus on particular industries as well. 

Too many times we hear from clients that they drop off their books once a year with their CPA and pick up their statements and taxes once completed and never speak to their accountant.  As an owner, it is up to you to build a working relationship with your accountant and meet with them to get their advice.  They are professionals, so this is not a free service, but is an important one.  Running  and Reviewing Monthly Reports There are reports that as a business owner you should be running on a monthly basis to understand how your business is performing.  At minimum you should be running the following reports.

  • Profit and Loss Detail :  This report will provide you with your revenue, CoGS, expenses and net income.  This is also called an Income Statement. This lets you know if you are making money on a month to month basis.

  • Balance Sheet Detail:  This report provides you with your current and long-term assets, your current and long-term liabilities and equity. This shows if you are able to pay your bills on time by reviewing working capital, or if your company is ‘technically solvent’ by reviewing net assets or equity.

  • Statement of Cash Flow Detail:  This report nicely ties the income statement to changes in the balance sheet. This statement links the balance you had in your bank at the beginning of the year or month, and outlines what business activities provided or consumed cash to arrive at your bank balance at the end of the year or month. We have clients ask, “If I am making money, then why am I always short of cash?” This statement provides the answers; paying back loans, buying equipment, paying back suppliers, not collecting from your customers, all impact the cash balance in your bank.

  • Accounts Receivable Aging Detail :  This report provides you with the outstanding accounts receivables. You will find out who pays on time and how long others are taking to pay you; remember, Accounts Receivable is your money in other peoples pockets.

  • Accounts Payable Aging Summary:  This report provides you with the outstanding accounts payables. This report may provide some insight as to why some suppliers are easier to deal with than others. Always paying late, or when you are being chased? How is that working out for you?

  • Budget vs Actuals: This report provides you with how you actually performed versus your budget. Budget should be looked as “how you expected the business to perform”; it is not cast in concrete.

Sitting down and reviewing these reports monthly will help you make informed decisions about your business. From the reports you might see that your expenses are running too high, your margin is not what is expected, your accounts receivables are out of control, you are not paying your vendors on time, or you are not earning the revenue that you forecasted.  Understanding what is going on will help you make the decisions you need to make changes in order to make any necessary changes in order to improve your financials moving forward. Having Compiled Statements Developed Every incorporated business should have compiled statements developed by a  CPA.  The level of compilation is dependent on your requirements.  In most cases, most businesses have a Notice to Reader performed.  In the case of Notice to Reader statements, your accountant is relying on your books and what you provide them to be accurate and the covering letter will reflect this.  If you are having them performed as a management exercise, Notice to Reader statements are adequate.  It is important if you don’t understand the statements that you ask your accountant to sit down with you and go through them with you. Too many times we have clients tell us they have them done every year, but do not understand what they are telling them about their business.

This is also why it is important to review statements within your accounting system monthly , as compiled statements are after the fact which means they are completed and there is not anything that can be done to alter what has already happened.  It is best to catch it early and make the necessary changes, so there are not any surprises at the end of the year.

For businesses who are looking for financing or investment in their business, a bank or a lender may want Reviewed or Audited Compiled Statements.  These two assurance exercises perform more due diligence by the accountant on your books to provide a stakeholder an assurance that the financial statements being presented is fairly accurate.  What is required will be dependent on your credit rating, the amount you are looking to borrow or have invested, and your past history with the financial institution. Only Licensed Public Accountants can perform assurance exercises such as Reviews and Audits.

Understanding Ratios There are several ratios that as a business owner you need to understand about your business, because when you go to a bank in many cases it will be these calculations that will determine whether you get approved for a loan or not.  It would be better to know ahead of time before approaching a lender that you do not qualify versus waiting to be turned down.  If you have your compiled financial statements, then you can calculate the ratios for yourself.

Summary As a business owner, it is important that you have a good understanding of the financials of your business .  If you do not have a good understanding of how your business is performing or where there are potential issues and where to look, it will be difficult to move your business forward and meet the goals that you have set for your business.

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