Financial statements and your business

Many small businesses operate on a cash basis, and the extent of their financial reporting is a monthly bank statement. At the end of the year, they pull all of their receipts together and group them so that they can complete their tax forms. That is a tough way to run a business because it is difficult for business owners to keep track of their financial position without good financial statements.

Why do you need financial statements?
Financial statements tell the story of a business. Income statements tell the story over time. Balance sheets tell the story at a point in time. Business owners want to know if they are making a profit and if they are going keep making a profit. Financial statements can help answer those questions. At some time or another, business owners will want to tell this story to others as well.

• Investors
• Suppliers
• Customers

Investors want to know if they are going to be paid back. Suppliers want to know if you will be around as a customer. If you are, how they want to know how big a customer you might be, and they want to know if you can afford to pay for their goods. Customers want to know if you are going to remain in business. If they buy products from you, they want to know that you will be able to stand behind them. If you provide some sort of professional service, they want to know that they will be able to go to you in the future.

Why not have financial statements?
Some small business owners have the misperception that it is too difficult or too expensive to maintain the records necessary to produce financial statements. Fortunately, keeping good financial records is actually fairly simple and not very expensive. Business owners can use spreadsheets such as Microsoft Excel, or they can use bookkeeping programs such as QuickBooks. Templates are available for spreadsheet users. Businesses that opt for bookkeeping software will even find that the software grows with them. The cost of these programs can be under a couple of hundred dollars. Business owners can also hire bookkeepers to do the work for them. This is also less expensive than many business owners realize, and having organized records and financial statements will reduce the cost of tax preparation. It can also make it easier to obtain financing.

Basic Statements
However you keep your records, you should produce these statements.

• Balance Sheet: This is a snapshot of short-term and long-term assets and liabilities.
• Income Statement: This is commonly called a P&L or profit and loss statement. It begins with revenue and then shows the effect of various expenses and ends with net income.
• Statement of Cash Flows: This is a description of how cash flowed in and out of your business, and it describes generally where money came from and how it was used in terms of operating, investing, or financing activities.
• Statement of Retained Earnings: This is a statement showing the accumulated earnings of a business.

Financial ratios
Once you have your financial statements in hand, you can review them. A few of the common ratios typically used to evaluate businesses are listed below. The list is far from complete. For example it does not include activity measures such as conversion periods or turnover ratios.

Measuring profit
Gross profit margin: This is a measure of how much of your income can go towards overhead and profit.

Gross Profit / Net Sales

or

(Net Sales – Cost of Goods Sold) / Net Sales

Operating margin: This tells you the profitablity of your core business.

Operating Income / Net Sales

or

(Operating Revenues – Operating Expeneses) / Net Sales

Measuring Liquidity
Current ratio: This is a measure of your ability to pay short-term debt.

Current Assets / Current Liabilities

Quick ratio or "Acid Test:" This is a more stringent variation of the current ratio. The Acid Test compares current assets net of inventory to current liabilities.

Evaluating Debt
Debt to assets ratio: This measures how much you rely on borrowing to finance operations.

Total Liabilities / Total Assets

Times interest earned or Interest coverage: This ratio measures the relationship between your income and your interest expense.

Net income / Interest Expense

Debt service coverage: This ratio shows the relationship between your operating income and your debt service expense.

Net Operating Income / Debt Service

How to save money on your bookkeeping and tax services

Have you thought that you pay too much for accounting, bookkeeping, and tax services? You may be right, and there are things that you can do to reduce those expenses.

Keep good records.
Keep accurate records throughout the year, and organize them so that they will be ready for your bookkeeper or accountant. Separate your personal and business records. Divide your business expenses into categories such as office expenses, supplies, travel, meals and entertainment. Keep records of purchases for items such as office equipment, phones, and computers or other items that you can depreciate. If you drive an automobile for work, get one of those auto record books and keep it. Keep your business and personal records separate. If you have a home office, track your expenses for utilities, taxes, and anything that you spend related to your business. If you aren't sure what is important, ask your CPA or bookkeeper.

Organize your records.
Think about buying a bookkeeping program. It is worth your time to talk to your CPA or to a bookkeeper to learn how to set up your records. If you have a small business, seriously consider purchasing bookkeeping software such as QuickBooks or Peachtree. If you do, it is worth your while to ask an accountant or bookkeeper to help you set up your books.

Find a CPA.
If you do not already have a regular CPA, hire one. Ask the CPA that prepares your taxes to take you on as a regular client. A CPA can provide you with advice, he or she can help you avoid making mistakes, and he can help you understand how your business is doing. A good CPA's time is worth every penny.

Find a bookkeeper.
Ask your CPA for a recommendation. Paying for bookkeeping might seem expensive, but it is probably less expensive than doing it yourself. A good bookkeeper will be faster and more accurate than you are likely to be, and the time you save will be time you have to devote to your core business.

The cost of paying a bookkeeper to do your books throughout the year also will be less than the cost of asking your accountant to do it a month before your taxes are due or before you need financial statements for a loan. Even more important, a bookkeeper can provide you with regular statements to help you understand your business' financial position and cash flow.

Ask what you can do to reduce bookkeeping costs.
Talk to your bookkeeper! Find out if there are things that you could do to keep your costs down. Here are several examples.

• Do you stuff all or your receipts in a folder and then ask your bookkeeper or accountant to organize them for you? This is expensive because your bookkeeper is not necessarily familiar with all of your activity. It takes extra time to figure out how to categorize expenses if you have not already organized them.
• Do you wait until the end of the period to provide your documentation and then ask your bookkeeper or accountant for fast turnaround for your statements? There is always a tradeoff between time and money. Asking for expedited service adds to your cost.
• Do you mix up your personal and business records? It takes time for your bookkeeper to figure out which is which, and it increases the possibility of mistakes.
• Figure out how often you want financial statements and which ones you want. Your bookkeeper can provide you with them as often as you wish, but you pay for them even if you do not use them.

Ask what you can do to reduce your tax preparation costs. 

Talk to your CPA or the professional that prepares your filing. He or she can tell you exactly what you need to do in order to simplify your tax filing and to make it less expensive to prepare your return. Here are a few things  you can do.

• Make sure your CPA and your bookkeeper talk to each other.
• Take advantage of the checklists and organizers your accountant provides.
• Review your documents before you take them to your accountant. Make sure that you have everything you need.

Return your calls! Respond to email!
When your bookkeeper or CPA calls or emails, assume it is important and respond! If you do not return your calls or answer your email, then one contact becomes two or three or more. That wastes a lot of time.