Financial Accounting – Don’t reinvent the wheel when accounting for the future of your business

It has been said that the only thing that is constant is change, and if you have been in the business for any length of time you know how true that is. If there’s one thing that separates long-term successful companies — think IBM, General Electric, Wal-Mart, Microsoft, for example — from everyone else, it’s their positive response to change.

Adapting to change impacts a company’s ability to win and retain its market, grow its business, and sell its products and services profitably. However, every small business owner or manager must learn to distinguish between business processes that need to evolve and those that should remain stable.

When change is destructive

While evolution is essential to meet changing consumer demands and an ever-changing technological environment, there are some business processes where change and evolution are counterproductive, even destructive. One of them is financial accounting.

The accounting scandals that took down several large companies in the early 2000s highlighted the destructive potential when it comes to financial accounting if you get too “creative.” While the government passed legislation attempting to curb such accounting irregularities, it is still the primary responsibility of business owners and their accounting professionals to produce and provide financial information that I call ARTistic: Accurate, Relevant and Timely.

Accounting rules can and will change over time to reflect changing business models and new types of business transactions. However, financial accounting as a business process should remain stable and only evolve after careful consideration of the potential implications of reporting transactions differently.

A complete overview of the basics of financial accounting is beyond the scope of this article. However, by sharing some standard accounting concepts with you, I hope I can motivate you to perhaps take a closer look at the financial statements your CPA will be handing over your desk next month.

The Chart of Accounts

Let’s start at the very beginning: with the financial data collection system, the so-called chart of accounts. This is a systematic listing of all ledger account names and associated numbers used by your business, arranged in the order in which they appear in your financial statements (more on that in a moment): typically assets, liabilities, equity or equity, income and expenses.

A chart of accounts enables you to report and summarize all of your company’s financial transactions in an orderly manner. For example, you can go back and look at all vendor invoices that were paid during a specific time period to see exactly what work was done, why it was done, and which organization benefited from the spend.

Think of the chart of accounts as a collection of buckets, each containing a specific type of data. There can be a bucket for every asset of your business, every debt you owe, every product or service you sell, and every type of expense you incur selling products and services.

The Chart of Accounts is an organized, comprehensive list of all of these buckets. The buckets, in turn, are labeled with the appropriate account number and organized by the type of data they contain. They can be reordered during the billing process as their content is counted and reviewed (usually monthly) so reports can be generated summarizing the data they contain.

The Ledger

No, this is not the person who secretly runs the accounts and puts out all these reports that no one can read! The general ledger is the last place where all accounting processes rest and the data source for your financial statements.

Think of the ledger as a big, old-fashioned scale that’s always kept balanced by adding and subtracting an equal weight on each side. All buckets that appear in the Chart of Accounts are arranged in one tray or another. As transactions occur, add the appropriate data to each bucket that represents the financial impact of that transaction.

For example, when something is added to a bucket on the asset side, something else of equal value must either be taken away from the asset side (like the money paid to acquire the asset) or added on the liability side (like a loan to pay for this) . This way the scales are always balanced and your business has a self-checking system to ensure the entire transaction has been properly recorded.

The end of the year

These are the real “meat and potatoes” of small business accounting. There are three primary financial reporting formats that appear in annual reports and most internal monthly company financial reports:

o balance sheet: This shows the company’s financial position as of a specific date, typically at the end of a month, quarter, or year. It lists all of your company’s assets on one side and all of your liabilities on the other. The difference between the book value of the assets and the liabilities corresponds to the share of equity attributable to the owners.

o Profit and Loss Account: Also commonly referred to as an income statement or income statement, this summarizes all of the company’s activities aimed at making a profit. It lists the amount of sales, any costs incurred for those sales (or the cost of goods sold), and the overheads involved in running your business (e.g. salaries, rent, utilities, etc.) .

o Cash flow statement: This shows the impact of all transactions that involved or affected cash but did not show up in the income statement. For example, if you borrow money and put it into your checking account for later use, there was no income or expense, so that activity cannot be reflected in the income statement. Instead, it would go to the cash flow statement. Every transaction that takes place in your company between any two balance sheet dates is reflected in either the income statement or the cash flow statement, and from these two reports the summarized results appear in the form of net changes in the balances on your balance sheet.

Make better business decisions

The key to making informed decisions lies in your ability to understand and use these extremely important business reports. They are the condensed result of every financial transaction your company has conducted and the result must be accurate, relevant and timely and understood.

This is a role that cannot be delegated. Don’t be afraid to ask your accounting department or CPA to explain every aspect of these reports until you really understand them. The success of your business depends on it.