5 Accounting Mistakes That Business Owners Make
Business owners wear many different hats, and your work can change from one moment to the next. You may work on new product ideas, address customer service, and interview a job candidate- all in the same day. Some tasks may fall behind, including your accounting work.
Here are five common accounting mistakes that owners make, and what you can do to avoid them.
#1 – Starting With The Chart of Accounts
You need to set up and maintain a complete chart of accounts, in order to create useful accounting reports. The chart of accounts lists each account and the account’s description, and your financial statements are generated based on the accounts you use. Many owners don’t update the chart of accounts for changes in the business.
Let’s assume that you own a sporting goods equipment manufacturer. Your firm has three product lines: baseball, football, and hiking equipment. You need accounts set up to track the performance of each product line.
If company revenue is posted to account #6000, you should create subaccounts for each product line. Revenue- baseball is account #6100, football is #6200, and hiking is #6300. You can generate profit and loss reports by product line, which allows you to make more informed decisions.
#2 – Planning Inventory Purchases
Managing inventory is a balancing act. You need enough inventory to meet customer demand, but you also need to avoid investing too much cash into inventory. Inventory ties up your available cash, and you can’t recover the cash until the inventory is sold.
Decide on a dollar amount of ending inventory that you can keep on hand at month end. The amount might be based on a percentage of monthly sales (maybe 10%).
If you get customer orders during the first few days of the next month, you’ll be able to fill the orders. Estimate your sales for the month, and use the ending inventory formula to plan your purchases:
Beginning inventory + purchases – sales = ending inventory
You can change any of the variables in the formula and manage your inventory.
Assume that a sporting goods retailer has a beginning inventory of baseball bats totaling 700 units, and the store forecasts 2,000 bat sales for the month. If the retailer wants 200 bats (10% of expected sales) in ending inventory, the number of bats purchased should be:
(2,000 projected sales + 200 ending inventory – 700 beginning inventory = 1,500 purchased)
Use the inventory formula to ensure that you maintain a sufficient amount of inventory, and to minimize the cash required for inventory purchases.
#3 – Forecasting Cash Flow
If you don’t have enough cash to operate, you’ll need to raise funds by selling equity or issuing debt. Selling equity means that you sell a percentage of ownership to a third party, and issuing debt requires principal and interest payments. To minimize the risk of running short on cash, create a cash flow rollforward using this formula:
(Beginning cash balance + cash inflows – cash outflows = ending cash balance)
You receive cash inflows from customers, and you pay cash for inventory purchases, payroll, and other costs. The ending cash balance for March is also your beginning cash balance in April, so each month is connected.
Create a cash flow rollforward, and update it each month. If the forecast projects a negative balance in cash, use the strategies in step four to collect cash faster.
#4 – Create a Formal Policy for Collections
You work hard to deliver a quality product or service, and you deserve to be paid in a timely manner. Put a formal policy in place to collect accounts receivable. You may email customers if an invoice is 30 days old, and call if a receivable is 60 days old.
Ask customers for a deposit when they order a good or service. People pay deposits for many different reasons, and your request for a deposit is reasonable. Explain that the deposit covers some of your costs as you start working on the customer’s order. When the sale is completed, the amount you’re owed won’t be as large.
#5 – Working With Profit Margin and Sales Mix
Making a sale is great, but many business owners don’t consider the amount of profit per sale, and the mix of products and services they can offer.
Profit margin is defined as (profit / sales), or the amount of profit generated on each dollar of sales. Assume that a sporting goods retailer earns $4 on a children’s baseball glove priced at $20, and a $45 profit on a $300 adult catcher’s mask. Here are the profit margins:
- Children’s baseball glove: ($4 / $20), or 20%
- Adult catcher’s mask: ($45 / $300), or 15%
The retailer earns more revenue (sales) on the catcher’s mask, but selling the baseball glove generates a 5% higher profit. While the catcher’s mask brings in far more revenue, the cost to purchase and sell the masks is much higher than the baseball gloves.
Now, consider a business that sells dozens or even hundreds of products. Sales mix is the percentage of total sales generated by each individual product. If a business focuses its marketing efforts on products that produce a higher profit margin, company profits will increase.
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