Tag: Accounting

Cost of Goods Sold

~ C.O.R.E. Beliefs ~ Leave a comment

Happy Tuesday.  Today I am having lunch with Delena Meyer of Way Enough Decision Coaching.  I was fortunate enough to work with her at my last Company where we had to work through some growing pains. For an Organization facing pressures (aren’t we all) it is worth bringing in an outside consultant to bring a different viewpoint and work with the management team to find ways to move forward together.  I will have more to write about Way Enough Decision Coaching tomorrow but I strongly recommend her if you want a coach who can cut to the chase.  Her number is 360.281.4743.  Give her a call and let her know you were referred by John.

Cost of Goods Sold

Inventory is typically the largest dollar value of current assets in many small businesses.  This is especially true in retail, wholesale, construction and manufacturing.  When goods are sold, the dollar value of the items is adjusted from inventory to cost of goods sold (CoGS).  Which by the way, typically means that cost of goods sold is the largest “expense” item on the Income Statement.

I can hear my editor now, “John, if it is such an important number, why aren’t you tracking it on the Dashboard?”

The answer is, of course, that we are tracking it – using the amount in Accounts Payable as a reasonable substitute.  The goods in a business are almost universally purchased on terms so a healthy business will typically have inventory approximately equal to the amounts owed vendors.

I will spend more time on inventory in a later blog post, but the big take-away for today is that CoGS represents a significant item and it is the largest opportunity for error and irregularity in small business.

A Client Story on CoGS

About 2009, the firm had a client, ABC (named changed to protect the innocent) which was a specialty manufacturer.  The Company had borrowed a substantial amount of money from the Bank and had also bought out a major shareholder and owed on a term note.  The Bank required ABC to have a reviewed financial statement.  The information below is what the financial statements reported each year.

2005 2006 2007
Inventory
Raw Material       5,000,000    5,500,000    5,200,000
WiP       2,000,000    1,800,000    1,600,000
Finished Goods       1,000,000    1,300,000    1,000,000
Total Inventory       8,000,000    8,600,000    7,800,000
Revenues      18,000,000  19,500,000  20,500,000
CoGS      14,000,000  15,400,000  16,500,000
Gross Profit       4,000,000    4,100,000    4,000,000
Profit Margin 22.2% 21.0% 19.5%
Net Profit      (2,500,000)   (2,750,000)   (1,500,000)

The 2008 Surprise Change to Cost of Goods

The client sent over their internal financial statements and trial balance in February 2009 showing the following information:

2007 2008
Inventory
Raw Material    5,200,000    6,000,000
WiP    1,600,000    1,750,000
Finished Goods    1,000,000    1,250,000
Total Inventory    7,800,000    9,000,000
Revenues  20,500,000  21,000,000
CoGS  16,500,000  14,500,000
Gross Profit    4,000,000    6,500,000
Profit Margin 19.5% 31.0%
Net Profit   (1,500,000)    1,250,000

The first thing the staff noticed was that CoGS dropped by $2,000,000.  When you look a little deeper, you realize that inventory increased by $1,200,000.  For the professional, this looks a little suspicious so we started digging.  By asking the following questions (and others) we discovered the truth.

  • How can sales remain flat while CoGS drops by 12%?  Is there a new customer willing to pay a hefty premium?
  • Did ABC stop what it was doing at the end of the year and physically count the inventory?  Who reviewed the count sheets?
  • What are 2009 sales projections for ABC?  Given that we are in a tight credit situation, will sales grow in excess of 20% over 2008 to justify the investment in inventory?

The answers we received sadly required the firm to withdraw from the engagement.  But the point of the story is that as a small business, you should ensure your management team is on top of things like Cost of Goods Sold.  The balance is potentially large, there are huge dollar amounts flowing through the account and a small change in the margins can impact your profitability – and potentially your banking relationship.

My recommendations for staying on top of your CoGS:

  1. Require a full physical inventory count at year-end.  No matter how good your accounting system, a physical count helps keep the computerized data synced.
  2. Review your gross profit margin monthly.  If you are averaging 40% gross profit and it suddenly dips to 30% for no reason, ask questions.  It may be legitimate, it could be a posting error, or it could be something like fraud.
  3. Go out and spot count a few high dollar inventory items and compare your count to the accounting system.  You doing it yourself will show your team how important you think inventory and CoGS is to your business.
  4. Don’t try to hide a business problem by adjusting your CoGS.  In the story, the business had to show a reasonable profit margin in 2008 or the bank was going to place ABC in Special Assets.  ABC still ended up in Special Assets. Also, the CFO was terminated, shareholder/manager compensation was reduced by 80% and the business could no longer pay the notes to the retired shareholders.  4 years later the Company was liquidated for about $0.15 cents on the dollar.  A few years later I ran into the banker and he said that the Bank may have been willing to work things out with ABC had they not tried to fool them. Sad.

If your business sells goods, your CoGS plays an important part of your profitability.  It is intimately tied to your inventory levels and can be challenging to stay on top of.  Knowing how CoGS is related to your revenues and feeds out of your inventory can help you grow profitably and with fewer headaches.  Talk with your accounting professional if you have questions or feel free to send me an email if you would like to discuss this article or anything else regarding your business.

