Accounting for Non-Financial Managers

by Michael W. Fooshe, CPA

It has been said, "Accounting is the language of business." But, accounting is something that most business owners would rather leave to someone else because of a belief that it is difficult to understand and not very exciting. After all, entrepreneurs rarely go into business for the opportunity to sort through stacks of paperwork, get out the ten-key and try to make sense of it all. No, the rush of owning a business is successfully selling to customers and reaping the rewards of providing extraordinary products and services. Now, that's exciting! But how do you determine how much to charge for your product or service? How can you know if you are making a profit or losing money? How do you know, while you're having fun running the business, if you can keep on having fun profitably? Sure, occasionally success bursts out onto the scene through the use of intuition or "gut feelings." And once in a while, through one's reputation, a business owner may be able to secure financing without providing the cold, hard facts. But, for the rest of us, our bankers want to see the bottom line and everything that leads to the bottom line!

Financial statements prepared in accordance with generally accepted accounting principles (GAAP) provide a financial "snapshot" of an entity's financial picture for a given period of time, generally monthly, quarterly and yearly. An understanding of the timely, useful financial statements that your certified public accountant (CPA) provides for you should give you information that you need to make necessary decisions about your business. Would you like to grow? Do you have the capital to expand? Do you have enough cash to meet the needs of your business? How long could your business survive on existing cash reserves? These questions are answered easily when a sound financial accounting process is followed and analyzed in a timely manner.

The basic financial statements that you should be seeing each month are: 1) the balance sheet, or statement of financial position; 2) the statement of cash flows, which summarizes the cash inflows and outflows during the time period; and 3) the income statement, which summarizes the results of the company's activities for the time period.

But, what is the useful information that you can learn about your business if you review these statements every month?

The Balance Sheet: A financial snapshot of your business as of a particular date.

The balance sheet is a detailed summary of the accounting equation which must always stay in balance: Assets (cash, equipment, inventories, accounts receivable, etc.) = Liabilities (accounts payable, notes and mortgages payable, etc.) + Owner's Equity (the owner's residual interest in the business after liabilities are deducted). The purpose of the balance sheet is to determine liquidity, financial flexibility and operating capability. Liquidity refers to the amount of time until an entity's assets can be converted to cash. Financial flexibility refers to the ability of the business to adapt to change through the use of its financial resources.

The Statement of Cash Flows: Where is the cash coming from and where did it go?

The statement of cash flows helps you to determine 1) the ability of your company to generate future cash flows, 2) the ability of your company to meet obligations and pay dividends, 3) whether or not your company needs external financing, 4) the reasons for differences between net income for the period and actual cash receipts and 5) the cash and non-cash aspects of the entity's investing and financing transactions during the accounting period.

The components of the cash flow statement which make it useful are the following: operating cash inflows (collections from customers, interest and dividends collected), and operating cash outflows (payments to suppliers and employees, interest and income tax payments). The difference is either an increase in cash retained by the business or a decrease in the cash balance due to operating activities.

The Income Statement: Did I make money or lose money?

Now, this is where the fun kicks in. The income statement (or profit and loss statement) summarizes the results of your company's operations for the accounting period. Like the balance sheet is ruled by the accounting equation, accrual basis net income is measured as follows: Revenues - Expenses + Gains - Losses = Net Income.

Revenues. Revenues are inflows from delivering or producing goods, providing services or other activities that constitute your business' operations. Revenues are recognized (recorded in the financial statements) when your business has earned the right to receive cash through its operating activities (the providing of services or at the time goods are sold).

Expenses. Expenses are outflows from your business or the using up of assets during the accounting period while delivering goods, providing services or other activities that constitute your business's central operations. To determine the income for an accounting period, your business' expenses (efforts) should be "matched" to revenues (benefits). For example, if your company's business is building dining room furniture, and the need arises for a new table saw, the cost of the equipment should be allocated over the useful life of the table saw. If it is determined that the useful life is five years, and the table saw had an original cost of $5,000, the cost associated with producing a year's worth of revenues would be $1,000. This is an example of a capital cost which would not be immediately expensed when incurred. Now, if the new saw required a new blade every two weeks, the cost of the blades throughout the accounting period would be expensed immediately.

Using the Income Statement

The beauty of having a monthly profit and loss statement is that you will know if you are producing income or producing losses. You should take that information and compare actual monthly revenues and expenses to budgeted revenues and expenses. What do you do if you see differences? If differences exist between the spending plan (budget) and actual expenses, ask yourself this simple question, "Why?" Are the differences due to a change in the yearly plan? Is something happening that you, the manager, are not aware of? If you become aware of expenses that you were not aware of, or did not initially plan for in your yearly budget, then congratulations! You have just successfully used accounting information to make a change for the better for your business. And if you ever have questions about your financial statements, such as the nature of an account or transaction, ask your accountant! Your CPA will be able to thoroughly explain the financial statements he or she has prepared for you. If your CPA explains the answer to your question in a way that is difficult to understand, ask the simple question, "Why?" again, and continue asking until you understand the answer. There is a clear explanation available for virtually any accounting problem or question.

Conclusion

Accounting is the language of business. Look forward to the day when your financial statements are prepared and delivered to you. You will then have the opportunity to review them in detail and ask a lot of questions of yourself, your managers and your CPA. And do not be intimidated by accounting information. It measures the success level of your business. Ask questions of your CPA and proactively manage the financial position of your new business. Good luck!

About the Author

Michael W. Fooshe, CPA, is an accountant in Dickson, Tenn. The Tennessee Society of Certified Public Accountants is the state professional organization for more than 8,000 CPAs in government, education, industry, business and public practice. For more information on small business issues, visit the Tennessee Society of CPAs' Small Business Resource Center on the Web at www.tscpa.com.