Introduction to Financial Record Keeping

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Introduction to Financial Record Keeping

• February 2008
• Cecile E. Reid, CPA, MBAPresident, Flat Rock
  Financial Services, LLC

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What is Financial Record Keeping?

• Every business has a Unique story to tell.
• A Profitability Story
• Money In, then Out then back In Again.

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What is Financial Record Keeping?

• Financial Record Keeping is the process of
  ensuring that your business story is COMPLETE
  and CORRECT.

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Why do YOU need Financial Record Keeping?

• Who needs the complete story?

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WHO?
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And he isnt alone!
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More Importantly
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?
Who are my best customers?
If I have to give up a job which one should I
give up?
? ? ?
Would I have turned a profit last month if that
last minute job hadnt come along?
Will storage costs eat up my saving on this
discounted material?
? ? ?
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What is Financial Record Keeping?

• Financial Record Keeping is the process of
  ensuring that your business story is COMPLETE
  and CORRECT.
• Financial Record Keeping consists of Bookkeeping
  and Accounting

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Bookkeeping vs.. Accounting

• Every time one of the following activities occurs
• Money changes hands, e.g. a sale or a purchase
• Money is promised, e.g. a loan made or an order
  is received
• A transaction is created.
• In order to tell a complete story all of these
  transactions need to be in one, central place.

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Bookkeeping is.

• The process to record, in a central location,
  ALL of the money transactions a business makes,
  whether cash or promises.

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What is Accounting?

• A good bookkeeping system must be set up so that
  transactions recorded can be analyzed in MULTIPLE
  useful ways.
• The system has to fit the business needs for
  information.
• The system must also be monitored so that it is
  working as designed.

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What is Accounting?

• Information must be extracted from the system so
  that it can be used to make decisions about
  ongoing business actions.
• Monthly checks and balances need to be performed
  to ensure the information gives an accurate story
  about the business profitability.

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What is Accounting?

• Timely reports have to be designed so that
  information is shown in a COMPARABLE manner.
• Monthly/Weekly/Qtrly reporting has to be
  consistently compiled so analysis is useful.
• This entire set-up, monitoring and reporting from
  the bookkeeping process is..Accounting.

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Accounting is

• The process of organizing and analyzing the
  centralized records.

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Bookkeeping Recap

• All money transactions, whether they are actual
  cash transactions and guarantees of future cash
  transactions all need to be recorded.
• Bookkeeping is the process to record, in a
  central location, all of these transactions.

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Accounting Recap

• The centralized bookkeeping system has to be
  designed to fit the needs of the business.
• The system needs to be monitored to ensure that
  it is functioning correctly.
• The information in the system has to be reported
  regularly with comparable consistency.
• The Accounting process designs, monitors and
  analyzes the centralized records.

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Titles

• Accountant
• Bookkeeper
• CPA (Certified Public Accountant)
• Tax Preparer

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Titles

• Bookkeeper
• Accountant
• Tax Preparer
• A CPA is licensed to perform the functions of
  a bookkeeper, accountant and tax preparer.
• Anyone performing accounting functions is an
  accountant but CPAs are state licensed.

Certified Public Accountant
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• Fundamental Fiscal Understanding

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What we will review

• Bank Reconciliation
• Cash and Accrual Accounting
• Asset Capitalization and Depreciation

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Bank Reconciliation

• Bank Reconciliation Report maps out the
  difference between your bank statement and your
  bookkeeping records.
• Bank Balances do not represent the following
• Checks not yet presented
• Deposits with holds
• Your Bookkeeping Records may not include
• Interest earned
• Fees assessed by your financial institutions.

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Cash vs. Accrual Accounting

• Affects the recording of transactions of income
  and expenses
• Cash Accounting recognizes transactions on the
  day when cash has actually changed hands.
• Accrual accounting recognizes transactions when a
  commitment is made although no cash is
  transferred.

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Cash Accounting

• Its Easy!!!!
• Cash in, Cash Out.
• Drawbacks
• Poor matching of Cash In to Cash Out
• Not acceptable to most users of your records.
• Expenses show patterns that are misleading.
• All the information you have is not in your
  reports.

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Accrual Accounting

• Captures Income and Expenses based on the accrual
  method of accounting.
• Essentially, when it becomes reasonable to assume
  that cash will be transferred in the future, then
  the transaction is recorded.

