cash flow

Budgeting is key to a successful start-up

More than half of recent college graduates plan to start a business someday, according to the results of a survey published in August by the American Institute of Certified Public Accountants (AICPA). Unfortunately, the AICPA estimates that only half of new businesses survive the five-year mark, and only about one in three reach the 10-year mark.

What can you do to improve your start-up’s odds of success? Comprehensive, realistic budgets can help entrepreneurs navigate the challenges that lie ahead.

3 financial statements

Many businesses base their budgets on the prior year’s financial results. But start-ups lack historical financial statements, which can make budgeting difficult.

In your first year of operation, it’s helpful to create an annual budget that forecasts all three financial statements on a monthly basis:

1. The income statement. Start your annual budget by estimating how much you expect to sell each month. Then estimate direct costs (such as materials, labor, sales tax and shipping) based on that sales volume. Many operating costs, such as rent, salaries and insurance, will be fixed over the short run.

Once you spread overhead costs over your sales, it’s unlikely that you’ll report a net profit in your first year of operation. Profitability takes time and hard work! Once you turn a profit, however, remember to save room in your budget for income taxes.

2. The balance sheet. To start generating revenue, you’ll also need equipment and marketing materials (including a website). Other operating assets (like accounts receivable and inventory) typically move in tandem with revenue. How will you finance these assets? Entrepreneurs may invest personal funds, receive money from other investors or take out loans. These items fall under liabilities and equity on the balance sheet.

3. The statement of cash flows. This report tracks sources and uses of cash from operating, investing and financing activities. Essentially, it shows how your business will make ends meet each month. In addition to acquiring assets, start-ups need cash to cover fixed expenses each month.

By forecasting these statements on a monthly basis, you can identify when cash shortfalls, as well as seasonal peaks and troughs, are likely to occur.

Reality check

Budgeting isn’t a static process. Each month, entrepreneurs must compare actual results to the budget — and then adjust the budget based on what they’ve learned. For instance, you may have underbudgeted or overbudgeted on some items and, thus, spent more or less than you anticipated.

Some variances may be the result of macroeconomic forces. For example, increased government regulation, new competition or an economic downturn can adversely affect your budget. Although these items may be outside of an entrepreneur’s control, it’s important to identify them early and develop a contingency plan before variances spiral out of control.

Outside input

An accounting professional can help your start-up put together a realistic budget based on industry benchmarks and demand for your products and services in the marketplace. A CPA-prepared budget can serve as more than just a management tool — it also can be presented to lenders and investors who want to know more about your start-up’s operations and its expected financial results.

© 2019

Lean manufacturers: Reap the benefits of lean accounting

Standard cost accounting doesn’t necessarily work for lean operations. Instead, lean accounting offers a simplified reporting alternative that generates more timely, relevant financial data. But it’s not right for every situation.

What’s lean manufacturing?

Lean manufacturers strive for continuous improvement and elimination of non-value-added activities. Rather than scheduling workflow from one functional department to another, these manufacturers organize their facilities into cross-functional work groups or cells.

Lean manufacturing is a “pull-demand” system, where customer orders jumpstart the production process. Lean companies view inventory not as an asset but as a waste of cash flow and storage space.

Why won’t traditional accounting methods work?

From a benchmarking standpoint, liquidity and profitability ratios tend to decline when traditional cost accounting methods are applied to newly improved operations. For example, to minimize inventory, companies transitioning from mass production to lean production must initially deplete in-stock inventories before producing more units. They also must write off obsolete items. As they implement lean principles, many companies learn that their inventories were overvalued due to obsolete items and inaccurate overhead allocation rates (traditionally based on direct labor hours).

During the transition phase, several costs — such as deferred compensation and overhead expense — transition from the balance sheet to the income statement. Accordingly, lean manufacturers may initially report higher costs and, therefore, reduced profits on their income statements. In addition, their balance sheets initially show lower inventory.

Alone, these financial statement trends will likely raise a red flag among investors and lenders — and possibly lead to erroneous business decisions.

How does lean accounting work?

Standard cost accounting is time consuming and transaction-driven. To estimate cost of goods sold, standard cost accounting uses complex variance accounts, such as purchase price variances, labor efficiency variances and overhead spending variances.

In contrast, lean accounting is relatively simple and flexible. Rather than lumping costs into overhead, lean accounting methods trace costs directly to the manufacturer’s cost of goods sold, typically dividing them into four value stream categories:

  1. Materials costs,
  2. Procurement costs,
  3. Conversion costs, such as factory wages and benefits, equipment depreciation and repairs, supplies, and scrap, and
  4. Occupancy costs.

These are easier to understand and evaluate than the variances used in standard cost accounting. In addition, box score reports are often used in lean accounting to supplement profit and loss statements. These reports list performance measures that traditional financial statements neglect, such as scrap rates, inventory turns, on-time delivery rates, customer satisfaction scores and sales per employee.

Should your company abandon standard cost accounting?

Most companies are required to use standard cost accounting methods for formal reporting purposes to comply with U.S. Generally Accepted Accounting Principles (GAAP). But lean manufacturers may benefit from comparing traditional and lean financial statements. Such comparisons may even highlight areas to target with future lean improvement initiatives. Contact us for more information.

© 2019

ASU 2016-14: Information about Liquidity

by Colleen Trombetta

Audit Senior at Atchley & Associates, LLP

 

Do you ever find yourself reading a set of financials statements and asking, “So how are we doing cash-wise?” or “Do we have enough cash to pay all our expenses this month… how about the next six months?” It’s clear that the readers of financial statements are concerned with cash. The FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is going to address this concern of cash and take it one step further by addressing liquidity, which is more complex than just cash-on-hand.