Have a great day.

Accounting for Revenue

~ C.O.R.E. Beliefs ~ 1 Comment

Happy Monday!  I hope you enjoyed your weekend.  Here in Vancouver it was nice and warm, upper 90’s both days, and it was a weekend with the boys which made it even better.  Did you do anything fun?

Revenues in Small Business

The accounting for revenues in a small business can be a little tricky.  Depending on your industry, sending out an invoice does not automatically make the amount “revenues” under Generally Accepted Accounting Principles (GAAP).  However, for your purposes as the small business owner, sending out that invoice as early as possible can be extremely important for your cash flows.

The 3 Reasons Not to Record the Invoice as Revenue

Under GAAP, revenues and costs are supposed to be matched so that someone outside your business who reads your financial statements – such as your banker when you apply for a loan – can understand your costs in relation to your income.  But there are other reasons to consider not recording some invoices as revenues at the time of invoicing your customer.

  • The Invoice is for a Deposit on Work to be Completed Much Later

At my last Company, we often charged a deposit of 50% to secure time on the master schedule.  Since many of these projects were worth over $20,000, the plan was to ensure the Customer had “Skin in the Game”.  From a cash flow perspective, it was great to get the money in before we had to start ordering materials and parts.  From an accounting perspective, however, we faced several potential issues.

  • Customer wanted to cancel the work

Eventually, a customer cancels the work that they requested.  If you are lucky enough to have the customer cancel in the same month, then there is no problem as the receipt of the money and the repayment happens in the same month and they cancel each other out.  But what if the customer cancels 2 months later?  Your Income Statement looks odd as Month 1 reports all this income and then Month 2 shows either a negative income for that amount or you show some sort of discount or allowance or perhaps you have a refunds account.  If it is only you looking at the financial statement, then it is probably not a problem, but if you have someone like your banker or insurance agent looking, you have to explain, which may cause them to question your accounting. Plus, the risk is your Company spent the money and has to scramble to find funds to repay the deposit. 

  • Labor and materials are not being used on the project for 3-9 months

This is somewhat along the lines of what we discussed above.  In month 1 you record all your income and then month 4 you have all your expenses, you cannot really tell how well you are doing by looking at your financial statement.  If you are trying to run your Company by the numbers, this may cause you to think things are going well in Month 1 and not-so-well in Month 4.  By using some method for project accounting, you can see how well your projects are doing over time, but these will not roll-up to your Income Statement.

  • The Invoice is for Work to be Done Over Time

Think Ongoing Contract like in a gym membership.  Lets say you give your customer a chance to pay monthly or offer a discount to pay in advance for a whole year.  Those who take advantage of the discount are still going to use the gym (well potentially use the gym but that is a different matter) over the next 12 months.  To match up with the members who pay monthly, you may want to make sure that your accounting team keep a different schedule (perhaps in Excel) which tracks who has paid and the charge per month for the year.

Revenues in small business are not always easy.  If you are the only person who will ever look at your books, then you can keep them anyway you want and work with your outside accounting firm at year-end to get the numbers right for tax purposes.  There are benefits to running your books to record revenues when invoiced, but there are perhaps many challenges to this as well.  Talk with your accounting professional for advice on the best way for your business.

If you have questions and would like a free, no obligation consultation, write me using the contact form below and we can have a conversation about your concerns and how to address them.

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Have an awesome Monday.

 

Beginning Accounting Dashboard

~ C.O.R.E. Beliefs ~ Leave a comment

I wrote in Friday’s blog about the Dashboard I kept which tracked the Company’s cash, A/R and A/P.  I realized, while enjoying a very warm Vancouver weekend with the boys and Kubae, that I should share a dashboard you can use in your business.  If you would like to have a copy of the accounting dashboard emailed to you, send me an email using the contact form below and I will send it right out to you.

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A word of warning, I have 2 Macros working on this dashboard.  One macro automatically updates the graphs on the Dashboard and the other prints the Dashboard to a pdf.  The Excel Workbook is saved as Dashboard.xlsm which is a Macro-enabled file. You will have to enable Excel to run the Macros.

I have also protected the Worksheets and the Workbook.  There is no password though so you are free to make changes if you like.  I recommend saving the file as a different file name prior to making any major changes so you always have the original to fall back on should something go wrong.

How to Use the Accounting Dashboard

There are two worksheets working in Dashboard.xlsm.  DataforDB is the worksheet where you have your accounting person enter the data. There are two sections – the first is the “end of day” balances for Cash, A/R, A/P and an amount for the upcoming payroll. The available cash automatically calculates for you.

The second section is where you can have accounting enter the data for Sales completed that day, Cash received that day, Purchases made that day and Cash Payments made.

After the data are entered into the worksheet, click the Update Dashboard button.  This runs a macro which updates the graphs.  You can also do this manually by clicking on Data Refresh All.

The second worksheet is the Dashboard.  Here is where the graphs are for the balances section from the DataforDB worksheet and for the daily transactions section.