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Handling Assets

• When a purchase is made, an expense is usually
  recorded.
• IF that purchase will be used beyond the end of
  the reporting year then the expense ought to be
  shared over the additional years.

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Hypothetical Purchase

• E.g. a tractor purchased for 30k will work well
  for 10 years.
• Suppose, in the first year expense would be 30K.
  In the remaining years, expense would be zero.
• Misleading trending in data
• Tremendous impact on annual incomes.

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Capitalization is

• A system to record a major purchase in a way that
  spreads the expense involved over the time period
  that benefit is derived.
• It is a way to tell the profitability story more
  clearly by showing that the major expense has a
  long term payback.
• Instead of Capital Expense 30K, we have Capital
  Asset 30K

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Depreciation is..

• The process by which the capital asset is then
  converted to expense over the several years.
• Instead of Capital Expense 30K in the first year
  we have multiple years of Depreciation Expense.
• So expenses are smoothed over a longer time
  period which is more in line with any revenue
  earned by the capital purchase.

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But..!
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Expenses Influence Income

• The greater your expenses, the lower your income
  and the lower your tax burden by extension.
• So the calculation of Depreciation Expense is
  very important to the IRS because their income
  is directly impacted.

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Depreciation Methods

• There are various depreciation methods, i.e.
  ways to convert a capital asset in one year to
  depreciation expense in subsequent years.
• Depreciation methods based on time
• Straight line method
• Declining balance method
• Sum-of-the-years'-digits method
• Depreciation based on use (activity)

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What you need to know about Depreciation

• Depreciation can be calculated in various ways
  and each method has its pros and cons based on
  your particular business.
• Each asset type should have its own depreciation
  method determined by your accountant.
• Your tax preparer should determine how to
  depreciate to calculate taxable income

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• Land is a fixed asset that is not depreciated.

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Fundamental Financial Reports

• Core Statements that tell the story
• Balance Sheet
• Income Statement
• Statement of Cash Flows

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Fundamental Financial Reports

• Balance Sheet
• A snap-shot.
• A picture of your business financial strength at
  ONE point in time.
• All Assets All Liabilities All Equity

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Balance SheetAs of DD/MM/YYYY

• Assets
• Current Assets
• Fixed Assets (net of depreciation)
• Total Assets XX,XXX
• Liabilities
• Current Liabilities
• Long Term Liabilities
• Total Liabilities
• Owners Equity
• Common Stock
• Retained Earnings
• Total Owners Equity
• Total Liabilities and Owners Equity XX,XXX

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Assets

• Short Term and Long term Assets Separately
• Short Term aka Current Assets
• Cash
• Receivables
• Long Term aka Fixed Assets
• Land
• Buildings
• Accumulated Depreciation

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Liabilities

• Short Term and Long term Liabilities Separately
• Short Term aka Current Liabilities
• Accounts Payables
• Line of Credit
• Accrued Payroll Liability and Withholding
• Long Term aka Long Term Liabilities
• Mortgage Payable
• Vehicle Loan Payable

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Owners Equity

• Common Stock
• Retained Earnings
• Owner Paid In Capital
• Cash Infusion to the business
• Personal Equipment given to the business
• Net Income for the current year

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Balance Sheet

• Shows the strength and potential of your business
  at a specific point in time
• Must be in balance
• i.e. (Assets Liabilities Equity)
• Assets and Liabilities expressed separately based
  on their life span
• Assets shown at capital cost with depreciation
  shown separately
• Must have an AS OF Date

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Fundamental Financial Reports

• Income Statement
• Tracking of Revenues and Expenses over a period
  of time.
• Answers two questions.
• Has Management accessed/developed a profitable
  customer base?
• Does Management know how to extract that profit?

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Income Statement

• Has Management accessed a profitable customer
  base?
• Gross Margin
• Revenue Earned in the period
• less
• Costs to Acquire or Make the Product

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Income Statement

• Does Management know how to extract that profit?
• Net Income (before Income Taxes)
• Gross Margin(or Gross Profit)
• less
• Operating Costs Overhead Costs

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Operating Costs vs. Overhead Costs

• Operating costs are directly impacted by growth
  of the business.
• Overhead costs are less impacted by growth of the
  business.

