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Financial Management

What Should I Know Before I Setup My Accounting Department?

Understanding the accounting department.

Entrepreneur

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A business’s bookkeeping system that tracks the money coming in versus the money going out is arguable the most critical aspect of business management.

Aside from every business owner’s inherent desire to stay in business, there are two other key reasons to set up a good bookkeeping system:

  1. It’s legally required.
  2. Bookkeeping records are an excellent business management tool.

Of course, staying out of jail is a good thing. And a good basic accounting system will provide useful financial information that will enable you to run your business proactively rather than reactively when it comes to important financial decisions

How do you choose a good accounting system?

While many businesses still operate using a manual bookkeeping system (cheque book and receipts), it’s generally not a good idea to use this type of system.

It’s far more efficient to go with an automated system, and there are now many bookkeeping software packages on the market that won’t break your wallet.

Financially complex businesses, such as a manufacturing concern, can buy industry-specific software, but there are also many generic programmes available that would suffice for most businesses.

A good accounting system meets three criteria

  1. Firstly, it’s accurate: the numbers must be right. Automation will help ensure accuracy, but it won’t guarantee it. Bookkeeping numbers should be checked and rechecked to maintain accuracy.
  2. Secondly, it’s relevant. The system provides information that’s required and needed. The law requires that certain pieces of financial information be tracked for tax reporting purposes. Obviously, these items (which comprise a basic income statement and balance sheet) must be measured and tracked. However, it’s equally important to include information that you’ll need to run your business successfully.
  3. Thirdly, a good accounting system is user-friendly. It shouldn’t require an expert to operate and interpret. Most of the Windows-based bookkeeping software packages on the market today are pretty user-friendly. They include tutorials and help screens that walk you through the programmes. Find one with which you are comfortable, even if it doesn’t have some of the bells and whistles of more complicated programmes

What is the function of an accountant?

Accountants help you keep an eye on major costs as early as the start-up stage, a time when you’re probably preoccupied with counting every paper clip and postage stamp. When you’re looking at the details, accountants help you keep your eye on the big picture.

Even after the start-up stage, many business owners may not have any idea how well they’re doing financially until the end of the year, when they file their tax returns. Meanwhile, they equate their cash flow with profits, which is wrong. Every cent counts for business owners, so if you don’t know where you stand on a monthly basis, you may find you’re not around at the end of the year.

No other business relationship has such potential to pay off. Nowadays, accountants are more than just bean counters. A good accountant can be your company’s financial partner for life – with intimate knowledge of everything from how you’re going to finance your next forklift to how you’re going to fund your daughter’s university education.

While many people think of accountants strictly as tax preparers, in reality, good accountants have a wide knowledge base that can be an invaluable asset to a business. A general accounting practice covers four basic areas of expertise:

  1. Business advisory services
  2. Accounting and record-keeping
  3. Tax advice
  4. Auditing

These four disciplines often overlap. For instance, if your accountant is helping you prepare the financial statements you need for a loan and he or she gives you some insights into how certain estimates could be recalculated to get a more favourable review, the accountant is crossing the line from auditing into business advisory services.

And perhaps, after preparing your midyear financial statements, he or she might suggest how your performance year-to-date will influence your year-end tax liability.

Roles of an accountant

What role should accountants play in providing business advisory services?

This is where accountants can really earn their keep. Since the accountant is knowledgeable about your business environment, your tax situation and your financial statements, it makes sense to ask him or her to pull all the pieces together and help you come up with a business plan and personal financial plan you can really achieve.

Accountants can offer advice on everything from insurance (do you really need business interruption insurance, or would it be cheaper to lease a second site?) to expansion (how will additional capacity affect operating costs?)

What role should accountants play in accounting and record keeping?

Accounting and record-keeping are perhaps the most basic accounting disciplines. However, most business owners keep their own books and records instead of having their accountant do it.

The reason is simple: If these records are examined by lenders or SARS, the business owner is responsible for their accuracy; therefore, it makes more sense for the owner to maintain them

Where accountants can offer help is in initially setting up bookkeeping and accounting systems and showing the business owner how to use them. A good system allows you to evaluate your profitability at any given point in time and modify prices accordingly. It also lets you track expenses to see if any particular areas are getting out of hand.It allows you to establish and track a budget, spot trends in sales and expenses, and reduce accounting fees required to produce financial statements and tax returns.

What role should accountants play in providing tax advice?

Tax help from accountants comes in two forms: tax compliance and tax planning. Planning refers to reducing your overall tax burden; compliance refers to obeying the tax laws.

What role should accountants play in auditing?

Auditing services are required for many different purposes, most commonly by banks as a condition of a loan. There are many levels of auditing, ranging from simply preparing financial statements from figures that the entrepreneur supplies all the way up to an actual audit, where the accountant or other third party gives assurance that a company’s financial information is accurate.

