Cash or Accrual: Which is right for my business?

If I had to make a list of the top questions I am asked by clients, I would put this one near the top: “Which is the better way to track my small business’s financial performance – cash or accrual?” You ask this to any CPA and they are bound to have a different answer. This is because… there is no “one size fits all” answer. Some business should be using cash basis while others should be using accrual, and some should be using a hybrid of the two.

If I’ve already lost you, never fear. Most business owners have heard of cash and accrual in the context of accounting for their business, but few really understand the little nuances that make one method better than the other for their particular business.

Under the cash basis of accounting, revenues are recorded when cash is received and expenses are recorded when cash is paid. The foundation for accrual based accounting is called “the matching principle”. Basically, this is the idea that expenses should be recorded when an obligation is incurred. For example, cost of sales (an expense) is recorded when the product is sold not when inventory is purchased. Similarly, when a company records a sale, the sale is income to the company when the product of service is provided to the customer and not when the customer paid the bill.

True accrual accounting is complex and time consuming. In a perfect world, all businesses would be using the accrual method. It gives the most accurate picture of a company’s performance over time because of how it matches the revenues with the expense in the period that each are incurred.

For example, a car dealer buys a used car in an auction for $1,000 in January. In March, he sells it for $3,000 on credit where the customer will pay down the loan over time. In the cash method of accounting, his January Income Statement would show a $1,000 expense for buying the car and no income. Then in March, it looks like he didn't sell anything because the customer didn't pay cash for the car. This is not an accurate picture of his business’s performance at all. In the accrual method, he would record the sale for $3,000 and the $1,000 cost of the car as an expense all in March so his true profit is $2,000 in March – which is an accurate representation of his businesses performance in March.

But – a lot of small businesses will opt for the cash method because - let’s be honest now - it’s easier. A lot easier. And a lot of small businesses don’t have the extra time or money to spend on keeping their books under the accrual method – and that is ok. Like all things in business, you need to weigh the costs and benefits.

I've created a little flow chart to help you decide which may be better for your particular situation. (You can save the image or view it in another window in order to zoom in.)

Why You Should Fall in Love... with Accounting

We fall in love.  We get married.  Then we realize that we said "I do" not only to the wonderful man or woman we married, but to everything that comes with them: their family, debts, pets, and quirks.  Some of these things are not easy to love, but we need to learn to love those things that will ultimately make our marriages stronger and more successful.

Similarly, when we fall in love with entrepreneurship, we say "I do" to a business and all the "baggage" that comes with it. We open a coffee shop because we love coffee and we know a lot about coffee, but more often than not, we don't love the accounting that has to be done in order to manage the coffee business.

If you marry someone but don't get along with their mother, you have two choices. You can let this divide and potentially destroy your marriage or you can find a way to love or accept your mother-in-law.  In business, accounting is like the overbearing mother-in-law.  You may not want to deal with the accounting, but if you don't learn to love it or at the very least, understand it, your business will never reach its potential and could quite possibly fail. 

Without having a grasp on your company's financial situation, you are flying blind.  Its not enough to go through your books every year around tax time.  Business owners should be reviewing their financials each month, asking questions, and striving to understand the numbers.  I tell my clients that they should have the results from January by mid-February at the very latest - the quicker, the better.  That way you have timely information available so you can make adjustments on how you are running your business. How else would you be able to tell that your travel costs are getting out of hand, you're paying too much in unnecessary bank fees, your clients aren't paying you timely, or you have too much inventory on hand and its sucking up your cash flow?

So why should you fall in love with accounting?  If you want your business stand the test of time, you have no choice.  The good news is that you can hire an accountant to help with your business's finances... but you can't hire someone to deal with your mother-in-law. 

Learn more about Bonnie Forssell and her accounting practice here.

How Business Owners Should Be Using Their Accountant

Only 19% of small business owners go to their accountant for business advice according to the 2013 US Bank Small Business Survey.  I saw this and immediately thought - why not?  More often that not, a business owner uses their accountant once per year...during tax time OR they have a bookkeeper that is routinely paying bills and keeping their books in good shape. In both instances, the accountant may not be viewed as a trusted business advisor, but they could be!

If this is also your view, listen up!   A good accountant can be an untapped resource for your business!  After all, they are familiar with your company and have access to all the right data in order to provide you with useful information to help you make better decisions.  Your accountant may just hold the secret to how healthy your company really is and how to improve it.

If you are a relatively small company (i.e. less than $500K in revenue and/or less than 3 employees), you may benefit from consulting with your tax accountant at least twice a year on non tax matters.  If you are larger than this, but not quite ready for a full-time CFO, your business could really thrive with a part-time or outsourced CFO.  Consult with your CFO monthly or quarterly - depending on your needs and your budget.

Ask your accountant to examine your financial statements (P&L, Balance Sheet, and Cash Flows), to compare results to prior years, and to forecast future results. Discuss your current pain points and ask them where they feel improvement is necessary. Talk to them about your longer term goals and how your current results are either getting you closer to or further from your goals. 

Good accountants should be able to point your business in the right direction.  They are skilled at examining mounds of financial data, pulling relevant and meaningful information from this data, and translating that information into a format that you can use as a basis for making important decisions.

