When renowned American investor and philanthropist Warren Buffet once said that ‘Accounting is the language of business,’ he effectively conveyed the importance of understanding the numbers involved in any entrepreneurial venture or operation.
Given Buffet’s affinity for uncomplicated value-based investing, it is easy to see why he views the accounting function as the core of a business. What he may also have added is that, while accounting norms and guidelines are relatively easy to grasp, following them requires a certain amount of organizational discipline.
Here are a few tips for small and medium businesses as they attempt to fine-tune their accounting practices:
• Timely Billing: Delayed billing leads to delayed inflows and can place a business at risk for a cash crunch. Establish a policy (e.g. bill in advance or upon completion of 50% of the project) and follow it religiously in generating your invoices.
• Payment Recovery: Pending accounts receivables can also prove to be a drag on the cash flow of a business. Don’t slacken in collecting your receivables on schedule as timely payment recovery is a must for small businesses that are not typically flush with cash.
• Identify Your Primary Spending Categories: As in personal accounting, the first step to understanding where you are spending your money is to identify clear and distinct expense categories. These may differ based on the industry or type of service or product offering.
For a service-oriented business, manpower costs could be the largest expense group while a manufacturing concern could have a lot of raw material costs that it has to account for. Clearly defining these expense heads at the outset is a prerequisite to establishing an effective tracking system.
• Sub-Categorize for Better Tracking: Lumping expenses under one big broad category of, say, manpower, does not lend itself to useful analysis. As much as possible, use narrower categories (e.g. training, food & entertainment, insurance) for your expenses so that you can determine how they are distributed and more easily identify areas for potential cost-cutting.
• Record Expenses Big and Small: It doesn’t matter whether it’s a petty cash outlay or money spent on local conveyance, keeping track of every rupee spent is at the heart of financial discipline for a business. Minor expenses can add up over time and eat into your margins and so cannot and should not be brushed under the carpet of unrecorded costs.
• Budget…and Stick to it!: At the beginning of the year, establish your budgets for each of your major categories and adhere to these as much as possible. A good rule of thumb is to keep your actual expenses within 10% of your budgeted amount.
• Read the Pulse of Your Business through Reports: There are a number of reports that any sound accounting system can generate to help you determine if you are on track from a financial standpoint. The frequency of these will vary depending on the insights the user seeks.
They include reports to track revenues, orders in the pipeline (a way to keep an eye on prospects who might convert), receivables and cash flow status. By keeping a close watch on these predictors of business health, you can spot and fix a problem before it balloons into something larger.
• Measure Overall Health: A Profit & Loss Analysis report can be generated on a quarterly basis, or even once in six months, to gauge how the business is doing overall. This analysis will reveal if there are specific parts of the business that are weighing it down or others that are contributing to the bottom line and driving profitability in a big way.
A P&L report is thus the ultimate report card on the health of your business and one that you should take a good look at from time to time to help you make some clear-eyed business decisions. The practices described above form the nuts and bolts of a solid accounting mechanism and are applicable for any small or medium business, regardless of the industry.
There are no complex formulae or hard-to-grasp financial theories involved here – just discipline and a focus on clear-cut business goals. This article was written with input from Monica Shikhare, a Bangalore-based financial consultant.