1. Copyright Atomic Dog Publishing, 2005 Small Business Management: A Planning Approach Joel Corman Suffolk University, Emeritus Robert Lussier Springfield College Lori Pennel Bunker Hill Community College

2. Copyright Atomic Dog Publishing, 2005 CHAPTER 11 The Accounting Function PART 3 Planning and Implementation

3. Copyright Atomic Dog Publishing, 2005 11-1 The Interrelationship between the Accounting Function and Other Business Plan Components Accounting function links all other functional areas, such as production/operations, marketing, and finance. Equipment and operations budgets are prepared using inputs from production/operations, marketing, finance, and human resources. The reports generated by the accounting function are needed in each functional area to operate efficiently.

4. Copyright Atomic Dog Publishing, 2005 11-2 Record Keeping Balance sheet and income statement are compilations of the firm’s activity. Need records of the business activity to construct the various statements. Records must be kept:  To construct the necessary statements  To be able to compare budget figures to see if you are on target  To satisfy the requirements of IRS, which requires record keeping

5. Copyright Atomic Dog Publishing, 2005 11-2 Record Keeping (contd.) Records must be kept in the following areas (where applicable):  Sales 3 years  Inventory7 years  Accounts receivable3 years  Accounts payable3 years  Cash7 years  Payroll10 years  Depreciation Life of assets  Equipment Life of assets  Purchases 3 years

6. Copyright Atomic Dog Publishing, 2005 11-3 Accounting Systems As an entrepreneur, one must understand and use the accounting information to:  Know if your business is making a profit  Compare your firm’s current performance with past performance.  Project future performance  Compare your firm’s results with the results of other firms in your industry.  Make informed decisions about what future actions your firm should take.  Calculate tax liability  Prepare reports for shareholders and partners.  Prepare information for external constituents.

7. Copyright Atomic Dog Publishing, 2005 11-3 Accounting Systems (contd.) Chart of accounts is a list of all the accounts, to which changes are made. General ledger is a book or computer listing in which entries are made concerning all of a firm’s financial transactions.

8. Copyright Atomic Dog Publishing, 2005 11-4 The Balance Sheet A balance sheet is a snapshot view of the financial value of the firm’s assets, liabilities, and net worth at a particular point in time. It is divided into two major sections:  The value of the firm’s resources and the claims against them. There are two types of claims against assets:  The claims of creditors, and the claims of owners (equity)

9. Copyright Atomic Dog Publishing, 2005 11-4 The Balance Sheet (contd.) All balance sheets are structured so that  Assets = liabilities + net worth Asset is a tangible item or intangible rights owned by the firm. Liabilities are the obligations or debts that the firm owes. Net worth is what remains after subtracting liabilities.

10. Copyright Atomic Dog Publishing, 2005 11-4a Assets Tangible assets are those things that can be seen:  Land  Cash  Equipment  Buildings Intangible assets are owned items that cannot be seen:  Patents  Copyrights Current assets consist of cash and any other asset that will be converted to cash within a reasonable period of time.

11. Copyright Atomic Dog Publishing, 2005 11-4a Assets (contd.) Cash refers to bills, currency, coins, and checks on hand or in a checking or savings account. Merchandise inventory is the amount of goods the company holds for sale to customers at a particular moment. Supplies are those items the company holds that are used in supporting the production process. Prepaid expenses are expenses that a company has incurred and paid for but that have not yet been consumed.

12. Copyright Atomic Dog Publishing, 2005 11-4a Assets (contd.) Fixed assets consist of land, buildings, equipment, and assets that are not consumed in the production of the firm’s goods and services and will usually last longer than one year. Depreciation is the use of a fixed asset. Accumulated depreciation is the amount of a fixed asset’s value that has been written off over time due to wear and tear. Leasehold improvements are changes made to leased buildings or property to facilitate doing business.

13. Copyright Atomic Dog Publishing, 2005 11-4b Liabilities Current liabilities are those obligations that are due and payable in less than one year. Accounts payable are payments due to suppliers for inventory and/or services. Long-term liabilities are those obligations due after one year. Notes payable are those loans due to lenders other than banks.

