Entrepreneurs in Management Aspect by ozm75856


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									                          Financial Management for Entrepreneurs
                                      By Robert Low

For most entrepreneurs, financial management is hardly the most enjoyable aspect of running a
business. Most find tasks like promoting their business or planning for expansion more
stimulating than tracking sales or producing financial projections. But while financial
management skills may not be the reason entrepreneurs enter business or initially succeed in
building their businesses, those skills are critical for continued success.

Every business is required to file taxes and most prepare regular financial statements. But
financial management encompasses more than just these basic accounting functions. In fact,
those tasks are primarily designed to meet the needs of people outside your business – the IRS
and outside investors. Things like planning, internal controls, and cost accounting help you run
your business and actually add to, and don’t just add up, your bottom line.

Types of Accounting

There are three main types of accounting done by for-profit businesses: financial, tax, and
management (or cost). Financial accounting is based on Generally Accepted Accounting
Principles (GAAP) and is used to prepare standard financial statements. These are an income
statement, balance sheet, and statement of cash flows. All publicly owned companies are
required to issue regular financial statements and most private companies do so voluntarily. If
you have outside investors or lenders, they will almost certainly insist on regular statements,
usually with the further requirement that they be audited or reviewed by a CPA firm (more on
this below). Pick up a textbook on accounting or take an introductory class and it will almost
certainly be about financial accounting.

One principle of financial accounting is that statements usually are prepared on an accrual basis.
This means that income and expenses are counted when work is done or goods are used rather
than when cash changes hands. For example, if someone pays a deposit to rent your facility to
host a function a month from now, financial reporting requires you to defer recording the
revenue until the event has taken place. Similarly, if someone provides a service to you and gives
you 30 days to pay, you still record the expense immediately.

The use of accrual accounting creates an important distinction between profit and cash flow.
Companies reporting profits, particularly rapidly growing ones, can run out of cash while other
companies can generate substantial cash while reporting only modest profits or even losses. In
addition to the examples above, things that generate differences between cash flow and profit

-   purchases of equipment (cash is paid up front but the expense gets spread out over several
    years using a depreciation method)
-   carrying inventory (cash paid up front but expense only recorded as goods get sold);
-   adding or repaying debt (affects cash but is neither revenue nor expense)
-   deferred compensation (expense recorded when work is performed no matter when payment
    is due).
Both profit and cash flow are important concepts. Profit attempts to show what truly is earned
each period and keeps irregular transactions like a large capital purchase from distorting the
financial picture. But cash is the lifeblood of a business so tracking profit alone is not enough. In
addition, while financial accounting can be subject to a great deal of judgment, cash flow is
always objectively measured and easily understood by non-accountants. If your accountant or
bookkeeper is only providing you with financial statements, insist as well on a report of cash
flow. When doing forecasting, project both profit and cash flow.

Tax accounting has its own set of rules laid down by the IRS. The differences from GAAP are
not so substantial that a separate accounting system is needed, but you will need to make sure
you are tracking certain pieces of information. For example, meals are only partially deductible
and if you lease equipment you’ll find tax and GAAP rules differ. Also, while high profits might
impress investors they also mean higher taxes. Because your choice of accounting methods as
well as the timing of transactions can impact your bottom line you may have some strategic
decisions to make about trading off profits and taxes. You should consult a CPA for advice on
how to minimize your taxes as well as any tax-specific record keeping requirements.

Management Accounting

Many numbers helpful in running a business either don’t appear in financial statements or don’t
get reported on a timely basis. For example, statistics such as the number of customers, average
revenue per customer, employee turnover, and revenue by time of day or day of the week won’t
show up in statements. Because standard financial statements are generally prepared no more
frequently than monthly and often aren’t ready until at least a week after period end, the
information can be stale. Keeping daily tabs on things like cash flow and revenues can provide a
fresher picture. Finally, financial statements are frequently highly aggregated. For example, a
bowling alley may have food sales, video games, and equipment sales as well as lane rentals.
Yet, there is no GAAP requirement to report anything other than total revenue.

To draw an analogy with baseball, GAAP reporting resembles measures like batting averages
and earned run averages. Those statistics have specific rules that objectively define how they are
calculated. This standardization allows for objective comparisons across teams, leagues, and
seasons. However, a baseball manager will want more specialized information such as how a
batter does against a specific pitcher or where he tends to hit. Though box scores may be very
efficient in summarizing information, a manager needs more. Similarly, a business owner needs
more than just financial statements.

Management accounting is the discipline dedicated to capturing the internal, operating
information needed by managers. Unlike GAAP or tax reporting, there are no rules. Data can be
detailed or aggregated, reported on whatever time period is desired, and can include non-
financial measures. In other words, it can contain whatever is considered relevant and be
formatted as desired. However, while business owners may be instinctively in tune with the need
for such information, accountants and bookkeepers may be so focused on GAAP reporting that
they overlook management accounting. You may need to specifically request such information.
You may also find that if you track certain key data, like daily receipts and headcount, that you’ll
develop an instinctive feel for what your bottom line is well before financial statements are

Who the Players Are

Your internal accounting and financial management is likely to be done by people with titles
such as bookkeeper, accountant, controller, comptroller, or chief financial officer (CFO). Though
titles vary from company to company, bookkeepers and accountants usually do the mechanical
work of daily transactions and compiling basic financial statements. Controllers oversee
accounting but have broader, operating, responsibilities including interpreting financial
information, controlling expenses and cash flow, planning, systems, and internal controls.
Interestingly, the term “comptroller”, which derives from the French word for counting, has
generally been replaced by “controller” as the role played by these financial managers has
expanded. CFOs have the added responsibilities of general administration, treasury, and
financing. Smaller companies, perhaps less than $5-$10 million, likely won’t need a CFO and
under $2 million may get by with just a bookkeeper. Increasingly common is the use of contract,
part-time Controllers and CFOs to fill these needs.

