Using a business owner perspective; why would you need a proper bookkeeping? You, most likely, are not a business owner. But, unless you use a business owner’s vision, you won’t be able to see (not even sense it) why a business need proper bookkeeping. So do the board members of the accounting standard setter.
If you are a senior (probably a certified public accountant who work as an independent auditor), I have a question for you: does ignoring the interest of the business owners (your clients) work best for you, as a practitioner?
Not quite sure about your opinion; to me, putting client’s interest on top of other’s, works better and tends to result in more fair output for all.
Using a business owner’s perspective, bookkeeping can sometimes seem a chore – especially if you feel like getting on with other things such as production or sales for example. But, it’s worth remembering that there are several reasons (and advantages) for keeping good business records, and many of them are a real advantage to you;
- to show you where you stand financially
- to help you make important financial decisions
- to help you agree (and perhaps reduce) your tax liabilities; to control VAT – collecting it in and paying it out
- to help your audit in certain cases, and keep the auditing costs down; and
- to discuss your financial position with other people.
Let’s consider them in turn.
Knowing Where You Stand Financially
Without proper business records a business owner will never know what his/her real financial position is. If you’re a business owner, you will face the same issue. Not all businessmen and women, particularly when running small businesses, want to produce detailed financial statements every month, but it is very useful to be able to work out:
- how much money you have at the bank
- how much is owed to you by your customers
- how much you owe to your suppliers.
If you know that the money owed to you is enough to pay off your creditors and the bank, then you should certainly be able to sleep at night. [Do you know your current financial position?].
Suppose you suddenly find yourself short of $540 to pay a pressing supplier. You decide to telephone your bank manager to see if he will grant you some temporary help to tide you over:
Business manager: Hello Alan, I wonder if you can help me? I urgently need to find $540 to pay off a supplier who’s threatened to stop an important delivery of new materials unless I pay. Can you help?
Bank manager: Yes, I should think so. What’s your overdraft at the moment?
Business manager: It’s only about $1300 . . .
Bank manager [checking statement]: Yes, but hold on – I see some cheques still haven’t cleared. I make it $1819.89 – and didn’t we agree a limit of $1500?
Business manager: Eighteen hundred quid? Good heavens, are you sure? I’d no idea.
Bank manager: Well, you should have! How much is owed to you by your customers? If it’s a lot, we may be able to sort something out.
Business manager: I don’t think we’ve got an exact figure – it must be a thousand or two. The papers are all over the place at the moment.
Bank manager: Look, why don’t you get your accountant in, and get the exact figures, then we can meet and see what can be done.
Business manager: That’s going to take ages and cost money – isn’t there anything else we can do?
Bank manager: Well, we’ve got to have the facts first. . .
What message did the above conversation send?
The business manager needs help, and the bank manager wants to give it – but not just on a wing and a prayer.
What would you think of your bank manager if he was sloppy with key figures; could you answer the above questions about your own business?
Broadly speaking. If “what we’ve got [asset]” is MORE than “what we owe [liabilities]’ then the business is solvent. If not, it is insolvent and probably should not go on selling.
However, it should be kept in mind that some of the assets [“what we’ve got”] are not in a form that can be used to pay the bills. The vehicles and equipment, etc. [collectively called “fixed assets“] are for the long-term benefit of the business and are not readily turned into cash. You should therefore also consider the situation without taking account of these items. But these are basic questions, and are only the beginning of gaining a real understanding of your business as a financial entity.
Making Financial Decisions
Armed with an up-to-date statement of your financial position and recent selling you can start to make real financial decisions. Can you afford to replace the delivery truck? Is it worth taking on an extra salesman? Do you need a partner?
Without business records to provide you with the necessary facts you will not be in a position to make such decisions.
Let’s take some examples:
. Decision#1. Do you want to buy a new delivery truck?
- Exact cash position? –> Business records: Cash book
- General liquidity position? –> Business records: Sales and purchase ledgers; cash flow forecast
- Enough profit to cover? –> Business records: Management accounts
. Decision#2. Do you want to take on new staff?
- Wages and payroll tax costs? –> Business records: PAYE records, Profit forecast, Cash flow forecast
. Decision#3. Do you want to rovides extra credit to big customer?
- Can I finance it? –> Business records: Cash book, Cash flow forecast, Profit forecast
“We got a great new account (lots of new business) but had no idea what giving them so much credit would mean. If only we knew what our selling margins had been, and had a proper cash flow” ~Director of insolvent engineering company.
“I desperately needed a partner to help the business and put in more cash, but I just couldn’t prove to him that we’re getting a good return on our money.” ~Proprietor of a catering firm.
