Authors: Inc The Staff of Entrepreneur Media

Start Your Own Business (103 page)

BOOK: Start Your Own Business

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SAVE

Following are three tips for your accounts payable system that will improve your business’s cash flow: 1.
Take discounts whenever feasible
. Saving 1 or 2 percent on an order can be significant. 2.
If discounts aren’t offered, don’t pay early
. There’s no need to drain your cash flow unnecessarily. 3.
Keep your suppliers informed
. If you do fall behind, keep the lines of communication open with your suppliers. You can ill afford to get put on c.o.d.

Financial Statements

One of the primary benefits of a good bookkeeping system is the generation of timely and useful financial statements. Most automated software packages offer the capability of producing monthly financial statements. This information includes a balance sheet, an income statement and a cash-flow statement. These monthly reports provide invaluable information on the historical measures you need to make the financial decisions that will positively impact your business tomorrow.

Refer to the next chapter for a look at these financial statements in detail and how you can use them for effective short- and long-term financial planning.

IT ALL ADDS UP

I
n the not-too-distant past, to set up an automated bookkeeping system you had to spend countless hours yourself or hire a programmer to customize an accounting system for your business. And since most new business owners did not have the time to do it themselves or the financial resources to hire a programmer, cumbersome manual systems were used, or the bookkeeping function was completely outsourced to an accountant or bookkeeping service.

Fortunately, those days are over. In today’s market, new business owners will find a number of very affordable and full-featured accounting software packages from which to choose. These popular accounting packages not only allow business owners to track and manage every aspect of their companies’ finances, but they also reduce accounting expenses by saving accounting firms time and effort in producing companies’ year-end tax return and/or financial statements.

Here are some of the most popular “canned” accounting software packages: Intuit’s QuickBooks Pro, Peachtree’s Complete Accounting, and Sage’s Simply Accounting. They range in price from $50 to $299. Regardless of which package you buy, it will be one of the most beneficial purchases you make in starting your small business.

For the Record

As you set up your bookkeeping system, you will need to establish procedures for keeping financial records. The IRS requires that you keep records on hand for certain specified periods of time. And with some financial records, it just makes good business sense to keep them so you can access them at a later date.

One key point here is to make sure these records are kept in a safe place. Whether you store them on-site or at a remote location (some business owners use self-storage units), make sure you use a fireproof cabinet or safe.

Another recommendation is to minimize paper buildup by storing as much as possible on CDs, microfilm or DVDs. Here is a list of what you need to save and for how long, as recommended by accounting firm PricewaterhouseCoopers:

Record Type
How Long?
Income tax reports, protests, court briefs, appeals
Indefinitely
Annual financial statements
Indefinitely
Monthly financial statements
3 years
Books of account, such as the general ledger
Indefinitely
Subledgers
3 years
Canceled payroll and dividend checks
6 years
Income tax payment checks
Indefinitely
Bank reconciliations, voided checks, check stubs and register tapes
6 years
Sales records such as invoices, monthly statements, remittance advisories, shipping papers, bills of lading and customers’ purchase orders
6 years
Purchase records, including purchase orders and payment vouchers
6 years
Travel and entertainment records, including account books, diaries and expense statements and receipts
6 years
Documents substantiating fixed-asset additions, depreciation policies and salvage values assigned to assets
Indefinitely
Personnel and payroll records, such as payments and reports to taxing authorities, including federal income tax withholding, FICA contributions, unemployment taxes and workers’ compensation insurance
6 years
Corporate documents, including certificates of incorporation, corporate charter, constitution and bylaws, deeds and easements, stock, stock transfer records, minutes of board of directors meetings, retirement and pension records, labor contracts, and license, patent, trademark and registration applications
Indefinitely

Record Type	How Long?
Income tax reports, protests, court briefs, appeals	Indefinitely
Annual financial statements	Indefinitely
Monthly financial statements	3 years
Books of account, such as the general ledger	Indefinitely
Subledgers	3 years
Canceled payroll and dividend checks	6 years
Income tax payment checks	Indefinitely
Bank reconciliations, voided checks, check stubs and register tapes	6 years
Sales records such as invoices, monthly statements, remittance advisories, shipping papers, bills of lading and customers’ purchase orders	6 years
Purchase records, including purchase orders and payment vouchers	6 years
Travel and entertainment records, including account books, diaries and expense statements and receipts	6 years
Documents substantiating fixed-asset additions, depreciation policies and salvage values assigned to assets	Indefinitely
Personnel and payroll records, such as payments and reports to taxing authorities, including federal income tax withholding, FICA contributions, unemployment taxes and workers’ compensation insurance	6 years
Corporate documents, including certificates of incorporation, corporate charter, constitution and bylaws, deeds and easements, stock, stock transfer records, minutes of board of directors meetings, retirement and pension records, labor contracts, and license, patent, trademark and registration applications	Indefinitely

chapter 38

MAKING A STATEMENT

How To Create Financial Statements

By J. Tol Broome Jr.
a freelance business writer and banker with 28 years of
experience in commercial lending

I
n the last chapter, we explored establishing a good bookkeeping system for your new business. And while a well-organized bookkeeping system is vital, even more critical is what you do with it to establish your methods for financial management and control.

