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13 Ways an Effective Accounting System Can Improve Business Decisions

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13 Ways an Effective Accounting System Can Improve Business Decisions

13 Ways an Effective Accounting System Can Improve Business Decisions

An accounting system can be an extremely powerful tool for business owners.  When structured with the specific needs of the business in mind, it has the power (through debits and credits) to convert data into a format that tells an interactive, completely personalized story about your business.  The balance sheet is a snapshot at a specific date, while the profit and loss is more akin to a narrative.  By providing feedback on how your business is doing it allows you to control the course of your story.

Some of the feedback that can be gleaned from your accounting system is discussed below:

  1. HOW MUCH MONEY DO YOU HAVE IN YOUR BANK ACCOUNT?

Many business owners, in the absence of an accounting system, will just look at their bank balance to determine their available funds. This method has limitations in that it does not reflect transactions that have not yet been processed including outstanding cheques, deposits, pre authorized payments etc.  This can result in unnecessary overdraft charges and payments being returned insufficient funds, which can be detrimental to your credit rating, not to mention the headaches of calling the customer, bank etc. Ensuring that all banking transactions are properly recorded in your accounting system allows for a thorough review, which helps to prevent against unauthorized and erroneous transactions. 

Accounting software also facilitates the bank reconciliation process which essentially allows you to verify that every bank transaction has been entered thereby ensuring the completeness of your records. Once you have set up a system to track all banking transactions, the amount available funds in your accounts is readily accessible and appropriate decisions can be made.

  1. HOW MUCH DO YOUR CUSTOMERS OWE YOU?

Knowing your exact accounts receivable balance i.e. what customers owe you at any given time is an essential component of a good accounting system. Even if you only have a handful of customers who pay on credit, it is important to know the amount of cash to expect once they are paid and to ensure that the payments received match the amounts invoiced.    Your business may be generating significant revenue, but if you have not yet been paid it can have an adverse, unexpected effect on short term cash flow since you need the cash to continue to pay suppliers. Also, following up on  customer receivables on a regular basis is far more effective when done earlier, rather than months after the goods or services have been provided and can help reduce bad debts .  Finally, businesses seem more credible when they can generate customer statements upon demand rather than cobbling something together in a word or excel document.

  1. HOW MUCH DO YOU OWE YOUR SUPPLIERS?

Tracking your bills when they are due can help you optimize your cash flow by paying them when they are due or can help save money by taking advantage of discounts. By reviewing your accounts payable (how much you owe your suppliers) and recording your bills when you receive them, you can also see where you stand in relation to the amounts you expect to receive from customers. You can also build a history of amounts paid to suppliers which can be helpful when renegotiating terms or looking for new suppliers.

  1. HOW MUCH DID YOU SELL?

An understanding of your sales is a key figure to know on an absolute basis and when comparing to a benchmark like your breakeven point and sales forecasts.  Your accounting software will allow you to structure your accounts so that you can track sales by different groupings including sales by category, item, type or geographic region.  This in turn can help you focus your sales efforts on products or regions that are more profitable.

  1. WHAT WERE YOUR TOTAL EXPENSES

Any accounting system will allow you to track your individual expenses so that you can quickly identify how much you are spending, by different categories eg. labour, rent, supplies, raw materials etc,. Although many small business owners track this on an excel sheet, this method does not allow you to review history and comparatives. Once you have entered your expense data, you can analyze it by categories (in a profit-loss statement) or review expenditures by suppliers or items purchases.  By creating and modifying your chart of accounts, it is up to you decide how detailed you want this listing.  For example if you are a manufacturer of pickles, you might want a separate account for cucumbers to assess the costs which might give you some leverage with suppliers in the future if you can demonstrate how much you actually spent. Alternatively, you can combine this cost with other direct cost such as vinegar and herbs and call it raw materials. There are endless options for combining and analyzing data.

