A successful business rests on sound record keeping practices and solid cash flow. Without good records it is impossible to determine the financial condition or profitability of a business.
Similarly, in order to survive a small business must achieve a positive cash flow in the long term. This Financial Guide provides the basic information the owner of a small business need to establish good record keeping practices in your business and to minimize cash flow problems.
Large and medium-size companies have internal accounting personnel and sophisticated records and systems to guide management. On the other hand, the owner of a small business usually relies primarily on a bookkeeper and an outside accounting firm to maintain the company's records and provide guidance.
Therefore, the small business owner should be familiar with, and recognize the importance of, proper record keeping requirements and cash flow planning.
Record keeping and why it is necessary
Complete and accurate financial record keeping is crucial to your business success for a number of reasons:
Accurate and complete records enable you, and your accountant, to identify all your business assets, liabilities, income and expenses. That information, when compared to appropriate industry averages, helps you pinpoint both the strong and weak phases of your business operations.
Good records are essential for the preparation of current financial statements, such as the income statement (profit and loss) and cash-flow projection. These statements, in turn, are critical for maintaining good relations with your banker. They also present a complete picture of your total business operation, which will benefit you as well.
Good records are critical at tax time. Poor records could cause you to underpay or overpay your taxes. In addition, good records are essential during an IRS audit, if you hope to answer questions accurately and to the satisfaction of the IRS.
What good record tell you
The specific records a company needs depends on a number of factors, such as the type of business, the company's goals, management's needs and interests, and cost factors. Based on the relevant factors, your accountant can help you determine what records to keep and what information they should provide. In fact, you might want to update your record keeping procedures to reflect your current business needs. Here are just some of the questions that might be considered in assessing your record keeping needs:
It is essential that you try to determine the precise financial condition of your business. It is as critical as maintaining good customer relations.
Good record keeping is time-consuming and can take away from the time you need to run your business. However, as shown above, it is essential.
Basic record keeping systems
A basic record keeping system, whether on paper or an off-the-shelf computer software program, should be simple to use, easy to understand, reliable, accurate, consistent and designed to provide information on a timely basis. It generally needs:
Your accountant can develop the entire system most suitable for your business needs and train you in maintaining these records on a regular basis. These records will form the basis of your financial statements and tax returns.
Cash flow basics
To be competitive, small business owners must prepare for all future events and market changes. One of the most important aspects of such preparation is cash flow planning. Failure to properly plan cash flow is one of the leading causes for small business failures.
As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. Any significant changes over time will also appear. Understanding this will lead to better control of your cash flows and will allow adequate time to plan and prepare for the growth of your business.
Aiming for positive cash flow
To achieve a positive cash flow, you must have a sound plan. Your business can increase cash reserves in a number of ways:
Tightening credit requirements: As credit and terms become more stringent, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing uncorrectable accounts. While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services. Any consequent increase in sales should be measured against a possible increase in uncorrectable accounts.
Adjusting the price of products: Many small businesses fail to make a profit because they erroneously price their products or services. Pricing is the critical element in achieving a profit and maintaining positive cash flow. Before setting your prices, you must understand your product's market, distribution costs and competition. Remember, the marketplace responds rapidly to technological advances and international competition. Monitor all factors that affect pricing on a regular basis and adjust as necessary.
Taking out short-term loans: Loans from various financial institutions are often necessary for covering cash-flow problems. Revolving credit lines and equity loans are common types of credit used in this situation.
Increasing your sales: Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until, say, 30 days after sales, a substantial increase in sales can quickly deplete your firm's cash reserves. A computer can facilitate tracking this critical data, as well as speed the time required to consider "what if" scenarios.
Managing your expenses: Watch your expenses carefully. It makes sense to pay early if your suppliers offer a discount for early payment. If no discount exist and the supplier allows you 30 days to pay, take advantage of the 30 days and do not pay in 5. However, beware of penalties for late payment and the potential impact on your credit rating. You should monitor your expenses to make certain they are necessary and reasonable in amount.
Your cash reserve
You should always keep enough reserve cash on hand to cover expenses and as an added cushion for security. However, it is unwise to keep more money on hand than is necessary. Excess cash should be invested in an accessible, interest-bearing, low-risk account, such as a savings account, short-term certificate of deposit or Treasury bill. Keeping excess cash on hand limits both your growth and the return on your investment.
Cash flow projections
Cash flow projections, as well as good accounting records, are important tools for a small business. They will help answer important questions about the company's financial future and provide direction. The failure to make proper projections, even if only informally, reduces the potential for long-term success.
Record keeping with your computer
The computer makes it easy to develop cash-flow projections and many other useful financial-planning tools. A good financial-management package will enable you to review projected inflows and outflows of cash from month to month or year to year. By analyzing these projections, you can see the fluctuations in cash flow and create management policies to avoid potential shortfalls.
There are numerous computer programs for making projections and keeping records. Programs range from basic bookkeeping and "what if" analysis to inventory control or market-demand projections.