Many small to mid-sized businesses are operating today with the basic financial information they have used for years. In many cases, the owner started with QuickBooks and used the standard template for the Income Statement (often referred to as the Profit & Loss statement) when setting up the accounts that would track the business. Over the years, new accounts were added as needed. And now, looking at what has evolved, the P&L has become a mix of accounts in an order that doesn’t make sense, and can’t be used to really understand the business.
In many cases, a company should make significant changes to the format and accounts they use. By setting up accounts that are really needed, and putting them in the order that will most effectively enable the owner to understand the results, the P&L can be used to determine areas to be investigated, and the owner can begin to actually manage the business.
Here are some brief pointers about what is needed to generate the financial statements you need:
Chart of Accounts. Unless you create the proper accounts needed to track every transaction, you will not be able to produce useful financial statements. For example, many companies record, as one total amount, the payment they make on their credit card, even though it can include expenses for purchases of inventory, travel, entertainment, supplies, contributions, and many others items. At the end of the year there is a large amount in the Credit Card account when there should instead be amounts in each of the individual categories.
Proper Recording in Each Account. There should be a description of what belongs in each account so that items are recorded consistently. Salaries paid to sales personnel do not belong in the same category as the salaries paid to the controller or to employees who make the company’s products or provide the company’s services. Combining all into one “Salaries” account may be simple, but it makes it impossible to properly determine gross profit, selling, and administrative expenses.
Organization of the P&L. The order of the accounts is as important as the accounts themselves. A company needs to understand its gross profit, for example, so it is critical that only the proper accounts be used to determine “Cost of Sales.”
Cash or Accrual Basis? While many companies maintain their books on a cash basis, most should be using the accrual method to better understand the current and future impact of transactions. QuickBooks and other packages can handle either, but the controller or bookkeeper needs to understand the differences to be able to properly record transactions.
Once you have developed the basic building blocks, you will then be in a position to begin to create a reliable P&L. (You will also be in a position to determine your overall profit as well as profit by department or customer, and understand how your P&L affects your balance sheet and cash flow and allow you to better run your company.)
The above also applies to the company’s balance sheet. It is just as important to properly create the needed accounts and organize them in the balance sheet as it is for the P&L. For example, you need to know your level of Current Assets and Current Liabilities (which allows you to compute your Current Ratio). Without a doubt, your banker is very interested in your balance sheet and your Current Ratio, so you need to be, as well.
There are other areas that are important:
- Setting goals and creating a budget.
- Closing the accounting books every month, and as early in the month as possible.
- Comparing actual results to budget and taking corrective action quickly.
- Learning how to read and understanding all of your financial statements.
- Developing key performance indicators (KPIs) and knowing what the drivers are for success in your business.
If you don’t understand any of the above concepts, or if you are not sure why they are important, you need to talk to a B2B CFO® who can review your current financial statements and explain how they can be improved. Without accurate, reliable, and current financial statements, you are not truly managing your business – and that’s a risk you should not take.