The transaction graphs for A/R and A/P have “Slicers” attached. These are ways you can look at your data without bothering the basic graph.  For instance, It may be helpful to how sales are by day of the week so I included that as a Slicer for the A/R section.

You can have your accounting person complete the data at the end of the day (or first thing the next morning) and then it can be emailed to you.  All they do is click on the button Print Dashboard and it will generate a pdf file named Dashboard that is saved in the users documents section. They can also go to File Saveas and change the file type to pdf if they want to prefer the manual method.

Your team can also simply email you the spreadsheet or save it to where you can get access to it on your time.

I hope this helps you think of new ways to get access to the pulse of your business without you needing to dig through your accounting system.  Try using it and let me know your thoughts. If you or your accounting specialist needs help or would like to understand how a Dashboard can be helpful, send me a comment and I will see what I can do for you.

Enjoy your first taste of Pacific Northwest Summer.

 

Balance Sheets for Small Business

~ C.O.R.E. Beliefs ~ Leave a comment

One of the major differences I found between public accounting and private accounting is the actual “attention to detail” required in private accounting.  My day actually began by updating and reviewing the dashboard – which focused on the primary accounts and the transactions that made up the changes from the day before.  There were only three primary balance sheet accounts that I focused on daily and I will explain why below.

The Balance Sheet for Small Business

These three accounts represent the assets and liabilities that the business actually controls.  That doesn’t mean that the other balance sheet accounts are not important – they are – but that they are what I term “accountant controlled” meaning that the account exists because the accountant believes it helps in understanding the Company’s assets and liabilities.  The three key accounts for a small business owner to follow are Cash, Accounts Receivable (A/R) and Accounts Payable (A/P).

Cash

To steal a phrase, “Cash is King” and cash is very important in a small business.  It is the one asset that small business owners cannot get enough of and it can drive every decision.  Often our management meetings started with the question, “How much cash is in the bank?”  It is also the one account where we have a good independent record of the balance – the bank statement.  And with the ability to log in to the bank’s website and look at the balance and recent transactions, the small business owner has an unprecedented ability to know where the cash balance is daily.

Trying to run the business only on the balances in cash can be dangerous though.  For instance, having $100,000 in the bank: What does that tell us?  Some business owners are worried when cash is that low and other small business owners rejoice.  So, for every management meeting I answered the question of “How much cash is in the bank?” by linking the cash to the next two accounts.

Accounts Payable

Accounts payable (A/P) is a measure of what the small business owes vendors for the all goods and services purchased and that haven’t been paid for yet.  A small business gets the privilege of having an A/P balance by paying their vendors on their terms.  Moving from cash/COD/Credit Card payment to net30 day terms is a major milestone for a small business as it means the vendor trusts the business to buy today and pay later.

To continue the example above, if cash is $100,000 and accounts payable is $20,000, my answer to the question, “How much cash is in the bank?” is “We have $80,000 available today.”  The owner and management team need to understand that the A/P is a claim on the cash and ignoring it can lead to big problems when vendors put the Company on credit hold for not living up to their promise.  I looked at accounting’s role as “Keeping the promises that the sales professionals made” and we purchased goods and services on terms for the sales team to sell to customers.  You should never let the promise go unfulfilled.

Accounts Receivable

Accounts receivable (A/R) is exactly like A/P but for the benefit of the customer.  At some point, especially in business-to-business (B2B) transactions, there is an expectation that the customer can buy on some customer-friendly term such as Net 30.  It is a trust relationship between the small business and the customer and it is important that the small business manage this trust relationship.  Selling on terms can get you access to new customers but can lead to failed commitments from the customer.  This, sadly, is a fact of business but the potential for loss should not keep the small business from selling on fair terms.

Continuing the example, if cash is $100,000, A/P is $80,000 and A/R is $100,000, how is the question answered?  My answer would be, “The Company has $70,000 available.” Why would I answer that way?  Because of the experience of many years in public and private accounting.  Below is how I come up to the answer.

The Company will want to keep its promise to the vendors and pay on terms.  So the company plans to pay out $80,000 – leaving $20,000 in the bank.

The Company wants to believe that all its customers follow this same pattern – that terms are important and they want to honor them.  We want to believe that all of the $100,000 due from customers will be paid in the next 30 days.  But the reality is that some will be late.  So, to ensure that the Company does not make plans or promises it cannot keep, the safe and conservative approach is to say only 1/2 will be collected, or $50,000.  The $50,000 plus the $20,000 equals the $70,000 of cash available for the business.

Back to Cash

Knowing how much cash is available allows the small business owner to make more effective decisions.  If payroll is $90,000 over the next 30 days, the business may need to draw on the Line of Credit.  By starting with cash and then subtracting the Company’s promises (A/P) and adding in a reasonable amount of the customer’s promises (A/R) the business owner can start making better decisions about how business gets done.

If you would like more information on how to get clarity on your accounting, feel free to contact me or visit our website.  We will be happy to email you our free guide to “Five Important Things Business Owners Need to Know about Financial Statements” to help you understand what Bankers think about when they review your financial statements.