Your “Chart of Accounts” is the list of accounts in your accounting software. The accounts are listed in your reports, and the totals allow you to determine how much you’ve spent, made, own, or owe depending on the type of account.
It’s essential to create a list of accounts that you need in order to make better business decisions. Your chart of accounts needs to be designed intentionally. If it hasn’t been, it’s never too late.
Two Types of Accounts
There are two major types of accounts:
- Balance sheet accounts that tell what you own and owe. These are determined by your checking accounts, inventory, and credit cards.
- Income statement accounts that tell you about current period operating results. These, in turn, have two major categories, income and expenses. For companies with inventory, expenses are further broken out into cost of goods sold and other expenses.
A chart of accounts should meet three needs:
- Make it really fast for you to do your taxes
- Give you all sorts of “Aha’s”
- Allow you to spend far more time on revenue analysis than expense analysis because that’s where success lies for small businesses
Your accounts should be the same as (or be able to be grouped into) the lines on your tax return. You can find a copy of the tax form you fill out. For example, a sole proprietor will use a Schedule C of the 1040, and a corporation will complete an 1120.
There are a few special needs, such as meals and entertainment which are only partially deductible, that you need to pay special attention to. We can help you with that.
As small business owners, we work with a gut feel, but when you see what you’ve made or spent in black and white, it takes on a whole new level of meaning. Your income statement and other reports should do that for you. If they don’t you may not have your accounts set up right.
Think about how you want to see your revenue:
- By product line
- By major supplier
- By category of solution to the customer
- By customer type
- By service type
- By location (you can also use Class for this)
- By job
- By distribution method
We can help you brainstorm based on your industry and type of business.
If you’ve been putting all your revenue into one revenue account, it will be exciting the first time you see your new Profit and Loss statement.
If you’ve been breaking out your revenue but it hasn’t led to any actionable change in your business, then there may be a better way to break it out.
If you’re happy with the way your revenue is broken out, then think about how you can take it to the next level.
Once you see your new chart of accounts, you will likely have even more questions. The chart of accounts can be an evolving entity, designed to serve your business needs.
Before we get too far into 2017, let’s take a look back at 2016 results and five meaningful numbers you may want to discover about your business’s performance. To start, grab your 2016 income statement, or better yet, give us a call to help you compute and interpret your results.
Revenue per Employee
This number measures a company’s productivity with regard to its employees and is relevant and meaningful for all industries. If you have part-time employees, compute a full time equivalent total and use that as your denominator.
Compare this number to prior years to see if your company is getting more or less productive. Also compare this number to businesses in your same industry to see how your company compares to peer companies.
You may also want to compute other revenue calculations, such as revenue by geography, revenue by product line, or average sale: revenue by customer, if you feel these may be meaningful to your business.
Customer Acquisition Cost (CAC)
How much does it cost your business to acquire a new customer? That is the customer acquisition cost and is made up of marketing and selling costs, including marketing and selling labor. You’ll need the number of new customers acquired during 2016 in order to calculate this number.
Compare this number to prior years as well as industry peers. You can potentially do a lot to lower this number by boosting your marketing skills and implementing lower cost marketing channels.
Overhead costs are costs that are not directly attributable to producing or selling your products and services. They include items such as rent, telephone, insurance, legal expenses, and executive salaries. Although it’s not standard practice to break out overhead expenses from other expenses on an income statement, it’s valuable to know the numbers for performance purposes.
Compare your overhead costs to prior years and industry averages. You can actively manage your overhead cost by re-negotiating with vendors on a regular basis and trimming where it makes sense.
Your profit margin can help you determine which division of your business is most profitable. If you sell more than one product or service, you can compute a gross or net margin by product or service. You can also compute margins by geography, sales rep, employee, customer, or any other meaningful segment of your business.
Your accounting system may be able to generate an income statement by division if everything has been coded correctly and overhead has been allocated appropriately. Reach out if you’d like us to help you with this.
Seeing which service or product is most profitable can help you decide if you want to try to refocus marketing efforts, change prices, discontinue items, fire employees, attract a different type of customer, or any number of other important decisions for your business.
Do you know how many units you need to sell in order to start generating a profit? If not, the breakeven calculation can help you learn this information. The formula is Fixed Costs / (Sales Price per Unit – Variable Costs per Unit) which results in the number of units you need to sell in order to “break even” or cover your overhead costs.
The breakeven point helps you plan the amount of volume you need in order to ensure that you have healthy profits and plenty of cash flow in your business.
These five numbers can help you interpret your business performance on a deeper level so you can make better decisions that will lead to increased success in your business. If we can help with any of them, please give us a call any time.