Think of your new bookkeeping system as the body of a car. A car body can be engineered, painted and finished to look sleek and powerful. However, the car body won’t get anywhere without an engine. Your financial management system is the engine that will make your car achieve peak performance.

You may be wondering what exactly is meant by the term “financial management.” It is the process you use to put your numbers to work to make your business more successful. With a good financial management system, you will know not only how your business is doing financially, but why. And you will be able to use it to make decisions to improve the operation of your business.

Why is financial management important? Because a good financial management system enables you to accomplish important big-picture and daily financial objectives. A good financial management system helps you become a better macromanager by enabling you to:

• Manage proactively rather than reactively

• Borrow money more easily; not only can you plan ahead for financing needs, but sharing your budget with your banker will help in the loan approval process

• Provide financial planning information for investors

• Make your operation more profitable and efficient

• Access a great decision-making tool for key financial considerations

TIP

How does your business measure up against others? Check out
Annual Statement Studies
, a massive and detailed comparison of financial data from the Risk Management Association’s (RMA) member institutions. Find out more at RMA’s website at
rmahq.org
(click on “Products and Services,” then “RMA Bookstore”).

Financial planning and control help you become a better micromanager by enabling you to:

• Avoid investing too much money in fixed assets

• Maintain short-term working-capital needs to support accounts receivable and inventory more efficiently

• Set sales goals; you need to be growth-oriented, not just an “order taker”

• Improve gross profit margin by pricing your services more effectively or by reducing supplier prices, direct labor, etc., that affect costs of goods sold

• Operate more efficiently by keeping selling and general and administrative expenses down more effectively

• Perform tax planning

• Plan ahead for employee benefits

• Perform sensitivity analysis with the different financial variables involved

Creating Financial Statements

The first step in developing a financial management system is the creation of financial statements. To manage proactively, you should plan to generate financial statements on a monthly basis. Your financial statements should include an income statement, a balance sheet and a cash-flow statement (see pages 663, 666 and 670, respectively).

AHA!

Many business owners make the mistake of preparing financial statements only at year-end when the IRS requires it. The consequence is reactive financial planning. If you want to be a proactive financial manager, generate monthly financial statements and use them to make the key financial decisions that affect the daily success of your business.

A good automated accounting software package will create monthly financial statements for you. If your bookkeeping system is manual, you can use an internal or external bookkeeper to provide you with monthly financial statements.

Income Statement

Simply put, the income statement measures all your revenue sources vs. business expenses for a given time period. Let’s consider an apparel manufacturer as an example in out lining the major components of the income statement:

•
Sales.
This is the gross revenues generated from the sale of clothing less returns (cancellations) and allowances (reduction in price for discounts taken by customers).

•
Cost of goods sold.
This is the direct cost associated with manufacturing the clothing. These costs include materials used, direct labor, plant manager salaries, freight and other costs associated with operating a plant (e.g., utilities, equipment repairs, etc.).

•
Gross profit.
The gross profit represents the amount of direct profit associated with the actual manufacturing of the clothing. It is calculated as sales less the cost of goods sold.

•
Operating expenses.
These are the selling, general and administrative expenses that are necessary to run the business. Examples include office salaries, insurance, advertising, sales commissions and rent. (See the “Schedule Of Operating Expenses” on page 664 for a more detailed list of operating expenses.)

•
Depreciation.
Depreciation expense is usually included in operating expenses and/or cost of goods sold, but it is worthy of special mention due to its unusual nature. Depreciation results when a company purchases a fixed asset and expenses it over the entire period of its planned use, not just in the year purchased. The IRS requires certain depreciation schedules to be followed for tax reasons. Depreciation is a noncash expense in that the cash flows out when the asset is purchased, but the cost is taken over a period of years depending on the type of asset.
Whether depreciation is included in cost of goods sold or in operating expenses depends on the type of asset being depreciated. Depreciation is listed with cost of goods sold if the expense associated with the fixed asset is used in the direct production of inventory. Examples include the purchase of production equipment and machinery and a building that houses a production plant.
Depreciation is listed with operating expenses if the cost is associated with fixed assets used for selling, general and administrative purposes. Examples include vehicles for salespeople or an office computer and phone system.

•
Operating profit.
This is the amount of profit earned during the normal course of operations. It is computed by subtracting the operating expenses from the gross profit.

•
Other income and expenses.
Other income and expenses are those items that do not occur during the normal course of business operation. For instance, a clothing maker does not normally earn income from rental property or interest on investments, so these income sources are accounted for separately. Interest expense on debt is also included in this category. A net figure is computed by subtracting other expenses from other income.

•
Net profit before taxes.
This figure represents the amount of income earned by the business before paying taxes. The number is computed by adding other income (or subtracting if other expenses exceed other income) to the operating profit.