Setting up records should also be accompanied by hiring the right accountant for your business
Start Up Handbook series part 6, Setting up your records, a bookkeeper, an accountant, hiring the right ones for your business
Knowing basic accounting principles: GAAP and IFRS
GAAP (Generally Accepted Accounting Principles) is the accounting standard used by most U.S. small businesses. The American Institute of CPAs (AICPA) recently endorsed a different set of standards used by small and midsized businesses called IFRS for SME (International Financial Reporting Standards for Small and Midsized Enterprises), which is more appropriate for companies that do business internationally.
CASH vs. ACCRUAL
- Cash basis businesses recognize income and expenses when they are paid or received, not when a product or service is delivered.
- Accrual basis business recognize income and expenses when they are incurred rather than when they are received.
IRS gives business owners latitude to elect to use either bookkeeping accounting method but does require businesses that carry substantial inventory to use the accrual basis method. Additionally, many small business operate on what is informally referred to as “modified” cash basis, which means that the company keeps its books internally using the accrual method but pays income taxes based on a cash basis.
There is no significant advantage to using either method, especially if using an accounting software. Using accrual basis financial statements will help you better understand how your business is operating and is typically required when applying for a business loan.
When you are generating reports using software programs such as QuickBooks, you have the option to choose the output in either the cash or accrual basis, an advantage that allows you to assess your financial position if using a different method.
FOUR WAYS TO PREPARE FINANCIAL STATEMENTS:
1. Internally Prepared Financial Statements:
These are prepared by the business owner or by an in-house bookkeeper or controller. They are typically prepared monthly and should be prepared at least quarterly. Because they are used internally for operations, they show no amortization of loans or depreciation of assets, and may or may not be prepared in accordance with GAAP.
Lenders often accept internally prepared financial statements as interim financial statements or, for very small businesses, in place of financial statements compiled by a certified public accountant (CPA).
2. CPA-Compiled Financial Statements:
This annual compilation of a company’s financial accounts is prepared by a CPA, an accountant or someone else familiar with GAAP, and is the basis for a tax preparer to complete your company’s tax returns. It reflects how depreciation of equipment and amortization of loans and intangible assets affect the company’s tax liability.
Banks and other lenders often require two or three years of compilations.
3. CPA-Reviewed Financial Statements:
CPA-reviewed financial statements are accompanied by a CPA’s expression of limited assurance that the information is materially correct and complies with GAAP.
Reviewed financial statements are generally not necessary unless your bank or other stakeholder requires them.
4. CPA-Audited Financial Statements:
Audited financial statements provide the highest assurances to stakeholders and involve extensive examination of multiple parts of your business. Auditors look at every financial transaction you have booked for the year and make sure it is properly categorized. They test much of your underlying financial data and express opinions about any risks they perceive.
Audited financial statements are required if you want to sell stocks in your business on a public stock exchange. They may be required by banks as a condition of making a large loan and may help you obtain a higher sales price for your business.
Next: Setting Up Your Records Keeping Systems: A Bookeeper and Accountant or Both