If there is a period of time between when your customers receive your goods or services and when they pay for them, then several things are true:
- You have a balance in Accounts Receivable on your balance sheet that represents how much customers owe you
- You have an invoice process that you follow
- You have granted credit to customers
- You may have some that don’t pay as quickly as you’d like them to
Each invoice you send should have payment terms listed. A payment term is the period of time you expect the invoice to be paid by the customer. Your payment terms should be set by you, not your customers!
Payment terms are always measured from the invoice date and define when the payment should be received. Here are some common payment terms in accounting terminology, and then in English.
Payment is due 30 days from the invoice date.
2/10 Net 30
Payment is due 30 days from the invoice date. If you pay the invoice in 10 days, you can take a 2% discount off the total amount of the invoice as an early pay discount incentive.
Due Upon Receipt
Payment is due immediately
If you use Net 30 or Due Upon Receipt, then you may want to change your terms to get paid faster. When people see Due Upon Receipt, sometimes they translate it into “I can take my time.” A more specific term spelled out such as Net 7 or Net 10 will actually get you your money faster than Due Upon Receipt.
Do you have issues with people paying you late? If so, you might want to set consequences. Consider adding a line on your invoice that provides interest charges if the payment is late. Utility companies do it, and so do many businesses. A common percentage to charge is 1% – 2%, however, some states have laws that limit you to 10% or another percentage.
The wording would be something like this:
“Accounts not paid within __ days of the date of the invoice are subject to a __% monthly finance charge.”
You will also need to make sure your accounting system can automatically compute these fees.
If you have questions about payment terms, your invoicing process, or your accounts receivable, please reach out.
Accounting automation has come a long way in the last few years, and the process of handling invoices and receipts is included in those changes. No longer is there a mountain of paperwork to deal with. In this article, we’ll explain some of the changes in this area.
Most invoices are now sent electronically, often through email or from accounting system to accounting system. Some accounting systems allow the invoice document, usually in PDF format, to be attached to the transaction in the accounting system. This feature makes it easy for vendor support questions as well as any audit that may come up.
Some systems are smart enough to “read” the invoice and prepare a check with little or no data entry. Others are able to automate three-way matching – this is when you match a purchase order, packing slip, and invoice together – so that time is saved in the accounts payable function.
Today’s systems allow you or your bookkeeper to scan in or take cell phone photos of receipts – whether cash or credit card – and then “read” them and record the transaction. This type of system cuts way down on data entry and allows the accountants to focus on more consultative work rather than administrative work.
Some vendors will email you receipts so all you have to do is use a special email address where your accountant is copied or forward the receipt as you receive it.
The biggest challenge for business owners is getting into the habit of photographing the receipt and sending it to the accountant. The days of shoebox receipts are not completely over, but cloud-savvy business owners are definitely enjoying the alternative options of today’s paperless world.
Some systems automate bill approval. This is especially handy for nonprofits or companies with a multi-person approval process. It cuts down on approval time and the time it takes to pay the bill.
There are many 3rd party applications that automate a part of the vendor payment or receipt management system. All of them have different features, platforms, software requirements, integration options, and pricing. Many of them integrate with Quickbooks, some with the desktop version, some with Quickbooks online and some integrate with both platforms.
- Receipt Bank
If you are interested in finding out more about automating your accounts payable invoices or receipts, please reach out anytime. We have partnerships with many of these 3rd parties for preferred pricing and in most cases we have certified in their products.
If you grant credit to customers, then you have a balance in accounts receivable. DSO stands for Days Sales Outstanding, and this helps you measure how fast your receivables are being converted to cash.
Here’s how to calculate it:
DSO = Accounts receivable balance / Annual net credit sales * 365.
DSO is measured in days and it represents how many days it takes to collect the customer invoice balance and convert it to cash.
Whether the DSO measure is “good” or not varies by industry as well as the terms you’ve set for your clients. If you’ve set your invoices to be due in 30 days and your DSO is 45 days or less, that’s pretty good. If you’ve set your invoices to be due in 10 days and your DSO is 60 days, then you might want to consider a more aggressive collection policy to speed up your cash flow.
Here are some tips to reduce DSO:
1. Invoice clarity.
Make sure your invoices are accurate and clear. Make it clear whom to make the check out to, where to mail it, the due date, and the amount due. All of these features should be easy to find on the invoice.
2. Consider discounts.
A common discount term is 2/10, net 30. This means the customer can take two percent off their invoice if they pay in 10 days; otherwise they owe the whole amount in 30 days. If you have customers from large companies, discounts are often required by policy to be taken and this can speed up your payments from them.
3. Consider electronic payments.
Going paperless with your invoicing as well as your payment process can speed up the entire billing cycle. Customers getting their bills earlier will also pay earlier.