14. Copyright Atomic Dog Publishing, 2005 11-4c Net Worth/Owner’s Equity Retained earnings, a section in net worth, which represent accumulated net income of the company from its inception to the present Corporations may have a separate section in their balance sheet called retained earnings that may or may not show owner’s equity as a separate category:  The balance sheet, by definition, always balances.  Assets = liabilities + net worth

15. Copyright Atomic Dog Publishing, 2005 11-4c Net Worth/Owner’s Equity (contd.) How net worth changes

16. Copyright Atomic Dog Publishing, 2005 11-5 The Income Statement The income statement shows all the revenues and expenses that result in the profit or loss from operations during a given time period. Cost of goods sold represents the cost of merchandise sold. A profit is revenue minus cost of goods sold and minus operating expenses. An estimated income statement is called a pro forma profit-and-loss statement.

17. Copyright Atomic Dog Publishing, 2005 11-6 Cash Flow Statement The cash flow statement shows only the actual dollars collected and expended. Depreciation or any non-cash items are not included. Net cash flow will not be equal to the profits. As long as cash is available, the company can pay its bills, and hence can operate. You should not regard the balance sheet or the income statement as either precise or exact, as they are based on some estimates such as depreciation. Most assets are worth more than their book value.

18. Copyright Atomic Dog Publishing, 2005 11-7 Bank Statements Business practices use the check as a medium of exchange. With advancement in technology, electronic fund transfer (EFT) is becoming more popular. Care should be taken when using EFT to reflect all such transactions in your records. All receipts and payments are routed through your bank. Checks are only authorizations directing your bank to use your funds to pay another party, checkbooks thus serve the purpose of cash control. All written checks should have proper documentation.

19. Copyright Atomic Dog Publishing, 2005 11-7 Bank Statements (contd.) Paid bills should be filed such that proof of payment can be furnished if and when required. Canceled checks are checks paid to various people or businesses that they, in turn, have presented to their banks for payment. The process of making sure the balances agree, and taking any corrective action necessary, is called reconciliation. Most banks provide a reconciliation form and instructions for its use on the reverse side of the statement.

20. Copyright Atomic Dog Publishing, 2005 11-7 Bank Statements (contd.) Bank reconciliation form

21. Copyright Atomic Dog Publishing, 2005 11-7a The Monthly Bank Reconciliation To begin the monthly bank reconciliation process, you should have:  Last month’s bank statement, with the balance reconciled  This month’s canceled checks  Your checkbook, showing all checks written  The current bank statement The dollar amount of each check should agree with the amount in the checkbook and the bank statement. All checks in the statement should be recognized in the checkbook as having been paid to the recipient.

22. Copyright Atomic Dog Publishing, 2005 11-7a The Monthly Bank Reconciliation (contd.) The steps for reconciliation are:  Enter all deposits made since the date of the last entry and add to the bank balance.  Reconcile by adding items such as bank service charges and any preauthorized transactions.  List and total all outstanding checks and deduct from the bank balance.  To the balance on the statement add the deposits and subtract the unpaid items.  The balance should agree with the checkbook balance. The process is simple and must be done regularly every month.

23. Copyright Atomic Dog Publishing, 2005 11-7a The Monthly Bank Reconciliation (contd.) Bank reconciliation process

24. Copyright Atomic Dog Publishing, 2005 11-8 Fixed Asset List A fixed asset list, or capital equipment list, is a statement that itemizes the firm’s operating equipment and its corresponding dollar value. Should follow the statement of sources and application of funds Especially important to an existing firm that wishes to borrow money during low-profit periods A new firm’s capital equipment list will include the equipment it needs to begin operations.

25. Copyright Atomic Dog Publishing, 2005 11-8 Fixed Asset List (contd.) The capital equipment list in the business plan is important for two reasons:  In all existing businesses it serves as a complete disclosure statement, allowing investors or banks to determine the value of the firm in terms of operational assets.  In a new firm it estimates the start-up costs in terms of machinery needed to commence operations.

26. Copyright Atomic Dog Publishing, 2005 11-9 Pro Forma Statements Pro forma statements are those statements based on forecasts of activities or hypothetical events. Serve as a guide to what the company’s future financial position might be These statements can be used as a control mechanism, by taking the following steps:  Compare your actual results to your forecasted statements.  Determine the difference between actual and forecasted results.  Analyze the differences with respect to why these differences occurred.

27. Copyright Atomic Dog Publishing, 2005 11-9 Pro Forma Statements (contd.) The control cycle