Ac×count×ing \n: the system of recording and summarizing business and financial transactions and analyzing, verifying and reporting the results.
Many business owners consider accounting to be a boring, unpleasant process. However, a well-designed accounting system can be a tool to help an owner evaluate the strengths and weaknesses of his or her business. It is much more than a necessary evil to be reviewed once or twice annually. It can provide an accurate snapshot of the financial results of your operations and contain enough detail to analyze business trends. Your accounting system can provide the right amount of information to investigate any potential problems or opportunities.
A properly designed system can signal potential problems early in their development. For instance, your studio experiences great attendance at the Thursday, 7 p.m. class, but the recorded revenue seems smaller than it should be. By investigating your accounting detail you should be able to determine whether students are attending without paying. Or perhaps the revenue has been miscoded or students have been paying an incorrect rate. A well-designed and maintained system will have the detail necessary to identify the problem and help in the development of a solution.
ELEMENTS OF A SOUND ACCOUNTING SYSTEM
There are several crucial components that go into a rigorous accounting system: strong and effective internal controls, accuracy and completeness.
What is internal control?
One textbook defines it as “the plan of organization, procedures and records designed to enhance the safeguarding of assets and the reliability of financial records of an organization.” In other words, it is the structure put into place to ensure your business’ assets are not being spent in a manner you would not approve of and your financial records are accurate and complete.
GIGO – Garbage In Garbage Out
The data entered into your accounting system must be accurate. If not, your records will be unreliable. For example, if a regular class instructor also holds a special workshop and a portion of workshop’s revenue is incorrectly recorded to Class Revenue instead of Workshop Revenue, you may decide to not offer workshops in the future.
To ensure accuracy, most accounting systems will have built in opportunities to verify the accuracy of your input. The system may keep a running total of the dollar amounts being entered. The person inputting the information will have calculated the total in advance and can compare and verify the input accuracy immediately.
Completeness
In addition to being accurate, the accounting data should include all of the transactions that relate to the proper period. Unpaid bills and uncollected income should be recorded in the correct month. Accrual entries are recorded in the correct month and when bills are paid or income collected, the accrual entries are reversed.
Accounting System
When setting up your accounting system, your accounts will fall into one of five categories: Revenues, Expenses, Assets, Liabilities and Owner’s Equity. If you have created a business plan, the initial accounts to be set up will be the categories that were included in the plan. If you don’t have a business plan, the categories below will be a good starting point.
Revenues will include classes, workshops, rental of studio space and retail sales. The internal control objectives include measures that:
- Ensure that all services or sales are promptly billed and recorded at authorized rates.
- Payments are received promptly.
- Unpaid accounts are adequately followed up.
Revenue transactions should be detailed enough to allow the owner to evaluate the effectiveness of a given activity. The information recorded in your accounting records should tell you how a revenue or expense is related to your business. For instance, if your yoga studio has daily classes, it would be important to know if certain classes are more profitable than others. Therefore, you should record individual class revenue. You should also record significant, related expenses by class (i.e., salaries). This will result in the ability to evaluate the profitability of individual classes.
Expenses include the following categories:
- Payroll
- Business permits
- Cost of retail products sold
- Taxes
- Utilities
- Legal and accounting fees
Payroll will be one of your major expenses. The payroll control objectives include measures that:
- Ensure that payroll disbursements are made only upon proper authorization of management to bona fide employees.
- Payroll disbursements are properly recorded.
- Related legal requirements (such as payroll tax deposits) are complied with.
Accounting for payroll activity can be daunting. It is one of the areas you may consider outsourcing to ensure all tax laws are being properly followed.
Utilities seems to be one of the areas everyone tends to underestimate. Make sure this area is adequately tracked, because it tends to be a significant portion of expenses.
The Income Statement will list revenues and expenses and the net income or loss for a given period (i.e., month, quarter, year). Typically, the current period will be compared to the prior year’s time frame to evaluate the direction of your business and answer such questions as: have sales increased, have utility expenses decreased, etc.
Cash, investments, accounts receivable and fixed assets (i.e., assets that have significant costs and are useful for more than 1 year) are some of the accounts that are consideredAssets. Cash is considered the most liquid asset and is therefore listed first on a Balance Sheet. (Liquidity is the ability of an asset to be converted to cash.) Accounts Receivables are created when a customer purchases a service or product and does not immediately pay for it. It is important to monitor your level of receivables. You want to make sure payments are occurring in a timely manner and are being posted to the correct customer account. The older a receivable, the less likely it will be collected.
Liabilities are unpaid obligations. If you took out a business loan to renovate your yoga studio, the unpaid balance is considered a liability. Liabilities include Accounts Payable, Notes Payable and outstanding loans. It’s important to record the correct liability in the correct period.
Owner’s Equity represents your original investment in your business plus or minus the results of operations (income or loss). Another formula for Owner’s Equity is Assets minus Liabilities equals Owner’s Equity. The Balance Sheet lists the Assets, Liabilities and Owner’s Equity of the company as of a specific time period (month, quarter, or year end).
Analysis of Business Results
The end result of your design will be a system that produces financial statements that can be used to evaluate the effectiveness of every aspect of your business. Time spent properly setting up your accounting system will pay huge dividends down the road.
Barb Woods has consulted with businesses, nonprofits and governmental agencies and is currently teaching Intermediate Accounting at Upper Iowa University. Contact Barb at blw@barbwoods.com