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Three Things You Should Know About Looking Under Your Financial
Hood
Management Business Advisors, LLC.
Ken Cone, CPA
June 25, 2009
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Introduction
Common Pitfalls in Accounting:
• Not understanding the financial statements.
• I have no cash, why do I owe taxes?
• Unusable financial statements.
If I use a term you do not understand, please interrupt me.
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The Balance Sheet is a Measure of Your Condition at a Point in Time
• Do you operate your business primarily by cash? Or, do you track receivables and payables?
• If I have money in the bank, I can spend it.
• My receivable and inventory are killing my cash flow.
• My payables are too high; or too low.
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The Balance Sheet
• Fixed assets: should I buy or lease?
– Buying fixed assets normally requires more cash up front than leasing
– Leasing keeps fixed assets and any corresponding liability off the books
– Compare the cost of financing with a lease versus with buying.
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The Balance Sheet
• What is the right amount to borrow? Leveraging – risk versus security; profit potential versus huge losses
• Owner’s Equity. Corporations account for equity differently than sole proprietors
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The Profit and Loss Statement is a measure of business activity during a
period of time
• What is revenue to you may not be the same as revenue to the government. Some taxes are based on gross income. Therefore, they define income as including expense reimbursements.
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Profit and Loss
• In QuickBooks™ different “Items” should be used for income and for expenses. I have often seen invoiced income show up in the P&L as a negative expense. The problem is that an income item gets assigned to an expense account.
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Profit and Loss
• What is cost of goods sold?
– Direct Costs
– Costs that are partially direct and partially overhead
– Costs that are not direct but are only spent for the purpose of production.
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Profit and Loss
• How to use the P&L for management:
– Compare financial statements across periods:
– Year to year and current month to year to date
– Include an analysis of expenses as a percentage of total revenues. Look for changes in ratios. If you approve of the reason for significant ratio changes, that is fine. Otherwise, take corrective action.
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I have no cash. Why do I owe Taxes?
• If your business generates the funds to pay your personal expenses, you will likely be taxed on the income required to cover those costs.
• If you went into debt to build your business, the payments on principal are not deductible. You will likely be taxed on the income required to cover debt service.
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I have no cash. Why do I owe Taxes?
• If you invested your income to build up assets you may owe taxes. Assets come in different flavors:
– Accrual basis taxpayers may pay taxes on the increases in accounts receivable and inventory.
– Fixed assets that cannot be immediately deducted under Section 179 may trigger income taxes.
– Accrual basis taxpayers may pay taxes from reducing accounts payable.
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Unusable Financial Statements
• Do you know why you even look at financial statements?
– Analyze them for over or under spending. They help you in maintaining discipline.
– They offer clues to planning future cash flows. In the absence of outside influence, recent financial statements offer clues about what will happen in the future. Watch out for those outside influences.
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Unusable Financial Statements
• Timeliness of the data:– The sooner you have useful data the more help it
provides. It also costs more to get it faster. So, there is a trade off between usefulness and cost.
• Understand where your money comes from and where it goes:– Was collected cash from earnings, borrowings, or
contributed capital? The IRS and probably your CPA will assume collections are earned unless you document otherwise. – Document your deposits!
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Unusable Financial Statements
– Were expenditures applied to the correct account?
• When you pay payroll taxes are you paying down a liability or is it an expense? I have moved thousands of dollars from one bucket to another because of this issue.
• Is your expenditure an expense, asset acquisition, debt service, or capital withdrawal (dividend)?
• If you are burying personal expenditures in your company expenses there are consequences.
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Personal Expenses
• When you deduct personal expenses as if they are legitimate business expenses you run the risk of penalties if you are audited by the IRS.
• These expenses may decrease the resale value of your business when the time comes to sell. The value of your business is driven by its ability to create cash for the owner. Your personal expenses create the impression that your business is less profitable than otherwise.
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Questions?
• If you have any follow-up questions, contact me at 503-746-6611 or:
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