I-502 Accounting Basics: Avoid the Audit

NWMJLaw's Anne Van Leynseele leads the 502 Accounting Panel at MJBA Seattle

By Anne Van Leynseele, NWMJ Law

WHO’S STANDING NOW; WHO’S STANDING TOMORROW

We keep getting the same questions over and over from different clients so to save everyone’s time; we decided to share the answers with all of you MJBA members.

GOALS OF THIS SERIES:

  1. To increase your business literacy.
  2. To help ensure that you fulfill all of the responsibilities of a small business owner.
  3. To clarify why outside professionals are essential to your survival and how to find and use the best fit for your business.

As a small business owner you are responsible for every part of the business. Understanding the stages of development can help clarify what is important at each stage of growth.

In small business offices around the country sits shoeboxes or file folders full of business receipts, invoices, and accounting data. As the months roll by and the data accumulates, your business is sitting on a growing problem. Learn before it is too late why your accounting system can cost your business and more.

For many start-ups and sole-proprietors, the shoebox or file box was a temporary fix prior to setting up an accounting system. But with procrastination the box can become the nemesis of your small business.

What is an Accounting System?

An accounting system for your business is not as simple as a shoebox or file folder. These items will collect and organize your important business information but you need to look at what the numbers are telling your business. An accounting system will take your business beyond record keeping and provide important financial indictors. An accounting system will have the following parts:

  • Data Collection: Includes business transactions and operations data.
  • Data Organization: A method of sorting data by date and transaction type.
  • Accounting Database: Data entry into a spreadsheet or accounting software program will form the basis of accounting information.
  • Financial Statements and Reports: Balance sheets, income statements, budgets, and timetables comparisons will aid in running your business.
  • Analysis: Regular review of main controls to avoid problems and capitalize on opportunities.

If your small business accounting system is focused only on collection and organization until year end than discover why you need to change over to a complete system.

8 Reasons for Accounting System Upgrade

  1. Expense Creep: It starts off innocently as you begin to add more regular expenses to your operations. Without monthly tracking of expenses and costs, you cash flow can quickly dry up.
  2. Overdue Accounts: Ignoring the need for an accounting system can make tracking accounts receivables a guessing game. Don’t be in the business of bank lending. Misplacing a 90-day overdue account is costing you money.
  3. Cash Flow Crunch: Every business will experience the highs and lows of cash cycles. To overcome periods of cash shortages or to get needed funding, an accounting system will help you identify who owes you money and places for expense cuts. Create a full financial summary every quarter.
  4. Lack of Data Security: How safe is your shoebox? Is it reinforced steel, fireproof and waterproof against major disasters? Important financial information needs to be stored on a removable disk and on a secured offsite location. Never take a chance assuming it can’t happen to you.
  5. Added Costs: Having an accountant or bookkeeper organize and compile your accounting data at year end can be costly. Organize your invoicing, accounts payable, accounts receivable and most important know your cash flow.
  6. Audit Risks: Surviving an IRS audit can be easier if all financial matters of your small business are in order. Providing an auditor with financial statements, organized files, and well tracked transactions will make everything easier for all parties involved.
  7. Bankruptcy is NOT an option in legal cannabis: With the majority of businesses failing in the first 5 years, poor financial management remains one of the top reasons for failure. It is your responsibility as a small business owner to maintain and regularly assess your financials. Not putting an accounting system in place early during your startup can mean the end of business. Proper accounting can help you see money losing strategies before it is too late.
  8. Financing Difficulty: Do not bring a shoebox of invoices and receipts to your banker or investor meeting. The professional appearance of your company’s books is part of a winning strategy to financing.

The price of business ownership comes with the responsibility of establishing an accounting system. On the plus side you feel more control over your business, less stress, and better profitability.

 

WHERE DO YOU STAND?

The accounting cycle for a small business begins with establishing the chart of accounts for that business and ends with closing the books for that business at the end of the accounting time period. The accounting cycle is a series of steps that the firm takes every accounting time period in order to take account of its financial transactions.

Here are the steps in the accounting cycle for a small business:

  1. Develop the Chart of Accounts for your Small Business
  2. Understand The Source Document in an Accounting Transaction
  3. Accounting Journal Entries
  4. Construct the General Ledger for your Small Business
  5. How to Prepare a Trial Balance
  6. How to Make Adjusting Entries in your Accounting Journals
  7. Prepare the Financial Statements
  8. Closing Entries as Part of the Accounting Cycle

Washington State Business Entities

You may operate your business under any one of several business structures in Washington State. Each type of structure has advantages and disadvantages that should be considered. The descriptions of the structures below are provided to assist applicants and are not intended to be legal definitions with the force of law. You should contact an attorney, accountant, financial advisor, banker, or other business or legal advisors to determine which form is most suitable for your business or organization.

