Small Business Management:
A Planning Approach
Joel Corman
Suffolk University, Emeritus
Robert Lussier
Springfield College
Lori Pennel
Bunker Hill Community College
Copyright Atomic Dog Publishing, 2005
PART 3
Planning and Implementation
CHAPTER 11
The Accounting Function
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.
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
Copyright Atomic Dog Publishing, 2005
11-2 Record Keeping (contd.)
• Records must be kept in the following areas (where
applicable):
Sales 3 years
Inventory 7 years
Accounts receivable 3 years
Accounts payable 3 years
Cash 7 years
Payroll 10 years
Depreciation Life of assets
Equipment Life of assets
Purchases 3 years
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.
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.
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)
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.
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.
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.
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.
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.
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
Copyright Atomic Dog Publishing, 2005
11-4c Net Worth/Owner’s
Equity (contd.)
How net worth changes
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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.
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.
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.
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.
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11-7 Bank Statements (contd.)
Bank reconciliation form
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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.
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.
Copyright Atomic Dog Publishing, 2005
11-7a The Monthly Bank
Reconciliation (contd.)
Bank reconciliation process
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.
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.
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.
Copyright Atomic Dog Publishing, 2005
11-9 Pro Forma Statements (contd.)
The control cycle
Copyright Atomic Dog Publishing, 2005