Why you need an accountant year-round

I hear this often from entrepreneurs and small business owners: "I have the popular accounting software to manage my business checkbook. I can use it to create invoices and pay suppliers. I even use it to manage my payroll. It is simple, and it is just like my checkbook. I think I have it all covered. I use an accountant for my taxes, but do I really need an accountant other than tax season?"

The answer is,yes. You should have an accountant who can support your business year-round.

An accountant offers much more than bookkeeping and taxes. In fact, an accountant’s area of expertise often goes far beyond that of your neighborhood bookkeeper. While undoubtedly a bit more expensive than a bookkeeper, you should be able to rely on an accountant to add value to your business operations.

For example, an accountant will:

  1. Help you read and understand your financial statements.  If you are just printing them off your accounting program each month without a thorough understanding of what you are reading, your business may be in trouble, and you may not even know it.  An accountant can help you decipher the numbers on your financial statements and determine how to use those numbers to determine the actual condition of your business.
  2. Advise you on Generally Accepted Accounting Practices (GAAP).  Like most business operations, accounting has a defined set of “business rules” or the “acceptable way to do things.”  Although most accounting software packages provide some safeguards to prevent you from making significant errors in bookkeeping process and they do provide an audit trail for what you have done, they will not force you to follow these standard business rules. Regardless of your business size, you will want to be able to justify your record-keeping and financial reporting by the accepted practices.
  3. Provide a dose of business reality.  As a business owner, one of the most challenging things to do is to look at the books objectively. An accountant will provide you with an objective outlook on how your business is really doing.  Moreover, an accountant can give you guidance on how to get back on track if you find your business is heading south.
  4. Provide finance-based business guidance.  Most accountants can also provide you with a variety of other businesses services and advice outside what you might consider being the traditional accountant role of bookkeeping and taxes. Some accountants have experience in other areas of business, too, and can also provide support for:
  • Financing options and sourcing
  • Loan proposal assistance
  • Cash Forecasting
  • Budgets and projections
  • Business valuation
  • Fraud investigations
  • Business succession planning
  • Strategic and long-range business planning (business plan development)
  • Accounting software systems review and set-up

This is not to say that you should turn these functions over to an accountant. As the business owner, you have a responsibility to understand the numbers that drive your business deeply. An accountant can serve as a financial mentor to help you better understand why the numbers are significant and how to use them better to make more intelligent business decisions.

Remember that while accounting software can help you manage your daily administrative tasks relative to accounting, the software is just a business tool. As such, the software is not a replacement for a knowledgeable accountant who can help you navigate the financial side of your business.

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

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The Delicate Balance of Inventory Management

Any business that holds and manages inventory does so with the goal of selling that inventory to produce revenue for the company. The key is to maintain just enough to meet demand, but not so much as to have money tied up in inventory for a period longer than necessary. No business holding inventory desires to have more, or less, inventory than is needed to meet customer demand at any given time because failure to meet customer demand will negatively influence sales and profitability. These factors make inventory management one of the most significant challenges any business, but particularly a small business, can encounter.

Depending on the kind of business, there can be many different types of inventory. For example, manufacturers will likely have an inventory of raw materials, work-in-progress inventory, and finished goods inventory at a minimum. A retailer might have merchandise inventory, a service business might have an inventory of hours available to resell, and a magazine or online publication might have an inventory of space that could be filled with advertisements. How each business type manages its inventory may be a little different, but each has the same purpose in mind: To maximize cash flow.

Demand forecasts are an integral part of inventory management. If the business demand forecasts are incorrect, it can be a significant blow to cash flow. For example, if the business assumes the demand will be high, and the assumption is erroneous, it may have too much cash tied up in inventory assets, which in turn would restrict cash flow because the product on hand is not selling as predicted. Conversely, if the business predicts the demand will be low, and the assumption is incorrect, it may not have enough inventory to meet customer expectations, resulting in lost sales and therefore tighter cash flow.

One of the simplest ways to manage physical inventory is to measure productivity and turnover (Traster, 2007). The idea here is to determine how often during the year the business can convert its inventory assets into cash (learn more about inventory turnover and other financial ratios here). Assessing the most appropriate turnover rates is a factor of a company’s sales volume. The goal is to either turn the inventory more times over the course of the year or reduce the amount of inventory held at any given time to maximize cash availability. If money gets tight, it is smart to evaluate the slower moving inventory and determine how price adjustments might help improve sales and increase cash flow, even if the margin on the sale is lower than desired.

Another way to manage inventory levels to maximize cash is to improve supply chain processes using a just-in-time model. For example, gaining agreement from a supplier of raw goods to hold those items necessary to produce a finished product in the warehouse, but not take them into inventory until manufacturing demand requires it, means raw materials are not in stock before necessary. This is one way to hold on to cash a little longer. Another approach might be to make a process change and to delay final assembly and packaging of the product until just before a customer may need the product, thereby reducing labor costs and inventory levels until the very minute (Anderson, 2010). These are only a couple of ways that small modifications in the supply chain process might reduce inventory levels and improve cash flow.