  • A Sole Proprietorship is one individual or married couple in business alone. Sole proprietorship’s are the most common form of business structure. This type of business is simple to form and operate, and may enjoy greater flexibility of management and fewer legal controls. However, the business owner is personally liable for all debts incurred by the business.
  • A General Partnership is composed of two or more persons (usually not a married couple) who agree to contribute money, labor, and/or skill to a business. Each partner shares the profits, losses, and management of the business and each partner is personally and equally liable for debts of the partnership. Formal terms of the partnership are usually contained in a written partnership agreement.
  • A Limited Partnership* is composed of one or more general partners and one or more limited partners. The general partners manage the business and share fully in its profits and losses. Limited partners share in the profits of the business, but their losses are limited to the extent of their investment. Limited partners are usually not involved in the day-to-day operations of the business. Note: A limited partnership may opt to become a Limited Liability Limited Partnership* by including a statement to that effect in its certificate of limited partnership. Status as a limited liability limited partnership provides general partners with a shield from liability for obligations of the limited liability limited partnership.
  • A Limited Liability Partnership* is similar to a General Partnership except that normally a partner does not have personal liability for the negligence of another partner. This business structure is used most commonly by professionals such as accountants and lawyers.
  • The Limited Liability Company (LLC)* An LLC is formed by one or more individuals or entities through a special written agreement. The agreement details the organization of the LLC, including: provisions for management, assignability of interests, and distribution of profits or losses. Limited liability companies are permitted to engage in any lawful, for profit business or activity other than banking or insurance. Doing business as an LLC may yield tax or financial benefits.
  • A Corporation* is a legal entity, a corporation has certain rights, privileges, and liabilities beyond those of an individual. Doing business as a corporation may yield tax or financial benefits, but these can be offset by other considerations, such as decreased personal control. Corporations may be formed for profit or nonprofit purpose.
  • A Nonprofit Corporation* A nonprofit corporation is a legal entity and is typically run to further some sort of ideal or goal, rather than in the interests of profit. Many nonprofits serve the public interest, but some do engage in private sector activities. If your nonprofit organization is or plans to fundraise from the public, it may also be required to register with the Charities Program of the Washington Secretary of State.

Items marked with * must register with the Secretary of State, Division of Corporations and Charities.

See table below

LESSONS:

Set-up your company in a way that minimizes your tax liability

Make sure you understand your tax obligations

Keep a schedule of filing and payment deadlines

Do not fall behind

It is not too late to clean up the past

Money flows through a company and someone must keep track of it. A budget is a basic tool to understand the flow. A budget will inform your decisions by helping you decide how to allocate resources, control spending, and provide a way to plan for the next year.

Within an operating budget there are two major categories: fixed costs and variable costs. Each industry is going to have different forms or types of fixed costs.  In some industries, salaries are paid even if no work is accomplished. In 502 world, the insurance company has to be paid as a legal requirement for you to be in business. The sooner you offset the fixed costs within the accounting period, the sooner you will generate a profit, but to know what that number is you must have a budget. The rest I will leave to the experts on April 19th.

DRAFT OPERATING BUDGET

FIXED COSTS – Fixed costs are those cash expenses that must be paid whether the business produces or sells a single product. Some of these costs have a variable element, but you know the business will need to pay for the line item.
Building/location rent  
Equipment rent  
Advertising  
Website hosting/maintenance  
Insurance  
Software licenses  
Taxes  
License fees  
Utilities  
Dues and subscriptions  
CPA fees  
Legal fees  
Bank fees  
Security  
 
VARIABLE COSTS – A variable cost is a cost that changes in relation to variations in an activity. In a business, the “activity” is frequently production volume, with sales volume being another triggering event that increases variable costs.
Payroll  
Payroll taxes  
Benefits  
Contract labor  
Production supplies  
Packaging  
Commissions  
Delivery costs  
 

DRAFT CAPITAL EXPENDITURES BUDGET

Property purchase  
Computers/printer  
Tenant Improvements  
Buildout  
Farm equipment  
Equipment upgrades  
Emergency fund  
 

 

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>