Small- and medium-sized (SMB) business owners are usually pretty fearless, which is a great thing when it comes to becoming a successful entrepreneur. However, that very same “can do” attitude can very well get you into hot water if you try to tackle too much or get in too deep.
A recent study by office supplies giant Staples suggests that many SMB owners may be in over their head and not even know it, especially when it comes to one particular area of expertise in particular. We’re talking about financial accounting, even just having the most basic knowledge about much-needed accounting principles and concepts.
Principles of Accounting: A Lack of Knowledge
While more than 90 percent of SMB owners surveyed for the study said they felt confident in their ability to manage their finances, less than half of them were able to define the most basic of accounting principles, even the simplest ones like accounts receivables and accounts payable. And that’s a problem.
“A firm understanding of finances and business performance is crucial for a small business to be successful,” said leading small business expert and president of TheSelfEmployed.com, Steve Strauss, in a recent statement regarding the study’s findings. “Managing finances is a challenging process and many business owners are often unaware of the tools and resources available that can help them make smart decisions and, ultimately, improve their bottom line.”
Given this assertion, perhaps it is not surprising that the study also found that 28 percent of SMB owners lose sleep over cash flow, and 23 percent admit to bouncing a check in the past year. After all, how can you possibly manage your finances appropriately if you’re at all winging it?
Here’s the thing, there are lots of resources available to SMBs to help them either manage their own finances more efficiently or find someone who can, some of which are listed at the end of this article. In the meantime, we’d like to provide you with an overview of some of the most basic accounting terms and accounting concepts you’ll want to know about if you’re goal is to be a successful SMB owner or entrepreneur.
Basic Accounting Terms
Okay, thanks to the Staples study, we know that there are far too many SMB owners out there, prospective or otherwise, who don’t know even the most basic accounting-related terms and, more importantly, what they mean. So we’ve put together a little primer that you can use to bring yourself up to speed pretty quickly:
• Bookkeeping versus Accounting — Where bookkeeping encompasses the actual recording of all your business transactions, including sales, revenue earned and expenses, accounting refers to the financial statement that uses all of that information to analyze and forecast your business’ overall financial profile and health.
• Assets versus Liabilities — Assets are something your SMB owns that can provide future economic benefits, including cash, inventory, land, buildings and equipment, while liabilities are your company’s obligations, such as money that must be paid or services that must be performed. Successful businesses have greater assets than they do liabilities.
• Revenue versus Expenses — Revenue is money your SMB earns from doing business, where expenses are the costs you incur to generate that revenue. To remain viable, a company’s revenue must exceed its expenses, and a business’ break-even point is where the two exist in equal measure.
• Fixed versus Variable Costs — Fixed costs don’t change as the business’ profitability goes up and down and include such things as rent, non-performance or volume-based salaries and interest. Variable costs are just the opposite. They do change according to change in business profitability or volume and include such things as the cost of labor and materials for everything from manufacturing and production to packaging.
• Cash Method versus Accrual Method — Most individuals and many small businesses use the cash method of accounting, which means they record their expenses when they actually pay the bill, and they record their revenues when they actually receive payment for products sold or services rendered. As for the accrual method of accounting, it is designed to match income with expenses in a current year. In general, income is reported in the year it is earned, whether invoices have been paid or not, and expenses are deducted and capitalized in the year in which they are incurred as well.
• Accounts Payable versus Accounts Receivable — Accounts payable refers to the amount of money a business owes to its vendors and suppliers, while accounts receivable refers to the amount the business is owed by its customers.
• Write-down versus Write-off — The reduction in the valuation of an asset that has lost some, but not all of its value is a write-down, while a write-off is a complete reduction of an asset to zero due to a total loss in its value.
• Balance Sheet versus Ledger — A balance sheet lists a business’ assets, liabilities and capital and is a statement of its financial status at a given time, while a ledger is more all-encompassing and is the core of your business’ financial records. It tracks every transaction from your company’s inception to date.
Another Word for Scary: Audit
Lastly, and recognizing that there are many more terms where these most important ones came from, we’d be remiss if we didn’t mention the word “audit.” While it’s something that many SMB owners want to avoid, especially if it’s being conducted by the U.S. Internal Revenue Service (IRS), an audit is a whole lot more likely if you don’t know how to track your finances or don’t bother to conduct an internal one of your own on occasion.
An audit is a systematic review of your business’ financial records to ensure that everything is in its place and on the up and up, taking into account data, statements, records, operations and performance (financial or otherwise). The auditor evaluates it all and communicates the final findings in an audit report.