What’s your DSO? If you need help calculating it, give us a call.
The best cakes have layers and layers of different delicious flavors to enjoy. Stacked on top of one another, each layer is baked separately and becomes part of the whole. Like a layer cake, your business expenses have layers of meaning to them. When you can understand how expenses play a part in profit, you can manage them better.
Here’s how to make a layer cake of your business expenses. Let’s start with the most direct expenses.
If you have inventory you will have a balance in the Cost of Goods Sold account. It should represent how much you paid for product or inventory that you are selling. It is the most direct expense of all the expenses; if you don’t spend this money, you would not have a product.
If you sell services, you should not have a balance in Cost of Goods Sold, but you will have direct expenses that are tied to performing your services. These might include labor from wages of the employees who carry out the services for clients. Any supplies directly involved with delivering services should be included as well.
You may also have other direct costs related to selling specific products or to servicing specific accounts.
The next layer includes indirect expenses. These expenses do not make up your product directly and might contribute to several different lines of products. Indirect costs might be attributable to a group of products or projects and can be apportioned accordingly.
Although overhead is technically a form of indirect cost, it’s good to create a separate layer for it. It includes management salaries, rent, utilities, and other fixed costs that cannot be directly allocated to a product or service.
Assembling the Layers
A wonderful exercise is to classify each of your expense accounts in your Chart of Accounts as direct, indirect, or overhead. In that way, you can see how each account contributes to the costs of running your business. Some questions to ask yourself:
- What is my gross margin before indirect costs and overhead?
- What is my gross profit after indirect costs and before overhead costs?
- How can I cut down on any of these categories of expense?
- What is my breakeven volume in sales before overhead is factored in?
- Can my profit margin be changed if I spent less in a certain area?
This layered view is just another way to view the financial aspects of your business and can help you make better decisions down the road.
You can also break the layers down even further by classifying the expenses as critical and non-critical. This will help you determine where best to invest while maintaining the level of profit you desire.
You can’t manage what you don’t measure. Layering your expenses will help you have your cake and eat it too. And if we can help, just reach out as always.
Two very important skills for entrepreneurs to master are marketing and finances. Combine them by understanding the numbers behind marketing, and you have an even more powerful understanding of exactly what makes your business tick.
Key Numbers – Cost Per Client Acquisition
Do you know how much it costs your business to bring in one client? The technical term is “Cost per customer acquisition,” and it’s computed by adding the total marketing and sales costs excluding retention costs and dividing them by the total number of clients acquired during a period of time.
Cost per customer acquisition is important to know because then you can compute how long it takes before your business begins to make a profit on any one customer. In software application services with a monthly fee, the breakeven for a client can be around ten months.
It’s essential to understand this dynamic for pricing and volume planning purposes. If your services or products are priced too low so that your acquisition costs are not recouped in a reasonable period of time, it can play havoc with your cash flow as well as your profits. If you don’t have enough volume to cover overhead and acquisition costs, then your company will be in trouble in the long term.
Customer Lifetime Value
There is a simple and an academic formula for customer lifetime value. You can estimate it by multiplying the average sale of a customer by the average number of visits per year by the number of years they remain a customer. That’s the easy version.
The more difficult version of this formula takes into account retention rates and gross profit margins. The formula is: Average customer sales for life times the gross profit margin divided by the annual churn rate.
Once you know and track these numbers in your business, you’ll be better able to make smart decisions about your marketing investments and your pricing. And if we can help you, please reach out as always.
Outsmart your accountant and other financial friends with these accounting-related definitions:
Most companies report their results on a calendar year, from January 1 through December 31. Some companies use a different year for reporting, and that’s called a fiscal year. For example, Intuit’s fiscal year runs from August 1 to July 31. A nonprofit commonly runs from July 1 to June 30.
The word fiscal alone refers to government or public revenues and expenditures. A fiscal year can also be considered the period where companies report their financial results to the public.
Most companies sit down once a year and plan what they intend to spend. This set of numbers is a budget. It is prepared in income statement format which includes planned revenue and expenses. It can be done for a year, monthly or both.
A common report that compares budget to actual figures is the Income Statement Comparison to Budget which includes columns for month and year-to-date actual, budget, and variance (the difference).
While a budget is a longer term plan, a forecast is an attempt to predict the short-term future. Forecasts can be made for cash flow, predicting your bank account balance, or can be focused on potential profit for a period. A forecast is created by enumerating current and expected short-term cash commitments.
A general ledger is a fancy word for your accounting books. It’s also a very specific report that lists each account within the chart of accounts, beginning balances, the activity of each account for a particular period of time, and ending balances. It includes both balance sheet accounts, such as cash, accounts receivable, and accounts payable, and income statement accounts, such as revenue and expenses.