Hiring an accountant

Ask about fees upfront

Before engaging an accountant, ask about fees upfront. Most accounting firms charge by the hour, and these fees can range considerably. However, there are some accountants who work on a monthly retainer. Figure out what services you’re likely to need and which option will be more cost-effective for you.

Get quotes

Get a range of quotes from different accountants. Also, try to get an estimate of the total annual charges based on the services you’ve discussed. Don’t base your decision solely on cost, however; an accountant who charges more by the hour is likely to be more experienced and thus able to work faster than a novice who charges less.

References are a must

Don’t hire anyone without getting references, particularly from clients in the same industry as you. A good accountant should be happy to provide you with references. Call each of the references they supply and ask how satisfied the client was with the accountant’s services, fees and availability.

Agree on terms and conditions

After you’ve made your choice, spell out the terms of the agreement in a so-called “engagement letter” that details the returns and statements to be prepared and the fees to be charged. This ensures you and your accountant have the same expectations and helps prevent misunderstandings and hard fee.

What is accrual accounting?

The term “accrual” refers to any individual entry recording revenue or expense in the absence of a cash transaction

 Two basic methods

Most businesses typically use one of two basic accounting methods in their bookkeeping systems: cash basis or accrual basis. While most businesses use the accrual basis, the most appropriate method for your company depends on your sales volume, whether or not you sell on credit and your business structure.

Cash method

The cash method is the most simple in that the books are kept based on the actual flow of cash in and out of the business. Income is recorded when it’s received, and expenses are reported when they’re actually paid.

The cash method is used by many sole proprietors and businesses with no inventory. From a tax standpoint, it is sometimes advantageous for a new business to use the cash method of accounting. That way, recording income can be put off until the next tax year, while expenses are counted right away.

Accrual method

With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit. The sale is entered into the books when the invoice is generated rather than when the cash is collected.

Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when the cheque is actually written. The downside of this method is that you pay income taxes on revenue before you’ve actually received it.

Should you use the cash or accrual method in your business? The accrual method is required if your business’s annual sales exceed a certain amount of money and your venture is structured as a corporation. In addition, businesses with inventory must also use the accrual method.

It’s also highly recommended for any business that sells on credit as it more accurately matches income and expenses during a given time period. The cash method may be appropriate for a small, cash-based business or a small service company. You should consult your accountant when deciding on an accounting method.

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Financial Management

What do I keep in mind for financial planning in a business?

In the startup phase of any new business, the profits will usually be quite low. It is therefore important to be wise with every cent in these early stages.

Peter Gossman

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When doing financial planning for the first few months of my new business, what sort of things should I bear in mind?

Below are some financial considerations for the first few months of your new business.

1. Your Personal Salary

In this startup phase, the owner’s personal salary and the business viability will be strongly related. If you are solely reliant on your business to meet your needs, then you may need to reduce your lifestyle to ensure that your business will still break-even, while paying you enough to meet your essential needs.

Related: 6 Steps Of Financial Planning

Don’t start your business hoping to draw a large salary. This may come later, but seldom in the startup phase. Initially, you may have to personally contribute money to the business just to keep it afloat. If possible, work and save up as much as you can before starting your business. The startup phase will often require personal sacrifice.

Consider working a second job in the early months of your business. Your goal in the startup phase should be to take as little as possible from the profits, so that your business can grow as quickly as possible.

Reduce your personal lifestyle and expenses as much as you can. Carefully develop a personal monthly budget. Monitor this budget regularly and ensure that you adhere to it.

2. Separate business finances from personal finances

It is important to have a very clear separation between business transactions and personal expenses. Some owners use business funds for personal costs, often using cash from business sales to buy personal items, then declaring these as business expenses.

Any money taken from business profits for personal use cannot be expended to the business, nor should personal transactions be done through your business accounts. Also avoid business trading using your personal bank account. The only personal cost through your business accounts should be the salary that is paid to you.

3. Startup capital

In most businesses, you will need to invest money, (for stock, machinery, equipment, etc.) before you can trade. When determining your required startup capital, it is wise to start small and gradually scale up.

Avoid debt as much as possible. Focus on sales and begin selling as soon as you can. You don’t need a fancy office with billboards and business cards to start trading. Avoid large rental costs – initially try to work from home. Should you need a loan, try to get low-interest loans from friends and family before approaching institutions.

4. Cash flow forecast for your business

Plan a cash flow forecast for at least 12 months. Take time to realistically list the anticipated monthly cash flowing into your business (Sales, Loans, Investments), and out from your business (Salaries, Suppliers, Loan repayments, Rent, etc.).  Regularly review this forecast.

5. Accurately record all income and expenditure – personal and business

In order to draw up a realistic Personal Budget and Business Cash Flow Forecast you will need accurate historical information of all your business and personal transactions for the previous months. Start today: record all income and expenditure, especially cash transactions that do not leave a document trail.

Remember to keep personal records separate from your business records. Develop an effective filing system for all source documents.

6. Don’t give up

Starting a new business is tough, and the financial rewards are seldom seen in the startup phase. You may be tempted many times to just give up. Remember, every large tree started as a small seed and took a long time to grow.