  1. WHAT WERE YOUR GROSS MARGINS

A key metric for businesses who incur direct costs relating to their sales, that often applies to manufacturers of goods, is the gross profit or gross margin, which is calculated by deducting direct costs (cost of goods sold) from sales .  As a percentage this can communicate whether you conform to industry standards, how to implement greater economies of scale, and how much you have left over to spend on overhead.

  1. HOW PROFITABLE WAS YOUR BUSINESS?

Understanding how profitable your business is perhaps the most important number for many business owners, both as a standalone number and also on a relative basis, compared with prior periods. It also contributes to many business decisions including cash flow forecasts, how much to pay employees in bonuses, are the prices of goods or services high enough etc. It is important to note that profit might be negative in the beginning in the early stages of business growth  meaning that while being profitable is every business ultimate goal, it might take some time to get there. The important thing is to measure it and to ensure it lines up with expectations.

  1. HOW MUCH DID YOU CONTRIBUTE TO THE BUSINESS

Many business owners contribute to their businesses, particularly in early stages, either by purchasing shares/equity or through loans that will be repaid back once the business is generating enough cash flow. Your accounting system will help you keep track of how much you have contributed to the business and whether it should be a shareholder loan, which is a liability or shares in the company, which would be equity.  Many small business owners are interested in calculating their return on equity (ROI), to determine whether the business results in a higher return than simply investing in the stock market or another investment. Return on equity can simply be calculated as the net profit of the business divided by the amount of equity that was contributed. If you are not charging the business interest on your loan payable it should be included in the equity amount.

 

  1. HOW MUCH CASH FLOW DID YOU GENERATE?

Knowing how much cash flow you are generating is essential for any small business owner.  For several reasons, a business that shows a profit may not have enough cash flow (have a cash flow deficit) to cover its costs as a consequence of high accounts receivable, investments in equipment, excessive inventory.  Knowing where you stand with respect to your cash flow, particularly when you have significant costs to run your business can be the difference between success and failure.   Most accounting software will generate this report automatically at least as a starting point.

  1. HOW MUCH INVENTORY DO YOU HAVE ON HAND?

For companies that manufacture and sell products, find an accounting software that can handle inventory such as item classification amount of inventory on hand, price levels etc. can have a huge impact on how your service your customers’ needs, and allow you to control the amount of inventory you have at any given time. There is cost to not having enough inventory and also having too much inventory. It is therefore important to be able to control your inventory and also build up data to analyze it on many different metrics.

  1. HOW MUCH DEBT DO YOU HAVE AND WHAT ARE THE RELATED INTEREST COSTS?

The total amount of debt owing should be tracked regularly to ensure that payments are made on time, interest expense is accurately calculated and debt to equity and other ratios are monitored to ensure compliance with debt covenants. Banks can be very strict where it comes to maintaining covenants and conditions on borrowing so you don’t want to be offside where it comes to fulfilling these requirements and having your line of credit or loans withdrawn.

  1. HOW MUCH DO YOU OWE IN SALES AND INCOME TAXES?

Most accounting software have sales tax modules, specific to your country or region, that allow you to track exactly how much you owe (or are owed) at any given time. Since this is a significantly liability that can be a big hit on cash flow, it is very important to know this number and plan for how it is going to be paid. It is also always a good idea to ensure that your government debts are paid on a timely basis or if this is not possible, to work out a payment arrangement as governments can be gain control over your bank account, which can be devastating. 

Business income taxes are not usually specifically tracked but should be estimated periodically so that the amount owing at the end of the year is properly estimated. Also instalment payments are able to be tracked and you can set reminders as to when the payment is due.

  1. HOW CAN YOU SAVE MONEY?

A well structured accounting system will provide you with enough info to identify areas where you can save money whether you simply spend less on certain items, renegotiate terms with a supplier, reduce bank charges or buy greater quantities, there are numerous opportunities to reduce costs. You also adjust your prices to increase profitability and review changes to your sales and expenses to determine the ideal balance.