Trust but Verify

This phrase, based on an old Russian proverb, was famously used by President Ronald Reagan when signing the INF treaty with Mikhail Gorbachev in 1987.  While it is more poetic than logical, it is somewhat representative of how you should approach the professionals that assist you in running your business.  Unless you want to spend time getting a law degree or MBA in tax accounting, the easiest (and most immediately beneficial) professional to apply this phrase to is your bookkeeper.  Here are some basics that you should know:

Know whether you file using accrual or cash accounting. This will make a difference in how you read financial statements such as your Profit/Loss and Balance Sheets.  If you have reports printed in an accrual format, you will see the all of the financial information available, now and “future” (outstanding bills and invoices).  This will be good to help you forecast what’s coming up in terms of income and expense and see where you might be when it all shakes out.  It will, however, include things like invoices to clients that are dramatically late in paying you and will thus inflate your profit/income portion.

A cash report, on the other hand, is basically a report that gives you an overview of how much you’ve actually received (regardless of how much you’ve invoiced) and how much you’ve actually paid out (not including upcoming bills 0r bills that you are “holding on to for a day or two”).  This will be a more accurate picture of what has actually happened so far this year.

Recognize that these statements are vital to your day-to-day understanding of your business.  Many business owners tell me that they “don’t care what’s on the P/L because that’s my accountant’s problem.”  Nothing could be further from the truth.  The Profit/Loss statement is something that every business owner should be reviewing every week (if not daily – depending upon business volume).   This document is where the business is telling its owner what is happening.  It tells the owner how much money is being made and where it’s coming from.  It tells the owner how much is being spent and where it’s going.

If you wait until the end of the year to find out that you spent more on materials and subcontractors than you took in from all of your sales, then it’s too late to make mid-course corrections to improve your profit margin.  The P/L is also where you look to watch for unnecessary expenses or expenses that are out of control.  A regular review of the P/L will alert you to the fact that your “promotional” price for your internet service has suddenly ended and needs to be renegotiated because your Phone/Internet line item suddenly spikes.  It’s also the place to see whether your last advertised offer was working because you’d see a spike in income, but the discount and distribution cost of the advertisement cost more than the offer brought it.  All of this would be missed if the business owner didn’t review the P/L on a regular basis.

Bookkeepers are people too.  Bookkeepers work hard to make sure that your financial transactions are recorded correctly and attributed to the right place, however, they can make mistakes.  Sometimes a mistake comes because the business owner fails to correctly inform the bookkeeper of where certain income is coming from or where certain expenses are being charged to.  Other times, it can be just a simple keying error that puts a transaction in the wrong place.

Either way, failing to review the financial statements on a weekly (or daily) basis, leaves open the possibility of missing such a mistake and then it can get lost unless a thorough audit is done.  At that point, it can cause headaches if taxes were filed based on the incorrect information or even worse, business decisions were made on the incorrect information and the problems were compounded.  A regular review of the financials will help to catch these occasional problems and, through discussion, correct them and help to prevent them in the future.

All of this is to say that you, as a business owner, should have a basic understanding of what your financial statements are telling you and you should be reviewing them on a regular basis — not just at year-end or tax time.  If your bookkeeper doesn’t want to go over them and explain your numbers or answer your questions, it’s time for a new bookkeeper.

If you need further help or want to learn more about what your financial statements tell you about your business, please contact us.