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Operating Costs

• Operating costs are directly impacted by Gross
  Margin.
• If sales go up, these costs go up.
• If sales goes down, these costs go down.
• Predominantly Sales Expense.

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Overhead Costs

• Overhead costs are less impacted by growth of the
  business.
• If sales reach a certain level, these costs often
  go from zero to some set level.
• If sales goes down, costs stay put.
• Often the Bulk of Total Expense.

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Income StatementPeriod (DD/MM/YYYY to DD/MM/YYYY)

• Revenue
• Cost of Goods/Services Sold
• Gross Margin
• Operating Expenses
• Overhead Expenses
• Income before Taxes
• Tax Expense
• Net Income After Tax (sent to Balance Sheet)

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Fundamental Financial Reports

• Statement of Cash Flows
• Outlines the sources of cash for the business
  during a specified period.
• Shows the cash usage of the business during a
  specified period.
• Categories these cash flows.

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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)

• Cash Flow From Operations
• Cash Flow From Investing
• Cash Flow From Financing.

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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)

• Cash Flow From Operations
• Should start with Net Income
• and adjustments like
• Receivable, and Payables, and if no investing
  activity, Depreciation

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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)
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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)
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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)
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Statement of Cash Flows Period (DD/MM/YYYY to
DD/MM/YYYY)
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Fundamental Financial Reports

• Core Statements that tell the story
• Balance Sheet
• What Resources does your business have and how
  much of that is free from prior commitments?
• Income Statement
• Does this business have a profitable customer
  base and does management extract that profit?
• Statement of Cash Flows
• Where are the sources of cash for this business?
  How vulnerable is it to fluctuations in cash?Can
  cash needs be met internally?

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• These reports convey useful and reliable
  information only if they are based on
• accurate bookkeeping
• and
• careful accounting.

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• This creates a tension for
• owner- operated businesses.
• Owners hold management accountable for good
  financial record keeping.
• When the owner is the manager, this discipline
  can be overlooked.

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• Barriers to Recordkeeping
• Time Burden on management creates supply shortage
  of fiscal reports.
• Owners not using the report results in reduced
  demand.

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• Barriers to Recordkeeping
• Time Burden on management creates supply
  shortage.
• Accounting Software and Contract Workers
• Owners not using the reports so there is reduced
  demand.
• Regular review of financials as a part of
  strategy setting.

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Choosing Accounting Software

• Software should
• Match the needs of your business
• For contractors, your software should be able to
  track costs to specific jobs handle
  subcontractor billing and invoicing etc.
• Create estimates and convert to invoices.
• Offer Expandability
• If you dont accept credit cards right now but
  want to in the future, your software should have
  that capability.
• Ideally, that function should be purchased only
  when needed.
• Create reports easily
• Once properly designed by your accountant, your
  software should offer ease of accept to timely
  reports.
• Capable of minor report modifications without
  needing your accountant.

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Choosing Accounting Software

• Some Options
• QuickBooks,
• Peachtree,
• Accpac,
• and many more.

An accountant setting up the system for you, can
help with selection. But the choice is YOURS.
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Recap and Review

• Key financial reports tell the story of your
  business present profitability and its potential
  in the future to your owners and other interested
  parties.
• These reports are based on having all financial
  transactions captured in a central location
  (bookkeeping) that has been properly designed and
  monitored (accounting).

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Recap and Review

• Financial professionals such as bookkeepers,
  accountants and tax preparers are resources to
  help management satisfy the owners need for
  complete and accurate recordkeeping.
• Accounting software is also an excellent resource
  to simplify functions and create reports.
• Choosing the right accounting software decision
  requires matching the needs of the business with
  the capability of the software program.

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Your Instructor

• Cecile E. Reid, CPA, MBA is President of Flat
  Rock Financial Services, LLC a professional
  accounting firm providing Fortune 100 fiscal
  thinking to organizations of all sizes, by
  serving as their financial services partner.
• Ms. Reid earned her MBA from The Wharton School
  at the University of Pennsylvania. She also has
  Bachelor of Science in Accounting and Actuarial
  Science. Cecile is a licensed CPA and has served
  on the Board of Directors of a conglomerate with
  1Billion in assets for over 5 years.
• [phone] flatrockllc_at_netzero.com