Are you in a position today where you desire business success at the next level? Let’s say your business is growing and you need your financials to be improved. You may be asking why you would require better financials to get bigger. One key reason that would require greater and more focused financial reporting would be if you need a large loan or need to take on a new investor. Another key reason to move to a moderate level of financials is if your organization requires an audit of your financial statements.
Last week, I discussed different financial levels and focused on the basic areas all businesses and organizations need to be incorporating on a regular basis. Check out “What Level is Your Business” to review these basic steps all businesses need to incorporate into their financial accounting.
This week, I want to discuss ways to move to a moderate level of financial preparation for success. First, I want to explain why you want to do this.
Generally Accepted Accounting Principles (GAAP) strives to match the revenue and expenses earned for each period (typically a month). What if you pay for something in advance or at the beginning of the year? In this case, it is called a Prepaid expense, and you want to divide the expense evenly over the period you are using it. Common examples of prepaid expenses include travel, conferences, and software.
What if you know you are going to have to pay for something in the future based on some sort of activity today? This is known as an accrual. Common examples of accruals are bonuses and commissions. In this case, you are incurring expenses today that will be paid in the future. You want to enter an expense now to be prepared for paying for it later.
Estimating potential expenses is an important concept for GAAP accounting. If you have Accounts Receivable and typically write off a percentage of your customer invoices, you will want to estimate a percentage of bad debt.
Suppose you have inventory that you purchased a while back and it is getting old and obsolete. In that case, you are supposed to write off inventory you can’t sell. In this case, you enter an inventory provision to account for these future write-offs that will happen.
If you purchase equipment, computers, property, machinery, buildings, or vehicles, you want to record these transactions as Fixed Assets (Also called Property, Plant, and Equipment) on your Balance Sheet. Since you will be using these assets for the future, GAAP accounting requires businesses to depreciate (expense or write off) the asset over the useful life of the assets.
This is my favorite reason to improve financial statements and one of the most enjoyable aspects of what I do. While most businesses desire to understand and improve cash flow, most struggle to understand profitability by client, product, service line, or region. I get general statements from business owners all the time who struggle to understand their cash flow and are concerned about where their money has gone. The problem is that you cannot forecast without good consistent data. I know that forecasting the weather seems like it is inaccurate. But in reality, meteorology has improved drastically in the last few years. Meteorologists are better than ever at predicting one or two days out, in part due to their increased ability to accurately assess data over longer time periods to achieve model consistency. Your business is the same. The more consistent financial data you have over a longer period of time, the less your unfortunate financial surprises be will be. This improves your ability to make effective, confident decisions in your own business.
Forecasting and trending are only important if you have a dashboard for where you are today. For example, I’ll return to the weather forecast analogy above. Forecasting the weather forecast without knowing where we are today is pretty useless. A meteorologist must track temperature, humidity, wind speed, and other important current metrics. Your business requires similar metrics that must be measured currently that are unique to your own business. When a weather forecaster sees that the current situation is not in line with their previous forecast models, they are required to update their projection based on current trending. If the forecast predicted a 60 percent chance of snow, and it is not snowing currently, you can bet they will be updating their forecast based on current conditions. The same concept applies to your business. Key Performance Indicators showing where you are today are essential to ensuring accuracy in your forecast and trending discussed above.
In summary, beefing up to moderate level financials will improve your level of financial understanding and set you up for the prospect of growth for years to come. Moderate level financials will enhance your ability to make the correct decisions for the future of your own business. Accounting for prepaids, accruals, estimates, provisions, fixed assets, and depreciation as well as improving your financial forecasting, trending, and current dashboards will prepare you for the road ahead and improve your ability to have the increased foresight you have always wanted.
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