The financial assets that an organization has available to cover operating expenses consist not only of cash, but also of assets that will turn into cash within the coming year, such as accounts receivable, contributions and grants receivable and short-term investments. On the balance sheet, these assets are presented as “Current Assets.” If there are no donor restrictions or board designations, the current assets would be disclosed in the financial statements notes as assets available to cover operating expenses within one year of the balance sheet date.

ASU 2016-14 will require disclosure of the organization’s policies for managing liquidity. The policies should cover areas such as cash reserves, available lines of credit, and investment of cash in excess of current operating needs.

ASU 2016-14 will also require nonprofits to present, on the face of the financial position, the amount for each of two classes of net assets— net assets with donor restrictions and net assets without donor restrictions— as opposed to three.

ASU 2016-14 is effective for fiscal years beginning after December 15, 2017, with early application permitted.

 

 

References.

https://www.aicpa.org/interestareas/centerforplainenglishaccounting/resources/2016/asu-2016-14.html

https://www.nonprofitaccountingacademy.com/asu-2016-14-nonprofit-liquidity/

3 financial statements you should know

Successful business people have a solid understanding of the three financial statements prepared under U.S. Generally Accepted Accounting Principles (GAAP). A complete set of financial statements helps stakeholders — including managers, investors and lenders — evaluate a company’s financial condition and results. Here’s an overview of each report.

1. Income statement

The income statement (also known as the profit and loss statement) shows sales, expenses and the income earned after expenses over a given period. A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product.

Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.

2. Balance sheet

This report tallies the company’s assets, liabilities and net worth to create a snapshot of its financial health. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Net worth or owners’ equity is the extent to which the book value of assets exceeds liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your liabilities exceeds the value of the assets, your net worth will be negative.

Public companies may provide the details of shareholders’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.

3. Cash flow statement

This statement shows all the cash flowing into and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

Although this report may seem similar to an income statement, it focuses solely on cash. It’s possible for an otherwise profitable business to suffer from cash flow shortages, especially if it’s growing quickly.

Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. To remain in business, companies must continually generate cash to pay creditors, vendors and employees. So watch your statement of cash flows closely.

Ratios and trends

Are you monitoring ratios and trends from your financial statements? Owners and managers who pay regular attention to these three key reports stand a better chance of catching potential trouble before it gets out of hand and pivoting, when needed, to maximize the company’s value.

© 2017

Overview of inventory reporting methods

It’s critical to report inventory using the optimal method. There are several legitimate options for reporting inventory — but take heed: The method you choose ultimately affects how much inventory and profit you’ll show and how much tax you’ll owe.

The basics

Inventory is generally recorded when it’s received and title transfers to the company. Then, it moves to cost of goods sold when the product ships and title transfers to the customer. But you can apply different inventory methods that will affect the value of inventory on your company’s balance sheet.

FIFO vs. LIFO

Under the first-in, first-out (FIFO) method, the first units entered into inventory are the first ones presumed sold. Conversely, under the last-in, first-out (LIFO) method, the last units entered are the first presumed sold.

In an inflationary environment, companies that report inventory using FIFO report higher inventory values, lower cost of sales and higher pretax earnings than otherwise identical companies that use LIFO. So, in an increasing-cost market, companies that use FIFO appear stronger — on the surface.

But LIFO can be an effective way to defer taxes and, therefore, improve cash flow. Using LIFO causes the low-cost items to remain in inventory. Higher cost of sales generates lower pretax earnings as long as inventory keeps growing. To keep inventory growing and avoid expensing old cost layers, however, some companies may feel compelled to produce or purchase excessive amounts of inventory. This can be an inefficient use of resources.

Specific identification

When a company’s inventory is one of a kind, such as artwork or custom jewelry, it may be appropriate to use the specific-identification method. Here, each item is reported at historic cost and that amount is generally carried on the books until the specific item is sold. But a write-off may be required if an item’s market value falls below its carrying value.

Weighing your options

Each inventory reporting method has pros and cons — and what worked when you started your business may not be the right choice today. As you prepare for year end, consider whether your method is still optimal, given your current size and business operations, expected market conditions, and today’s tax laws and accounting rules. Not sure what’s right? We can help you evaluate the options.

© 2016

Flexible Budgets for Not-For-Profits

by Tyler Mosley

Audit Manager at Atchley & Associates, LLP

Many of the not-for-profit organizations we provide services for use budgets. For the most part, those budgets are static budgets that are set and approved by the board of directors at the beginning of the year and only modified if a significant event occurs during the year. I have seen a growing trend of companies moving towards flexible budgets which can be modified throughout the year based on updated information and current organizational conditions.

While static budgets are usually set at the beginning of a fiscal year and rarely modified, flexible budgets can be modified weekly, monthly or quarterly based on changing conditions. Most of the not-for-profit organizations that use a budget base their budget on projected cash inflows. While some not-for-profit organizations may have steady cash inflows and can reasonably project the fiscal year’s total revenues, many do not. Many not-for-profit organizations rely on donations from businesses and individuals which can vary in timing and magnitude. For these organizations a flexible budget would provide a more useful benchmark with which to manage program expenses. Program expenses could be budgeted for at the beginning of the year based on projected total cash inflow and then increased or decreased each month or quarter based on updated cash inflow information.

Updating the budget throughout the year will prevent surprises each period in which expenses may be under budget but exceed cash inflows. Alternatively, it would also prevent program expenses coming in well below cash inflows when the organization has a great fundraising year. When it is time for your organization to establish a budget, consider setting up so that it can be updated periodically throughout the year as you get more accurate information about your current cash flow situation.