Service businesses and publishers have a slightly different problem. In these companies, fixed inventory is available, and when it is not used in the defined period, it is revenue lost. A consulting firm or advertising agency might have calculated its available inventory of hours by assuming that every revenue-producing person should bill (to clients) an average of 95% of his or her hours per each week for the firm to be successful. Assuming a 40-hour work week and 30-minutes for lunch each day, each should bill 35.625 hours per week. If less than 35.625 hours are billed, that inventory of hours and the revenue it would have produced is lost. The firm must somehow make up that lost revenue elsewhere. Sometimes, hourly rates are increased over time to help make up the difference. But often the solution means firing those who consistently under-perform.

Publishers allocate and maintain an inventory of advertising space within a publication for a specific time. If the advertising does not sell before the publishing deadlines, the revenue is lost. To offset lost revenue, the publisher might offer deep discounts on the unsold space at the last minute to improve cash flow. The publisher might also increase the inventory availability in subsequent issues in an attempt to recoup revenue lost to unsold advertising space.

Inventory management is an art and science. It requires diligence, a reliable inventory system, and designated staff to maximize cash efficiencies. While different business types have different requirements for inventory levels, all businesses must have a keen understanding of their customer needs and market demands to forecast need. Moreover, companies must have a detailed knowledge and control of cost and production schedule to ramp up, or down, depending on the demand forecast. Striking the proper balance with inventory is vital to maximizing cash flow.

 

References

Anderson, L. (2010). Accelerating Cash Flow Through Supply-Chain Innovation. MWorld, 9(1), pp. 36-38.

Traster, T. (2007, May 14). 5 steps to get a grip on inventory. Crain's New York Business, 23(20).

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David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

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How to use Financial Ratios

In an earlier post, Financial Ratio Analysis and the Entrepreneur, I shared some insights on Financial Ratio Analysis and how investors and lenders may consider and use financial ratios to determine whether to invest or lend to an entrepreneur. Entrepreneurs should also understand how to use financial ratios in the regular course of business operations.  Each financial ratio has a purpose, and when compared to industry benchmarks, a ratio can provide insights as to a venture's performance as well as help set stretch goals for business improvements and growth.

The most common financial ratios used by investors and lenders include:

Leverage Ratios

These ratios indicate the long-term solvency and highlight the extent long-term debt is used to support the venture. Leverage Ratios include:

  • Debt-to-Equity Ratio which measures how much debt is used to run the business.
  • Debt-to-Asset Ratio which measures the percentage of the company’s assets that are financed by creditors.

Learn more about Leverage Ratios and how to calculate them here.

Liquidity Ratios

These ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health. Liquidity Ratios include:

  • Current Ratio which estimates the company’s ability to generate cash to meet its short-term commitments.
  • Quick Ratio which measures the ability to access cash quickly for immediate demands.

Learn more about Liquidity Ratios and how to calculate them here.

Efficiency Ratios

These ratios offer insights into operations and help to spot problem areas related to inventory management, cash flow, and collections. Efficiency Ratios include:

  • Inventory Turn-over which examines how long it takes inventory to be sold and replaced within a year.
  • Average Collection Period which looks at the average number of days it takes customers to pay for goods or services.

Learn more about Efficiency Ratios and how to calculate them here.

Profitability Ratios

These ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry. Profitability Ratios include:

  • Net Profit Margin which measures how much a company earns after taxes relative to sales.
  • Operating Profit Margin which measures earnings before interest and taxes (EBIT).
  • Return on Assets which provides insights on how well management is using the company’s resources.
  • Return on Equity which measures how much the company is earning for each invested dollar.

Learn more about Profitability Ratios and how to calculate them here.

As I mentioned in the previous post, these are just a few of the ratios used in determining the health and viability of a given business. Together with other factors such as customer acquisition costs, these ratios provide a great set of tools for managing an entrepreneurial venture. Fully understanding these ratios and the implications on the venture will be beneficial for an entrepreneur before he or she seeks additional investment or debt financing.

 

Resources

Here are a few resources that might be beneficial for identifying industry comparisons for your industry:

  • RMA Annual Statement Studies. Data on business for comparisons

http://www.rmahq.org/annual-statement-studies/

  • Almanac of Business and Financial Ratios ($)

https://www.amazon.com/Almanac-Business-Industrial-Financial-Ratios

  • Financial Studies of Small Business ($ or library)

http://www.worldcat.org/title/financial-studies-of-the-small-business/oclc/45625113

  • Bank Rate Small Business Ratio Calculators

http://www.bankrate.com/nsccan/news/biz/bizcalcs/ratiocalcs.asp

 

Reference

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

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David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below: