This is a topic that many inexperienced owners don’t understand when they’re looking at their financials versus what’s in the bank. This is usually more often a problem with those who are keeping their books under the method known as “accrual accounting”. Accrual accounting is the desired method according the General Accepted Accounting Principles (https://www.investopedia.com/terms/g/gaap.asp) that public companies must operate under. For smaller businesses, I strongly recommend a cash basis accounting system which means you’re more likely to know if you’re making money by the balance in your checking account. When you started your business formally with the IRS you had to select cash versus accrual accounting, and this is really the starting point of how yourself or your previous bookkeeper were maintain your books (https://www.irs.gov/publications/p538).
Accrual Accounting
Briefly, this method recognizes profit when it is earned. Regardless of whether you sold your merchandise for cash today or for a receivable in 30 days, it’s still profit. The same with expenses. If you incurred the expense now but you don’t have to pay for those marketing materials for another 30 days, it gets expensed now. There are times where you know you’ve got an expense coming, but the vendor hasn’t submitted his invoice yet. There’s no free pass here, you need to record an accrual to make sure that expense gets booked this month and will offset related income. This is the income matching principle (https://www.accountingcoach.com/blog/what-is-the-matching-principle). Big ticket purchases, while they may have drained the bank account, don’t get to be expensed in full. The delivery truck is recorded as a fixed asset and then is depreciated over its useful life. So there’s a smaller big of expense that is applied against the revenue it is assumed it is used for and contributes to. Also part of the matching principle. All of this actually makes financial statements a lot more easy to compare. Cash in the bank may vary significantly and requires extra cash flow analysis and forecasting for any size business.
Cash Accounting
This one is simpler and ideal for smaller businesses. If you sold merchandise today on cash, then there’s your profit. You don’t have to add up how much is outstanding to be collected, until you actually collect it. Same with expenses, until you spend the money and pay in cash, there’s not going to be any expenses to be accrued. Cash in is profit, cash out is an expense. Even that delivery truck you purchased gets expensed in full when you pay the cash. That month you’re going to take a huge hit to your profit for the month, but at least your cash in your bank will more closely mirror your profit in your reporting. This is what makes it so great and why its favored among small businesses. You can you look at your bank statement and quickly get an idea if you’re up or down. But then there is a big warning regarding looking at comparative profit statements, monthly profit can swing significantly depending on when you collect from customers and what you purchase for the month (https://www.investopedia.com/terms/c/comparative-statement.asp). This makes comparative financial statements harder to compare because of variances in what you’ve collected and what you’ve paid during the month. Cash flow forecasting is still going to be crucial because knowing when to expect cash in the bank or when the right time is to make that purchase of a delivery truck is going to depend on reliable cash flow forecasting.
Cash Flow versus Profit
Profit is what you’ve earned less what you’ve spent (http://www.businessdictionary.com/definition/profit.html). As you can see above, this can be what you’ve billed a client for, regardless of whether they paid you today or will pay you in 30 days. That revenue is then offset by what you’ve spent, even if you’re still waiting for the bill for your marketing materials if its accrual based. If your cash basis, then what comes in and out is your profit, i.e. your bank account. Cash flow is the results of the cash used or received as part of operating your business (http://www.businessdictionary.com/definition/cash-flow.html). Again, this can be easily estimated based on what you see in your bank account. Cash flow however still requires additional work to measure it and to forecast for it.
Cash Flow Forecasting
This is a value I can add to your firm. Whether you’re cash flow basis or accrual basis, cash flow forecasting provides an opportunity to see what is expected to come in, what is expected to go out and how to factor in those big purchases, like a delivery truck to expand your fleet. This can be done on a monthly basis and usually factors in the current rate growth month over month or year over year. If you’re a seasonal business and expect certain peaks, then cash flow forecasting is really useful in make sure the payroll can be covered during those valleys and opportunities to increase marketing can be supported in those periods preceding and during the peaks. When I take on the responsibilities of managing your payroll or especially your payables, I recommend cash flow forecasting as frequently as every week. This is to ensure that those highs and lows are adequately prepared for and you don’t have to worry about running short on cash. With cash flow forecasting we can ensure that your credit ratings with your vendors remains as high as possible because we’ll be ensuring that invoices are paid timely. We can make sure that not only can you pay your employees paychecks every 2 weeks, but you can also pay those payroll taxes.
If you feel like this is something you want to incorporate in your business, there are dozens of templates out there than you can try. Look for a monthly template and make sure to add enough rows to cover the categories you expect during the month. Remember, finite detail is not necessary, such as office supplies versus break room supplies. A general accounts payable line may be sufficient and often filled in last to know just how much cash you can pay during the month to your suppliers. Payroll and payroll taxes are usually rolled into one line as well.
If you’re not sure where to start and if any of this went flying over your head (I promise we’ll keep it between you and me) then it’s time for us to talk. You went into business to be an amazing chiropractor or florist and not to do accounting day in and day out. I did. I have spent the last 9 years focusing on accounting for small business and I’m ready to help you start focusing more of your time on your business. I believe firmly when I say, I do what I do best, so you can do what you do best!
Let’s find a time to meet when you won’t be interrupted with clients or customers, and let’s talk about where you’re at now and where you want to be. Let’s come up with a plan to get you to where you want to go!