Introduction... 4 Cash vs Accrual Components of the Balance Sheet How to Get a Snapshot View with Balance Sheet Accounts Ratios...

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2 TABLE OF CONTENTS Introduction... 4 Cash vs Accrual... 5 Components of the Balance Sheet... 6 How to Get a Snapshot View with Balance Sheet Accounts... 7 Ratios... 8 Entrepreneurial Finance: Bonus Ratios Balance Sheet... 9 Entrepreneurial Finance: Bonus Ratios P&L Conclusion PREDICTIONS

3 INTRODUCTION Why is this important for small businesses, especially the sole proprietor? Well, if you want to grow and you do, you want to make sure your income doesn t come back to bite you at year- end. Still you don t want taxes to drive your business or you will quite honestly stunt your growth. With the change in tax law and section 199A, it is even more important to plan for taxes, but it also complicates knowing the best business decision to make. Keeping on top regularly helps to ensure you make the right decisions for your business and, also helps to minimize your tax liability. Aside from regularly checking bank balances, often, the P&L is the primary focus for small business owners. Tax requirements generally drive this decision. For tax reasons, you are not required to report a Balance Sheet if total business income (before deductions) is under $250K. There are additional criteria to consider and, take note that certain states require it, so be sure to check your local state requirements. If you are an S Corp, Partnership or Corporation, you need a balance sheet for tax. The purpose of this document is not to go into tax strategies, only to highlight the importance of keeping big picture considerations in mind. Used in conjunction with the P&L and the Cash Flow statement, small businesses have powerful tools to use to manage and grow their business. We are going to discuss simple tactics that any business can implement. The more complex your business and business goals, the more in depth you can go. 3 InControl Business Svcs

4 These simple methods focus on areas that are common to all businesses. They show you how your financial statements tell you the story of the health of your business and how you can keep a proactive pulse on it at all times. Being in control over your financial position provides comfort knowing you can focus efforts on other areas that are also key to growing your business. While some companies prepare a Balance Sheet, they don t always utilize it fully in managing their business. Monitoring activity within the balance sheet can be like a looking glass into what is working well, what isn t, if your business is at risk and so much more. QUICK TIP!. One thing everyone should do is make sure that the Net Income within the Equity section of the balance sheet is equal to the amount of the Net Income on the P&L. If not, the difference should be investigated immediately. There could be a mapping error in the accounting system, or something else more serious. Real World Example: Several years ago, a client hired a friend s son to be his Controller. They called us to in to help with cash account reconciliations. First thing, the Balance Sheet and the Profit and Loss statements did not tie. Then, what should have been a simple, although time consuming task, became a little more complex. Yes, he was embezzling. You should be aware of this quick check, so you can be on the look-out if you have someone else preparing your financials. Not only can the Balance Sheet be a useful tool to help in proactive management of operations, but it can be used to help protect your assets and your company. 4 InControl Business Svcs

5 Cash vs Accrual Before going into the Balance Sheet, we should go over two methods used for preparing the financial statements. Cash basis is common for small businesses as this is the basis for tax. However, there is no requirement that financial statements cannot be kept on the accrual basis for book purposes. In fact, we prefer and highly recommend this. Not only does it follow generally accepted accounting practices, but also allows you to manage your business better. Cash Basis Income from goods or services is recorded when you receive it and expenses are recorded when they are paid. Literally, cash in and cash out. Accrual Basis Income and expenses are recorded when they are incurred. This is the cash even if you have not received the money for it. Example Transaction You sold a product on December 29 and receive payment on Jan 9 of the following year. Cash Basis: You report the expense associated with the product in Year 1 and record the sale in Year 2 when you receive it. Accrual Basis: You report the sale and related expenses in Year 1. When you made the sale, the customer promised to pay, and the sale is recorded with Accounts Receivable. The income is incurred at that time because the customer promised to pay at that time. 5 InControl Business Svcs

6 Components of the Balance Sheet The Balance Sheet consists of 3 main components: Assets, Liabilities and Equity. Assets and Liabilities are then broken down further between current and non-current. The accounts are generally listed in order of liquidity, meaning the ease of which they are converted to cash. The main sections are: Current Assets: Assets that can be converted into cash within 1 year. Examples are: Cash Accounts Receivable/Contracts Receivable *Costs/Estimates in excess of billings on uncompleted contracts Inventories Prepaid Insurance (rent, etc.) Note Receivable - Current Non-Current Assets: Property or other assets that will not be converted into cash within a year. Examples are:. Fixed Assets Deposits Notes Receivable Long Term Long Term Investments Current Liabilities: Obligations that you have to pay within 1 year. Examples are: Accounts Payable *Billings in excess of costs & est. earnings on uncompleted contracts Credit Card Payable Line of Credit Long Term Liabilities: Obligations you owe for a period of time greater than 1 year. Examples are: Notes Payable Deposits. Equity: Equity is the difference between your assets and liabilities. Equity also consists of Paid in Capital and Retained Earnings. Retained earnings is the amount that did not get paid out to shareholders but remained with the company to be reinvested. Additional accounts will be needed depending on your type of business and business complexity. It is also important to remember that the financial statements will show different results for cash vs accrual basis. For instance, cash basis will not show balances for amounts outside of the period you are working with. So, no Prepaids, Accounts Receivable, etc. *accounts common to contractors 6 InControl Business Svcs