If you give your small “business seed” the care and attention it needs, it will eventually grow and develop into a great tree and bear much fruit.

Related: How to Become a Millionaire by Age 30

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Financial Management

How should I calculate if a project is worth it?

Our turnover is great, but our profits are not. How do I calculate if a project is worth it? We excited by the deal, but I think they end up costing us more than they’re worth.

Louw Barnardt

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How should I calculate if a project is worth it?

If you’re an entrepreneur without a strong financial background, one of the biggest business challenges you might face is the evaluation of a project’s financial implication. Often new projects are enthusiastically undertaken without proper consideration of the real profit the company stands to make.

A new project or contract always means more revenue, but often it does not end up being profitable in total.

If your business has been growing its revenue, but profit has been going sideways or down, your company is actually only spinning its wheels in terms of bottom line profit.

It might be time to implement a basic financial analysis before a project or contract is accepted.

Considering net present value

Before you roll out that new line of business or accept that project, take the time to consider its net present value. Sure, it generates income and keeps your team busy, but after prudently taking into account all costs and the effect of your cost of capital over time, is it still making you money?

The process to undertake can be broken down as follows:

  • First, understand your company’s cost of capital
  • Plot your project’s cash flows over its life span
  • Calculate the project’s net present value using your cost of capital.

Cost of capital

Cost of capital means the cost of the equity (the owners’ own money) and debt (borrowed funds) of the company. It is calculated as the cost of equity times the weighting of equity in the capital structure, plus the cost of debt times the weight of debt in the capital structure.

Cost of Capital = (cost of debt x weight of debt) + (cost of equity x weight of equity)

A basic example to simplify this mouth-full:

Financial decision making

Peter’s company is half-funded by himself, and half by a loan. The weight of equity is therefore 50%, and so is the weight of debt.

The interest on the borrowed funds is 12% per annum. Because the interest is tax deductible, we use the after tax cost of interest. The cost of debt is therefore 12% x 0.72 = 8.64%.

Peter’s expected return on the money that he put in is 30% to compensate for the risk that he is taking in putting money into his business.

Let’s keep it as simple as this for our example. Applying our formula, Peter’s cost of capital can be calculated as:

Cost of Capital = (cost of debt x weight of debt) + (cost of equity x weight of equity)

= (8.64%x50%) + (30%x50%)

= 19.32%

Peter now knows that his company will need to generate returns of at least 19.32% in order for him to adequately cover his cost of capital.

Plotting your project’s cash flows

Peter’s financial decision is whether or not to purchase a new line of software with a five year licence for his design company. The new software will enable a new stream of income, as well as add to existing income streams and will cost him R200 000. He has plotted the project income and expenses over five years as follows:

Basic NPV model

On face value, it looks like the total net inflow for the project over five years coming in at a positive R328 400 is a definite must. But in order to properly analyse this, we need to compute the project’s net present value.

Net present value

The net present value of a project is the current value of all the project’s future cash flows, discounted at the company’s cost of capital.

In basic terms, the R21 200 profit of year one, discounted at the cost of capital rate of 19.32%, is worth only R17 767 at the beginning of that year. Likewise we discount each year’s profit back to its current (year zero) value to get the present value thereof.

The sum of these discounted amounts then make up the net present value:

Net Present Value

The project’s NPV comes out negative at -R14 407. As the NPV is smaller than zero, Peter should not accept the project as it will generate less present value profit than the cost of the funds employed in making that profit. Not the same answer as that of the first look at the project’s profit.

Likewise, doing a basic cost of capital calculation for your company and a NPV calculation for each new project, entrepreneurs can make better financial decisions that will drive bottom line profits instead of just spinning the wheels in one place.

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Financial Management

Which comes first, accounting software or HR software?

Start with accounting software and grow from there.

Peter S. Cohan

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Which do I need more for my small business – accounting software or payroll software? I can’t afford to buy both. And how do I choose between the plethora of options available?

Generally you should start with an accounting package and then add on others as you need them. That said, businesses are like fingerprints: Each one is unique, and has its own set of needs. You may need accounting or payroll or both.

It depends on details like how many staff you employ, how complex your finances are, and how many companies you’re running.

Choose the right software for your business

In my opinion this is one of the most important choices you will make because your accounting software is one of the most important business management tools you will invest in.

If you’re choosing professional software from a reputable software developer, the particular brand name shouldn’t really matter if they are trustworthy and have a strong local presence.

Goedkoop is indeed duurkoop

Too often I hear horror stories of small businesses buying the cheapest product on the shelf which is fine… until things go wrong.

The package doesn’t work properly, they can’t get support, the phones go unanswered and the company they bought the software from doesn’t have the resources to service its customers.

Take advice from your friends, your accountant, your bank, and then make sure you choose a brand with an established reputation and a local office that provides training, support and after-sales service.  Above all, understand that you are making an investment, not a purchase.

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