Now, as mentioned at the beginning, business accounting records are of essential importance to a business. Unlike tax accounting which is motivated by reducing unnecessary taxes, the goal of business accounting is to determine how a business is doing.
Is the business making a profit on the goods or services sold? If so, is the profit generated sufficient to cover general operating expenses? Also, is the company collecting payments owed by customers? Finally, are bills received and paid in a timely manner?
These are just some of the questions business accounting is able to answer. It does so with a focus on a method of accounting called accrual based accounting.
Unlike the cash method (which is used in most tax returns to calculate a business’ profits), under the accrual method of accounting a business sale occurs when a customer is invoiced not when the payment for the goods or services is rendered and expenses are recognized when a bill is received not when the bill is paid.
As a result, the accrual method accurately aligns revenues with the corresponding expenses associated with the particular sale transactions. This alignment allows for businesses to understand when sales were actually made and what costs were associated in producing and working on the sale.
Thus, a business can ascertain if its model is working or discover anomalies within the movement of transactions that have an effect on the operating profit of the business. For instance, if a business discovers in February it incurred an additional expense for electricity than it normally incurs in a February or that it had incurred in January of that same year it can investigate the problem and fix it before it impacts the company further.
Another aspect of business accounting is planning ahead.
When a business owner can see trends in sales, for example higher sales in the fall and slow sales in the summer, he/she can decide to either reduce expenses for the slow summer months or finance the expenses for the slow months knowing they will be paid back through the strong fall sales (presuming the summer expenses are unavoidable. Of course, another concept with regard to planning ahead is expansion and prior financial statements from the business accounting history can show how and when to expand operations.
In many expansion scenarios, financing (i.e., obtaining a loan) is strongly considered is the method of securing funds to expand so, having as much certainty with regard to expansion plans is important. Though, it should be noted most banks want to see profitability on both year-end financial statements AND tax returns. Hence, keep this in mind when preparing your taxes.
There is also another reason for maintaining business accounting records is to be able to compare your business to other businesses in the industry. As mentioned earlier, the best method to use for business accounting is a method called accrual based accounting. Not only is the accrual method the best method to use it is also the standard method used by most, if not all, businesses in some fashion.
As a result, you may be able to “benchmark” your business in comparison with other businesses in your industry. For those wondering, information regarding industry statistics is published and updated annually. For a fee, you can obtain this information from reputable organizations. This is a great tool to see how your business is performing and, most importantly, where you can improve especially if you cannot see where your business needs improvement.
We all understand the importance of getting a business’ books in order for tax time. However, just be sure that as this year’s tax time dust settles you continue to oversee those books for business purposes to ensure the future success of your business.
The intent of this article is to open up conversations on improving your business with your tax/finance professional. Every state has nuances, be sure to speak with a tax professional who is familiar with your state.
Safeguarding Cash Flow