“Our customer had several different invoices from us. He paid part of the third one, none of the first two and queried part of the seventh. We completely lost track of the account, and ended up having to write it off.” ~Housewife running a wholesale crafts business.
Agreeing Your Tax Liability
If the business seems to be “running itself”, you may not feel you need information to make financial decisions [although you could probably run the business even better if you did]. But you will still need to keep records in order to agree your exact liability with the IRS.
Under ‘Self Assessment‘ you are required by law to maintain proper accounting records and you can be fined up to $3,000 if you fail to do so. If you don’t keep on top of the situation you could soon lose out in several ways:
- fines imposed by the IRS
- loss of tax allowances you might be entitled to
- much wasted expense in getting your accountant in to sort out the details
- wasted time that could have been better spent on production or sales
- annoyed customers through mix-ups on their accounts, causing loss of business
- aggravation, spoiled plans and sleepless nights.
Accounting for Value Added Tax [VAT]
Except in certain cases your business will have to register for VAT. You will have to keep proper records so that you can account for the correct amount of VAT to the Customs.
You will usually need to charge 17.5 per cent VAT to your customers and pay 17.5 per cent VAT to your suppliers. There is no way round this (unless you run a crooked business) and you need to keep right on top of it each month or quarter – as the Customs & Excise most certainly will.
If you get behind, they’ll soon be after you with final warnings and penalties. But since you collect VAT, it can actually be a benefit to your cash flow.
Auditing Your Business
If your business is a limited company its accounts may have to be audited (checked) each year by an independent qualified auditor.
The auditor, usually a chartered accountant or certified accountant, has to go right through your records and satisfy himself that your accounts give a “true and fair” view of the company’s financial situation and of its profit or loss for the period. In the auditing lingo, technically, your financial statements do not contain “material misstatement” (erroneous or fraud.)
He must then give a report (which is appended to the accounts) to say that he has examined the records and to state his findings. This is required under company law.
If the auditor is not happy about the accounts he may qualify his report (include a note of warning or caution). A company has to file its audited accounts each year at Companies House, where they are open to public inspection for a small fee.
In addition various other legislative and professional requirements have made an audit necessary for certain classes of business. For example, solicitors’ accounts need to have a specific report submitted to the Law Society and the Financial Services and Markets Act 2000 requires an audit of businesses that do investment advisory work.
Without proper business records the auditor won’t be able to do his work and the business won’t be able to meet the requirements of an audit. What then? You will have to pay an accountant possibly large fees to sort out your books you may ultimately be prosecuted under company law.
However, once you do have the audited accounts, you should have an accurate picture of the financial position of your business. Indeed, you’ll probably be chasing your accountant to get them out as soon as possible, so that you know exactly where you stand.
Discussing Your Financial Position With Other People
From time to time you may need to give other people an up-to-date financial picture of your business.
In particular, if you are relying on bank finance then the bank may ask you to provide regular information about your customer [who owing you money] and creditors [money owed by you to your suppliers] so that they can monitor the healthy progress of the business.
And, you may need facts and figures to discuss with:
- any co-directors, partners or senior staff
- a possible outside investor or partner in your business
- a major supplier (for example, if you are hoping to get extended credit)
- any major creditor who is unhappy about the way your business is going, and the risk he is taking.
Hard to believe?
Yet the failure to keep proper business records is given time and time again as the main reason why an otherwise promising venture eventually failed.
Many people starting in business are tempted to rush out and buy a computer to “do the bookkeeping”. They are under the false impression that the computer will sort out their bookkeeping worries. Experience shows that unless the person knows what they’re doing, computerized records often end up as an unbelievable mess. This is no reflection on the computer software (indeed there is some very good software available) – it’s the human factor.
The software only does as it is told and where matters fall down is in the non-accountant’s idea of what is needed. Often the ‘run of the mill’ work (e.g. invoicing) can be handled with a fair degree of success, but problems arise over one-off transactions.
On a manual system the bookkeeper can handle such transactions by just noting sufficient details to balance the books and leaving the rest to the accountant to sort out at the end of the year. They can also write notes in the margin of the book to say what has happened and what they have done. On the computer system this is not possible. You’ll run into problems if you’re not yet familiar with double entry bookkeeping and the preparation of accounts. You also need to know the way in which your particular software treats each item.
Thus, business owners (or business managers) should therefore work through the rest of any basic accounting books [or e-books] to obtain at least a basic understanding of bookkeeping before they computerize their accounting records. Have you now got the sense of why a company need proper bookkeeping? Oh wait, by the way, a small business can still work wonders with a pocket calculator, isn’t it?