Certified Public Accountants (CPAs) work externally and specialize in two key areas: taxes and
auditing. Audits consist of an examination of a company’s financial statements and internal
controls and results in a written opinion from the CPA firm as to whether the statements conform
to GAAP. As mentioned earlier, an audit is required of public companies. Private companies
may be required to have an audit by outside investors or bankers or may elect to have one in
anticipation of future merger or financing activity, to ease establishing credit with vendors, or
just to get an independent appraisal of accounting practices and procedures.

Choosing what CPA services to use can be confusing. Only CPAs can certify financial
statements but if your investors don’t require a full-blown audit, consider having your CPA
provide a review instead. This process also examines your processes and statements but relies on
a smaller volume of information and results in an opinion on whether the auditor is “aware of
any material modifications that should be made.” You can also save money but using smaller,
local firms rather than a “Big 4” firm. Don’t be afraid to negotiate price and ask if you can save
money by doing certain work in-house. Be aware, too, that though CPAs may offer a range of
software implementation, payroll, and consulting services, the CPA designation does not assure
experience or training in these other areas.

Systems & Controls

Good record keeping is critical to keeping control over your business. Most accounting
transactions are directly generated by routine, every day activities such as paying bills and
collecting money. Two key elements are having efficient accounting systems for data entry and
retrieval and a sound system of controls to ensure accuracy.

Solid accounting software is no longer expensive or hard to use. Packages under $300 like
Intuit’s QuickBooks or Peachtree Accounting are great for getting started and can suffice for
surprisingly large businesses including those with basic point-of-sale needs. Implementations of
mid-range solutions, such as Great Plains, MAS-90, Solomon, and others may easily cost
$15,000-$60,000 or more and should only be selected if the number of system users or the
complexity of transactions outstrips what low-end packages provide. Many of these vendors also
have third-party modules specifically tailored to different industries so inquire about these.

If buying a mid-range solution, you will almost certainly need to work through a value-added
reseller (VAR). Implementation and training may be more important, and costly, than the
software itself, so pay particular attention to the skills of the VAR and be sure to budget
adequately for the implementation.

Strong internal controls, basically a set of checks and balances, are essential for accurate
processing. Though theft and fraud are concerns, errors and omissions in everyday processing
usually present a greater problem. Some basic concepts include:

-   Separation of duties. Just having at least two different people involved in a transaction
    greatly improves control. For example, don’t allow the same person who writes checks to
    sign them.
-   Reconciliations. When you have independent sources of information you can compare your
    accounting system to, do so. This includes essential tasks like reconciling bank statements as
    comparing vendor statements to your own records, and balancing daily cash register receipts
    to the cash drawer.
-   Physical control. Prevent access to assets by locking up cash and unused checks, labeling
    equipment, and keeping inventory in storerooms.
-   Control numbers and logs. If documents like purchase orders, and sales orders are pre-
    numbered and recorded any gaps in the sequence or inability to match them to invoices can
    identify problems.

Strong controls don’t have to be a burden. In fact, good checks and balances ensure accuracy and
eliminate the need for constant policing. Also, if systems start providing inaccurate information,
employees develop their own side systems as double-checks, a costly duplication of effort, or
stop using the system altogether.

Forecasts & Budgets

Though smaller companies may not need formal budgets, they should always maintain some type
of forecast. The forecast should go out at least 12 months, by month, complete with an income
statement, balance sheet, and cash flow. If cash is tight, a week by week cash forecast going out
one quarter should be prepared. Developing a forecast accomplishes several basic objectives:

-   It predicts future profits and cash flow, identifying risks of potential shortfalls or showing
    whether sufficient cash flow exists to support expansion plans
-   You can test outcomes for a variety of scenarios doing what-if analyses
-   It communicates expectations to investors and employees
-   By laying out milestones, concrete goals are set and progress can be measured
-   The process itself requires managers to go through the numbers which can be a valuable
    learning experience
Forecasting will always be somewhat imprecise but that should not stop you from continuing to
do them. Update plans if they become out of date and attempt to learn the reasons expectations
weren’t met. Also, use the forecasting exercise as a time to come up for air from the demands of
day-to-day management and think strategically. Not maintaining a forecast is like trying to steer
a car without headlights so stay in control by running the numbers.


Strong financial management is more than just accounting and can have a real payback. Timely
and accurate information, efficient processes, and solid planning not only help measure but
contribute to the bottom line. Financial management may not be the most interesting part of
running a business but understanding it can ensure you stay firmly in control.

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