If you manage a growing business, you may find it difficult to monitor how your company is performing. As your firm grows, your accounting and financial reporting becomes more complex, and you need systems in place to stay on track. Learn from these 10 common accounting mistakes to assess how you’re doing, and to make improvements in your business.
1. Chart of Accounts
The chart of accounts is a listing of each subaccount and its description.
Assume, for example, that you operate a hardware store using seven store departments. Each of your accounts can have a subaccount for each department. If the company-wide revenue is account #5000, for example, the revenue-outdoor department can be account #5100, the revenue-lumber department can be account #5200, and so on through account #5700.
|Account #5000||Account Title||Debit||Credit|
Many businesses do not create enough account categories to produce meaningful accounting reports. Using subaccounts allows you to generate relevant financial reports by department, which helps your firm manage profit and expenses at a more specific level.
2. Planning for Inventory
Firms risk losing a sale if inventory levels are too low.
Every company should plan for an ending balance in inventory at month end, which allows the business to fill customer orders in the first few days of the next month. You can use the ending inventory formula to ensure that you maintain a sufficient amount of inventory. It looks like this:
beginning inventory + purchases – sales = ending inventory
Ending inventory is often based on a percentage of monthly sales.
Assume, for example, that the hardware store’s beginning inventory balance of lawn mowers is 50 units, and that the company forecasts 300 mower sales for the month. If the business wants 30 mowers (10% of expected sales) in ending inventory, here’s how it should plan its inventory:
300 projected sales + 30 ending inventory – 50 beginning inventory = 280 purchased
The business should purchase 280 mowers for the month if it wants 30 mowers in ending inventory.
3. Cash Flow Forecasting
No business can operate without sufficient cash inflows each month, and many firms do a poor job of forecasting expected cash flows. Here are several factors that impact the amount of cash a company will have to operate:
- Accounts receivable: The dollar amount of credit sales that are not collected in cash, and the average amount of time it takes to collect the receivables in cash.
- Inventory: The dollar amount of inventory needed to fill customer orders over the next several months.
- Debt payments: Interest payments and any repayments of principal due in the next few months.
These factors help determine the amount of cash required to operate. If cash inflows are insufficient, the firm may have to access a line of credit or raise more capital through a stock or bond offering.
4. Operating vs. Non-Operating Income
There is an important difference between operating vs. non-operating income, and a well-managed business must use both categories in the accounting records.
Operating income is the profit you generate from your day-to-day business activities. The hardware store generates earnings from retail sales, for example.
If the hardware store sold a warehouse it owned, the profit would be considered non-operating income, because the warehouse sale is unusual. Businesses succeed by producing operating profit, and non-operating profit is not reliable or sustainable over the long term.
You must track both types of income to manage your business.
5. Profit Margin and Sales Mix
Each product may have a different profit margin (profit / sales), and a business can change the sales mix of products to generate a higher overall profit. Many firms don’t analyze sales mix, and these companies are missing the opportunity to increase profits.
Assume that the hardware store earns $4 on a garden hose priced at $20, and $45 on a $300 lawn mower. The profit margin on the garden hose is ($4 / $20), or 20 percent, while the lawn mower profit margin is only 15 percent ($45 / $300). The lawn mower generates far more revenue, but less profit per dollar of sales. The hardware store can increase the company-wide profit margin by selling more garden hoses and fewer lawn mowers.
Take the time to analyze your firm’s sales mix.
6. Outsourcing Payroll
Payroll is often the most time-consuming accounting task, and your firm may benefit by outsourcing this complicated process to a payroll firm. Managing payroll is difficult because the federal, state and local tax laws may change frequently. Businesses that don’t outsource the payroll function may spend too much time on the process and make errors that trigger tax penalties and interest costs.
7. Timely Bank Reconciliations
Successful businesses reconcile all bank accounts and investigate possible errors within a few days of each month end.
If you don’t reconcile your bank accounts quickly, you may not catch errors and possible fraudulent transactions in your cash accounts. Your company may post more transactions to cash than any other account in your accounting system. Bank reconciliation can help you find errors and reduce the risk of theft.
8. Monitor Accounts Receivable
Firms that do not closely monitor accounts receivable and enforce a formal collection policy may not generate sufficient cash inflows to operate. Your accounting software should provide an aging schedule for accounts receivable, which groups your receivables based on when the invoice was issued. You should monitor this report and implement a collections process to email and possibly call clients to ask for payment.
9. Using the Cash Basis of Accounting
The cash basis of accounting distorts your true level of profit and does not conform to generally accepted accounting principles (GAAP). The cash basis of accounting records revenue when cash is received, and posts expenses only when they are paid.
Instead, all companies should use the accrual basis of accounting so that revenue is posted when it is earned, and expenses are posted when they are incurred. Using this method matches revenue earned with the expenses incurred to generate the revenue. This process presents a more accurate view of your profitability.
10. Not Managing Debt
There are two ways to raise capital to operate your business. You can sell ownership in your company by issuing stock (equity), or you can borrow money and take on debt. If a firm doesn’t monitor the amount of debt borrowed over time, repaying the debt may become difficult.
One useful tool to monitor company debt is the debt-to-equity ratio. The formula is used to analyze debt as a percentage of total equity. It looks like this:
(total debt) / (company equity)
Let’s assume that a typical ratio for companies in your industry is 2-to-1, or $2 in debt for every $1 of equity issued. If your firm’s ratio climbs to 3-to-1 or 5-to-1, it may be a red flag that your total level of debt is not manageable. If that’s the case, take steps to reduce your debt load.
Take a Look at Your Business
Consider whether any of these 10 accounting mistakes affect your business. It’s never too late to make changes, and the changes you make will help you generate better financial results down the road.