7 HOW TO GET A SNAP SHOT VIEW WITH BALANCE SHEET ACCOUNTS While reconciling cash regularly is a necessity, this alone will not tell you the health of your business. Following are 3 areas that should be part of your normal financial management process and how to use them. Review the Aging of Your Accounts Receivable Aging balances can indicate issues with your collections policy, customers taking advantage of terms or customers who are unable to pay. Regular monitoring of Accounts Receivable aging provides you with a proactive approach to managing your cash flow effectively. In addition, if customers are paying late, beyond terms, not only is it difficult to manage cash flow, you are essentially lending them money and, in some cases, potentially giving away your service or product for free if they don t pay. Review the Age of Your Accounts Payable Aging payables can indicate a problem with the accounts payable process (is it too manual and slowing you down causing you to have to pay late fees). It can also impact your relationship with your vendors which you don t want to damage. Also, you may have an opportunity to take advantage of discounts and improve your cash flow.. Inventory If you have Inventory, look at an inventory movement report. This will show you activity such as purchases made and scrapped items. It is also useful for returns.. 7 InControl Business Svcs

8 RATIOS Analysis of the Balance Sheet with ratios is a great way to get insight into your financial health. You could go crazy with the ratios depending on what you want to measure and focus on, but we will discuss a few of the common ones. These are used by for banks for covering debt covenants and investors. These will get you started until it makes sense and you are ready to dig deeper into your financials. CURRENT RATIO Tells you if your business has enough cash on hand to pay bills coming due in the near future. Most try to keep this at 1.5 or higher. Formula: Current Assets/Current Liabilities DEBT TO EQUITY Tells you how much you own versus how much you owe to others. This ratio shows how much you rely on debt to operate, so obviously, the lower this is, the better. Formula: Total Liabilities/Shareholder s Equity WORKING CAPITAL Working Capital is equal to Current Assets minus Current Liabilities. It is what is available to pay the company s current debts. The goal with working capital is to get as close to zero as possible. You will not get to zero by managing your working capital. You will, however, gain strategic insight into identifying operating inefficiencies that are currently costing you money and sucking up your cash flow. 8 InControl Business Svcs

9 ENTREPRENEURIAL FINANCE BONUS RATIOS Balance Sheet Other common ratios used for further insight to proactively identify operations issues before they become too problematic: Accounts Receivable Turnover This ratio tells you how many days it takes to collect on a sale Formula: Accounts Receivable/Days Sales x Number of Days Example: Accounts Receivable = $350,000 Sales = $2, ,000/2,500,000 x 365 = 51.1 In this example, it takes 51.1 days to collect on sales. Unless you have a 60 day collection standard, this is not good and you should check it out to see how you can improve collections and your overall cash flow. 9 InControl Business Svcs

10 Days Inventory Outstanding This ratio tells you how many days you are holding inventory before you sell it. Formula: Inventory/COGS x 365 Example: Inventory = 55,000 COGS = 715,000 55,000/715,000 x 365 = In this example, the company carries inventory for 28 days before selling. Solvency Ratio This ratio tells you to what extent the company s total assets can handle its total debt. Formula: Total Assets/Total Debt Total Assets = 1,800,000 Total Debt = 650,000 1,800,000/650,000 = 2.8 This means that the company owns 2.8 more times than it owes and is solvent. 10 InControl Business Svcs

11 ENTREPRENEURIAL FINANCE BONUS RATIOS The ratios we talked about previously are to measure liquidity. You can take it further using ratios to look at operations and use ratios on the P&L. Below are some good profitability ratios using the P&L. These ratios are also known as efficiency ratios because they help measure how well you utilize your assets to help attract investor capital. While we have been discussing the Balance Sheet, these are too good not to share. You should be familiar with these: Gross Profit Margin This ratio tells you how much gross profit, or the sales after paying for the cost of goods sold, is generated by each dollar of net sales (gross sales less all returned goods). Formula: Gross Profit/Net Sales Operating Profit Margin This ratio tells you the relation of operating profits to net sales. Operating profit is also known as operating income, which is the same as EBIT or earnings before income and taxes. Formula: Operating Income/Net Sales

12 Conclusion Monitoring the movements within the Balance Sheet is not only a good best practice and internal control, but it can provide quick insight into operations and areas to improve efficiencies, which often, results in an increase to the bottom line. In general, the Balance Sheet is a good reality check showing you what your business is worth. If you ever want to sell your business, this will be important to know. A Balance Sheet is generally requested by banks and investors for funding, sureties for contractors, and may be required for tax purposes. By reviewing your receivable and payable aging reports, checking inventory reports, and calculating a few quick ratios, you will be able to demonstrate that you have it all under control and know your numbers.

13 ABOUT InControl Business Svcs InControl Business Svcs helps small to mid-sized businesses gain control over their financial management by providing innovative and forward-looking accounting, reporting, and business consulting insights and solutions designed to meet your business goals. We take a big-picture, consultative approach and create tailored accounting strategies that support your company s goals through our comprehensive suite of accounting and business solutions. Small Business Accounting. As a business owner, you have enough to do. We take care of your bookkeeping and accounting, helping you to keep a clean general ledger and accurate financial statements. QuickBooks. We are QuickBooks Online Pro Certified and help with set-up, clean-up and training. We also assist with subscriptions. Outsourced Controller/CFO. We help you with more complex transactions than just basic bookkeeping. We help you with management reporting, cash flow management and various other high level financial needs. We fit the needs of any businesses of any size. Financial Consulting. If you don t mind handling your accounting Tax Planning and Preparation. We keep compliance in mind when we work with you and your financial management. Our big picture approach helps ensure that you make decisions that are profit driven with a minimized tax liability in mind. We work with a large network of tax professionals to ensure we have you covered. and financial management yourself, but would like to brush up on some areas, we will teach you and your staff how to efficiently manage the accounting function customized to your specific business.

14 Sources 1. IRS Instructions Form , 1120s 2. Entrepreneurial Finance, Professional Education Services, LP Please Note: The information provided is intended as general guidance. Any accounting, business or tax advice contained in this document is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related matters. 14 InControl Business Svcs