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 desireable 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.
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.
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.
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.
As we start work with a client, there are many times that the owner will say, “My accountant does not provide me advice on my business, they only compile my statements and do my taxes”. What most business owners do not understand is that in most cases, they are only paying their accountant to perform those two tasks when they visit them once a year. In order to provide you advice on your business, the accountant would need to come in and learn more about your business in a lot more depth than your accountant does for what they are doing now. To fully understand this, it is imperative to understand the difference between financial accounting and management accounting, along with what functions you are asking your accountant to perform.
Financial accounting is for presenting the financial position of your business to its external stakeholders in order to understand the health of your business. External stakeholders can include your Board of Directors, other stockholders, investors or lenders. Your financial statements represent the results of your business over a specified time period and are used to compare present results to your past results to see if how your business is performing. Financial statements reporting is based upon what has happened, so they are ‘backwards’ looking.
As a private corporation, your financial accountant creates financial statement compilations (Notice to Reader). Your compiled financial statements are then used as the basis of calculating your business income tax. Your accountant may make recommendations based on the information you provide them, but they are not going digging into your financials to uncover any issues or misclassification's or any wrong doings – that would be done through an audit or review and is not what you are paying for when you ask them to compile your statements. The reports they provide with the compiled statements do not provide an opinion or give any assurances that the statements are in accordance with Generally Accepted Accounting Principles (GAAP). In some cases, an investor or lender may require you to have an audit or review which will require the financial accountant to go through your financials in detail to provide some level of assurance that the statements are free from material mistakes and fairly represent the operations of the company.
It is very important that when you review financial statements that you look at the beginning of the report to see one of 4 things:
Management accounting is used by business owners and other management to make decisions concerning the day to day operations in your business. Management accounting is based on current and future trends and does not require exact numbers to be used. Because you often have to make decisions in a short time period through a fluctuating environment, management accountants rely heavily on forecasting of markets and trends when working with you. Management Accounting combines accounting, finance, and management with professional insights and methods.
Unlike financial accounting where financial statements reporting is based upon what has happened; management accounting makes use of these statements combined along with analytical tools and techniques and will focus primarily using ‘forward’ looking analysis and reporting suited to managements needs.
Financial Accountants and Management Accountants
It is important to understand your requirements and your expectations when you hire or engage an accountant, as well as understand what functions they are able to perform for your business. Not all and in fact most do not perform all functions. In some cases you might have a financial accountant to compile your statements and help you file your business taxes. You might then need to engage a management accountant to come in and help you with functions such a performing feasibility studies or helping you with functions such a budgeting, pricing, costing, productivity analysis, or profit analysis. In many cases you will have accountants that will perform some functions of each based on their background and clientele. If you have an accountant that performs all of the functions you require, it is essential that you engage them for all the purposes you require. As with any professional you hire, they are not going to just provide you with advice on a particular issue with your business when that is not what you have hired them to do.
Business owners often struggle with what professional services that they should purchase or hire for internally for their business. The problem with bookkeepers is like any profession, all bookkeepers are not created equal. Though there are college programs for bookkeepers and there is the Canadian Bookkeepers Association that offers Registered Professional Bookkeeping Certification; there is nothing that permits anyone to call themselves a bookkeeper and provide bookkeeping services to the public.
Many business owners assume that bookkeeping is nothing more than someone that performs data entry into their accounting system and possibly takes care of paying HST and administering payroll. In some cases this may be true, but if this is the case, they are most likely not a professional bookkeeper and can end up costing you a lot more in back-end fees with your Accountant at the end of the year to straighten out your books before they compile your statements or do your taxes.
A good bookkeeper will spend the time to understand your business before performing your bookkeeping. How the books are setup for a manufacturing business is quite different than a services business that probably has little to no cost of sales. A bookkeeper is not an Accountant but should understand enough about accounting in order to create transactions and allocate them to the right account. A good bookkeeper will work with your Accountant versus independently of your Accountant.
The compilations your Accountant will prepare will be based upon what you have handed them. Stated within the Notice to Reader is: “based on the information provided by management”. If you assume that everything is correct and you hand your Accountant information filled with mistakes, they are going to prepare your statements and your taxes based on what you have in your accounting system.
If something stands out as offside to GAAP (Generally Accepted Accounting Principles) your Accountant will make adjustments, but if there is something specific to your business that needs to be accounted for in a specific way. Accountants are not going to look further unless you pay for their services to do so.
Over the last few years, we have found where mistakes performed by a bookkeeper has ended up with the financial statements being incorrect because transactions were put in the wrong accounts which could also affect paying too much tax or not enough. This is an important enough function whether you outsource or hire within your business, that you need to investigate their background and credentials thoroughly.
We find that businesses that have good bookkeepers tend to have a better handle on their financials and a better understanding of where they stand. We find that they usually have a good relationship and work directly with the Accountant for the business. When this happens you will find the business financials are very clean and easy to follow if help is needed and problems within the business need to be investigated. Not only does this save you on accounting fees (because it should take less time) at the end of the year with your financial Accountant that generates your statements and your taxes, but will also save you in consulting fees from a management Accountant or consultant that comes in to help you uncover and resolve a particular situation in your business.
Before you hire a bookkeeper, ask your Accountant if they can recommend one that they have worked in the past with other clients. If they cannot provide a name, make sure that you check client references from businesses that they have worked in the past and find out what credentials they have. You could also look to organizations such as the Canadian Bookkeepers Association, the Canadian Institute of Bookkeepers or the Institute of Professional Bookkeepers of Canada for guidance.
RK Fischer & Associates