CPA at Centaur Digital Corp, helping busy business owners decrease the amount of time and energy needed to manage their accounting system.
Wiley noticed that his business showed a loss for last year. He feels that can’t be true, so he decides to set an appointment with his accountant. “I know we made money last year, but the income statement is showing a loss!” exclaims Wiley as soon as he sits down. Taken aback, his accountant pulls up the income statement and balance sheet. “Take a look at these numbers,” he says as he hands Wiley a copy of the balance sheet.
An outsourced accounting service that handles your bookkeeping and taxes is a great way to ensure you can stay focused on your business. However, sometimes an outsourced service does not have the tie-in to the reality that someone in-house would. This makes it necessary to understand what the numbers mean and perform occasional audits. Ideally, this is something handled and guided by the accountant, but as business owners are ultimately responsible, they must understand the basics.
There are many financial numbers that tie directly into the reality of a business, making them easy to verify for accuracy. These accounts are the easiest to verify since they don’t require additional calculations or a review of all the transactions in a year. Verify the following accounts to ensure that the financial reality of your business is reflected in its financial statements.
Account One: Bank Balance
Before you begin a financial audit of your company, verify that the bank and credit card statement balances match your accounting system balances. If you use a bookkeeper, this should never be an issue, but it’s best to double-check. There are circumstances where the balance may differ, such as an outstanding check, but any incongruency should be explainable.
Account Two: Accounts Receivable
While most small businesses should be on a cash method of accounting — meaning there shouldn’t be any accounts receivable — most accounting software still tracks open invoices and thus can show you a balance for accounts receivable. To verify balances, pull up a list of open invoices or customers with open balances. Sometimes you might find customers with negative balances, meaning the customer paid more than what you invoiced. This often happens if you bill a customer automatically but forgot to create the invoice.
Account Three: Accounts Payable
While nearly all businesses have some type of accounts receivable from invoicing, most small businesses should manage their accounts payable, or unpaid bills, outside of their accounting software. There are scenarios where outstanding bills need to be tracked, but that should be handled by the accountant, not the business owner. If there is a balance for accounts payable on the balance sheet, the business owner should have a clear idea of where it’s from.
Account Four: Inventory
For businesses that hold inventory, a physical count of inventory at the end of the year is essential. Even if you are a cash basis taxpayer, at a minimum you need to do a physical inventory at the end of the year. The change in the amount of inventory from one period to another will directly correlate to a change in profit.
Account Five: Loans
If the business has long-term loans, the business owner has to be aware of exactly what those loans are. Most small businesses have few loans if any, so this account is easy to verify. However, it’s important to verify the outstanding balance of each loan — especially at the end of the year — since it’s easy to misclassify what should be a loan payment as an expense.
The five accounts listed above appear on most small-business balance sheets. These accounts are easy to audit and verify, but most small-business owners skip this step, which usually leads to errors in the balance sheet. Since the balance sheet is a snapshot of a point in time, it’s relatively fast to verify balances for accuracy and should be done at least once a year.
After the review of the financial statements, Wiley thinks he spotted the error. “We had this loan from a vendor. We paid them back already but it still shows we owe this amount.” After a quick review, the accountant is able to confirm the error. “It seems that the auto-categorization feature in the accounting software accounted for the payment as an expense since that’s what most payments to this vendor are. That would explain why there is a loss instead of a profit.” After the error was fixed, Wiley decided he needed to review the income statement too, something his accountant encouraged because every small-business owner should understand their numbers.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.