All of us have different habits and organise information in our own unique ways. That’s how we are used to getting around in our daily lives.
But when it comes to running a business, have you ever wondered how the way you work and handle information could be impacting your business decisions? Do you keep records of your receipts or lose them in the next moment? Are sales doing great but why isn’t the business turning a profit?
We take a moment to look at five habits that could be standing between you and a leaner business.
1. Mixing your business and private expenses
As an entrepreneur, it is easy to feel that all monies whether they are used for business or personal consumption are your own funds. Why go through the trouble to separate them?
Unfortunately the headache comes when you need to do up the accounts and tax for your business. A business has reporting obligations to fulfil and its activities are to be distinguished from the owner’s personal affairs.
Furthermore only business expenses qualify for deductions against income derived by the business. When funds are commingled, it is not clear which expenses are for business purpose and this could result in fewer deductions and higher tax for your business.
Therefore it is good practice to start keeping separate accounts for your business if you are not already doing so.
2. Recognising cash received as revenue
In accrual accounting, cash receipt is treated differently from revenue. Revenue should only be recognised when it is earned, that is when goods are transferred and services are rendered and this may be different from actual cash receipt.
An instance is when customers place deposits for goods in advance of delivery. If the deposits are recognised as revenue (instead of unearned revenue) before goods are delivered, you risk overstating your revenue.
When this happens, you may end up registering for GST (if your annual revenue wound up crossing the $1 million mark), when in fact your actual revenue hasn’t passed the threshold. Also your business pays more tax earlier due to the accelerated revenue.
Recognising revenue correctly is important as it has many implications, doing it right will ensure that you comply with financial reporting standards.
3. Not calculating gross margin
Sometimes a product may sell very well but is actually not turning a profit.
There are a number of costs involved when selling a product – for example, typically there are its purchase price, transportation cost and storage cost. When you do not take into account these costs, you may make the wrong decision to sell products that rack up losses.
One way around this is to calculate the gross margin for a product or line of products. Gross margin is revenue minus cost of goods sold which is the sum of the costs necessary for selling a product. This will help you to concentrate on products that fetch profits and make better decisions.
4. Not capturing your business receipts
Business receipts are necessary for record keeping and for substantiating tax deductions.
Receipts for smaller purchases are often printed on small pieces of thermal paper which makes them easy to misplace because they are so small. Even if you manage to store them safely, you may still ‘lose’ them as the printing on the thermal paper fades quickly, sometimes in just a few months’ time.
This poses a problem for the business’s record keeping.
To get around this, cultivate the habit of photocopying your business receipt when you receive it or snap a picture of the receipt and store it digitally. To go green, use the second method. Digital storage also makes organising records and finding them again the next time more convenient.
5. Treating cash flow as profit
Cash flow is different from accounting profits. By mistaking cash outflow for expenses, you end up with large fluctuations in profit and the risk of understating your expenditures.
An example is when you purchase machinery and equipment for your business which should be capitalised and depreciated over their useful lives. However if they are wrongly expensed to the profit or loss statement, a large increase in expenses will result for that period.
Profits will be understated, only to increase dramatically again in the next period. This obscures other events and issues such as unexpected hike in material costs that need your attention.
In addition trade creditors which you have yet to pay should be recorded as expenses or they will be understated.
How we conduct our transactions and manage information can impact our business flow and performance. Take a few moments to think about the way you work and how to gain greater clarity. Start some new habits to set yourself on the path to better accounting and decision-making for your business.