Basic Accounting Principles
Like it or not, your very survival as a small business owner may rest on whether or not you have a basic understanding of your own finances, even if it means starting at the most rudimentary level. For instance, there are several important rules that you need to be aware of, understand and act on if you are serious about making a go of your business over the long-term, and here are some of them:
Calculate Expenses versus Revenue Regularly — “Well, duh!” you might say, but it’s a fact that far too many SMB owners have little to no accounting expertise. In fact, it intimidates them to no end. As a result, they stick their head in the sand where financial management is concerned, preferring to fixate on and get excited by their gross sales and little else. They then neglect to evaluate what they’re spending on various aspects of the business, such as marketing, equipment or consultants. They figure that if gross sales are up, they have money to spend, and they never stop long enough to really analyze their ROI (return on investment) or even whether or not how much they are spending is jeopardizing their profitability in the short- or long-term. Here’s the reality though: Anytime your expenses go up faster than your revenue is coming in, you’re just one step closer to disaster. Being mindful and taking a proactive stance on this front and doing it as a matter of routine is crucial.
Know How to Break Even — In keeping with that last rule of thumb, it’s important to know what your break-even point is and to track it on a regular basis. Bottom line: Your business is breaking even when your revenue for any given period equals your expenses. But it’s not as simple as money in and money out. Breaking even actually requires you to know your total expenses, as well as your gross profit percentage, and you get that number by dividing your gross profit by sales. At the break-even point, revenue = fixed costs + variable costs, two terms we touched on earlier.
Recognize That Borrowed Money Is Not Profit — When SMB owners begin to do well and feel the need to grow, they oftentimes begin borrowing money for that purpose. That’s great so long as there is revenue coming in to cover any debts that are incurred. Trouble is that far too many of them see borrowed money in the accounts, and it gives them a false sense of security. Borrowing money when you don’t take the time to analyze whether or not you’ve got sufficient revenue coming in to cover it means you’re building the foundation of your business on a house of cards. It’s a vicious cycle that will come to an end inevitably at some point, and it won’t be pretty when it does.
Manage the Money You Are Owed — All too often, especially when a small business is doing well, there is little attention paid to unpaid debts on the part of its customers. All the SMB owner sees is that there is money that is owed, and he or she takes tremendous comfort in the fact that a windfall will be forthcoming. Once again there is a sense of well-being attached to that, but nothing could be further from the truth in far too many instances. Money owed is not money in the bank. In fact, if the debt not being paid has gone on too long, it may very well be a sign that your business is headed for the red. Changing tactics might be necessary.
Tips for When You Can No Longer Go It Alone
If your goal is to grow your SMB and assuming all goes according to plan or even if it’s because you recognize that financial matters are not your strong suit, there may come a time when being thrifty by doing your own bookkeeping and accounting just doesn’t make sense anymore. That’s the time to get help.
Essentially, there are three options to consider when you need assistance with financial accounting matters, including everything from start-up and basic record-keeping to tax planning advice and even auditing. You can hire a bookkeeper, an accountant or a CPA, which stands for Certified Public Accountant.
Each one of these professionals brings a different level of expertise where the overall discipline and principles of accounting are concerned. Additionally, and within each level of expertise, you may want to seek out individuals and firms that have specific understanding of your industry, have worked with companies and businesses of your size in the past and/or are adept in handling the specific complexities of businesses of your kind.
Most importantly, before you hire any one of the types of accounting professionals or firms described here, make sure to get references. After all, you’ll be entrusting them with your very financial survival and livelihood, and that’s something to never take lightly…
Bookkeeper — Typically this person is a an outsourced vendor to a small business and is responsible for recording basic accounting transactions and reconciling bank statements using accounting software on a regular basis, whether it’s weekly or monthly. Bookkeepers do not do taxes, and they don’t conduct any kind of in-depth analysis. Their focus is on monthly reconciliation and keeping your company accounting on track.
Accountant — Accountants are qualified to handle the bookkeeping needs of your small business, but they also handle payroll and sometimes your business taxes. These professionals generally have college degrees and are therefore trained for a higher level of analysis and interpretation of financial data than are bookkeepers.
CPA — CPAs are licensed accountants who have passed rigorous tests and can provide the full range of financial accounting services to you and your SMB. Many of them specialize in tax planning and filing, business consulting or auditing services. Only CPAs can certify an audit. Given their much higher level of expertise, their services can be very expensive.
If you’re an aspiring or existing SMB owner or entrepreneur who isn’t taking the time to learn the basics of accounting or dealing head-on with your business’ financial matters, you’re only postponing the inevitable. Stop dragging your feet, and get started today!
Need more help navigating the ins and outs of basic accounting concepts and options for your small business? Here are some great places to start…
U.S. Small Business Administration (SBA)’s Introduction to Accounting
SBA’s Online Portal for Managing Business Finances and Accounting
SCORE: Counselors and Mentors to America’s Small Businesses
America’s Small Business Development Centers (SBDC)
Citibank’s Small Business Resource Center