A fixed asset is a special type of asset that includes items such as land, vehicles, furniture, buildings, office equipment, plants, and machinery. Fixed assets cannot easily be converted into cash (cash equivalents are termed current assets) and they must last longer than one year. They are physical or tangible (as opposed to intangibles such as patents and trademarks).
Most fixed assets except land depreciate in value over time. For example, when you drive a new car out of the lot, no one will give you what you just paid for it. This reduction in value over time is recognized on accounting books by recording depreciation. Since assets need to be recognized at market value, depreciation is an estimate of this adjustment. Depreciation becomes an expense and reduces the value of the fixed asset. Unlike most other transactions, cash is not affected when recording depreciation.
There are two ways to keep books when it comes to the timing of how items are recorded: the cash method and the accrual method. Let’s invoke Popeye the Sailor Man’s friend Wimpy who always says, “I’ll gladly pay you Tuesday for a hamburger today.” Let’s say today is the Friday before this famous Tuesday.
If you are using the cash basis method, you would record the entire transaction on Tuesday, when you get the cold hard cash. If you are using the accrual basis, you would have two entries: one on Friday to record the sale to accounts receivable and one on Tuesday to zero out the receivable and increase cash. It’s the same net, effect; the only difference is in the timing.
Most small businesses that extend credit keep their books on an accrual basis so they can keep track of everything. Most taxes are paid on cash-basis books, requiring adjusting entries at year end that reverse at the beginning of the year.
A balance sheet is a very common report of all of the business’s account balances as of a specific date, such as December 31. These accounts include cash, receivables, fixed assets, liabilities, equity and others.
A journal entry is usually an adjustment that is made to the accounting books. The result is that some accounts increase and others decrease. In theory, every transaction made to a company’s books is a journal entry. When you write a check and it’s cashed, cash goes down and an expense is increased. When you receive a payment, cash goes up and revenue goes up. Each of these transactions is a journal entry.
Do you feel a bit smarter? I’m not sure how exciting this is for cocktail table talk, but hopefully you feel smarter when it comes you’re your business’s accounting function.
QuickBooks 2016 offers some new features that we are excited to share with our fellow accounting professionals. Batch Delete/Void Transactions and enhanced Statement Writer Support are two of the latest features available to Accountants only. Sorting on Item Custom Fields and Auto Copy Ship to Addresses are features only available in Premier (including Accountant) and Enterprise versions of the software.
Batch Delete/Void Transactions
We are cautiously excited about this new feature as it could prove to be quite dangerous in the wrong hands. Fortunately, Intuit realized that and only made the tool available in the Accountant and Enterprise versions of the software and in the Accountant Toolbox in the Pro and Premier versions.
It works for Invoices, Bill and Check transactions, but not for Credit Cards Charges or Deposits, at this time. It is also not available for Payroll or Sales Tax Transactions. The columns can be sorted by Entered Date, Modified Date or Transaction Date as well as by Payee, Type, Number, Account or Amount.
Any other transactions that are linked to the transaction to be voided/deleted are highlighted for you to be aware and to address them as well, if need be. For example, voiding a Bill-Check does not void the related Bill.
I am hopeful that Intuit will improve this feature and add the ability to work with Credit Card Charges, as I have seen many occasions where these were imported to the wrong account or even twice to the same account. As with any tool of this nature, we recommend a backup before and to Void instead of Delete.
Statement Writer Support for Microsoft Office
I do not prepare financial statements, but for those who do and for those who use the QuickBooks Statement Writer, it is essential to have the integration with Microsoft Word and Excel. With QuickBooks 2016, we have this integration with the Accountant and Enterprise versions of the software. However, we still do not have support for the cloud-based Microsoft Office 365.
Sorting on Item Custom Fields
In prior versions, we had the ability to sort on the Customer and Vendor Custom Fields, but not on the Items Custom Fields – those fields were mostly notational and not very reportable.
In QuickBooks 2016 Premier, Accountant, and Enterprise, Intuit introduced this feature which will allow sorting on Inventory Valuation and Inventory Stock Status reports as well as the Inventory Price List. This will save countless hours of exporting to Excel and creating Pivot Tables to gather the required information.
Auto Copy Ship to Addresses
For Contractors and Retailers who order materials or goods to be shipped directly to the job site or customer, QuickBooks 2016 – Premier, Accountant and Enterprise, has the ability to populate the Customer address in the Ship To Address directly from an Estimate or Sales Order, simply by selecting the Drop Ship to Customer checkbox when creating a Purchase Order.