Its time to start thinking of your accountant as more than your bookkeeper or your tax guy or gal.  They can be a trusted business advisor and can really help catapult your business to the next level! 

Learn more about what we do at www.mytrustedcfo.com.

What is the difference between a bookkeeper and an accountant? Who should I hire?

You've decided to hire someone to help with the books, but where do you start?  Many times the title of "bookkeeper" and "accountant" are used interchangeably because - lets face it - its confusing who does what!  Which is right for your business?

What is the difference between a bookkeeper and an accountant?

A bookkeeper, quite literally, keeps the books.  They are the paying bills, recording transactions, reconciling accounts, running reports, etc..  To be a bookkeeper or Certified Bookkeeper, you do not need a college degree, although some bookkeepers do have a 2 year associates degree or a 4 year college degree.

An accountant focuses on financial reporting, process improvement, business analysis, and often is a business advisor.  Accountants have 4 year degrees.  To be a Certified Public Accountant, you now need 150 college hours (the equivalent of a 5 year degree), to pass the 4 part CPA exam, pass the ethics exam, and meet certain experience requirements that vary by state.

As I'm sure you can guess, bookkeepers without a degree are the least expensive, while CPAs are generally the most costly.  Which level you need, depends on several factors.

Who should I hire?

This depends on your business. Is it complex?  Do you have several employees?  Do you require customized financial reporting?  In general, be weary of hiring a bookkeeper without some amount of formal accounting education.  Although they may have the necessary skills to complete the day-to-day tasks, that person typically lacks the broader perspective. 

A good option is to have an experienced bookkeeper to keep up the books on a regular basis and have a CPA that periodically works in tandem with the bookkeeper.  The CPA (sometimes you may hear them referred to as an outsourced CFO or controller) can offer customized solutions, innovative reporting, forecasting, improve processes, monitor costs, and can act as a financial advisor for your business.

Above all, you need to hire a bookkeeper and/or accountant with integrity.  This is the most important quality and the hardest to judge.  Try to get referrals from other business owners on who they use and who they trust and check references!

7 Clever Ways to Increase Your Bottom Line

Ok. It will come as no surprise that increasing sales will (usually) increase your bottom line. I'm not here to point out the obvious.  I'd like to explore a few less obvious ways to make your company more profitable.

1.  Think about your discounting differently!  There is a difference between the customer's perceived value of a discount and your actual cost. For example, you could sell a $1,000 computer at 20% off.  The customer sees a $200 savings and you see a $200 cut from your bottom line. Conversely, you can offer a free printer/fax/scanner that sells for $200 with the purchase of a $1,000 computer. The customer still sees a $200 savings, but the cost of that scanner might have only been $100...you can do the math from here.

2.  Stop selling low gross profit margin items!  To do this, you first need to invest a little time (if you haven't done so already) to know your profit margins by product.  If you are a restaurant that sells 80 different main entrées, you may be surprised to find that 10% have a profit margin that is much less than the other entrées. Stop selling those low margin items! If you consider the fixed costs, you could be losing money with each sale of these low margin products! 

3.   Take a second look at your vendors! I have found that companies don't like to change vendors because, frankly, it can be a pain.  You know the saying..."No pain, no gain!"  However, I'm not saying you have to switch up your credit card processor, your point of sale system, your payroll provider, your accountant, and all your suppliers in one go.  But, it may be worth it to go to market, see what prices you can get from your vendors' competitors, and then ask your vendors to match it.  You may be surprised in the flexibility your vendors have on price.

4.  Go green! Going paperless can save printer/copy machine, paper, utility, and postage costs!  Offer direct deposit, pay bills online, email rather than snail mail your customers, keep the office 1 degree warmer in the summer, turn off lights and your computer at night.  It all will add up!

5.  Don't be a luddite! Embrace technology! Don't know what I'm talking about? A luddite is a term describing those opposed to, or slow to adopt new technology.  Reduce travel costs by using video conferencing or conference calls where it is reasonable to do so.

6.  Manage your inventory!  I can't stress this enough. You can lose money from obsolete inventory. Monitor your turnover by product line. The way to keep profits high is to keep your turnover as high as possible without risking an inventory shortage. Its a fine line, and the companies that have done the appropriate inventory analysis can walk that line, and they will see higher margins.

7  Follow up on receivables timely! First off, if you are going to offer credit to your customers, do a credit check.  Second, if you have past due accounts, don't be afraid to contact the customer when the account becomes a few days past due!  Give them a call - you don't need to attack them. Tell them you noticed the invoice is past due, given them the benefit of a doubt, and ask if they received the invoice or misplaced it.  If the customer informs you that they can't pay it, offer to help by setting up a payment plan. Don't be shy.

There are many many more ways to increase that bottom line.  Sometimes you have to step back and think outside the box, develop new processes that are more efficient, or simply pass up on buying the brand new designer desk and fancy rug for your office (heaven forbid).

What have you done to increase your bottom line?  I'd love to hear how others have done it!

Please visit my website at www.mytrustedcfo.com to learn more about what I do.