Increase Your Company’s Profits: Know some basic accounting lingo

Step 2: Know some basic accounting lingo

As the leader of your business there are financial and managerial accounting concepts that you need to know so that you can understand and communicate. Understand what your financial statements are saying. Communicate with your financial team, your bookkeeper, your CPA, your CFO, your bankers, and your investors. This is how you overcome the “ I don’t know what I don’t know” factor. Finance and accounting is a foreign language and you’ll do so much better when you understand the lingo.

Plus, knowing these key concepts will give you greater clarity around what the leverage points are and are not when it comes to planning and visioning, expanding your business and increasing your profits. Knowing which leverage points to focus on saves you tons of time and money.

Cash basis vs. accrual basis

When you pull a P&L or a Balance Sheet, you have to choose which reporting basis you want: cash or accrual. This is a super important distinction to understand. Without a solid grasp of this, all kinds of confusion can ensue.

“Cash basis refers to [the] accounting method that recognizes revenues and expenses at the time cash is received or paid out. This contrasts with accrual accounting, which recognizes income at the time the revenue is earned and records expenses when liabilities are incurred regardless of when cash is received or paid.” Straight from Investopdia, accessed 10.17.18 https://www.investopedia.com/terms/c/cashbasis.asp

• If you make or distribute a product, use accrual basis. You have to, by the way. The IRS says so.
• If you only sell your time, use cash basis.
• If you don’t have inventory and are a project-based service business, use accrual for internal reporting and cash for tax reporting.

Getting the difference between cash and accrual basis is foundational. I can’t stress that enough. Cash basis is an accounting method of reporting what’s already happened. Cash basis is not to be confused with cash flow projections, which are estimates of future cash in and out of the checking account. Cash basis is not to be confused with Statement of Cash Flows, which shows the sources and uses of cash. And cash basis is not to be confused with cash cash. Checks, wires, ACH transfers, and credit cards all fall under the term cash.

Chart of Accounts

The canned chart of accounts that comes with QuickBooks or Xero is helpful, but not complete. It is designed with the tax man in mind. The accounts are listed in alphabetical order and the important categories are covered. This is just fine for tracking info for your tax accountant. Not so much for internal management purposes.

For that, your expense accounts need to be segmented into meaningful sections. Sales, Marketing, General & Administrative, Professional Development, and Website and then each sub category goes under the right parent header. Rent and salaries under G&A, merchant fees under Sales, Travel to a trade show under Marketing. That way, you as the CEO with your financial manager hat on will have greater transparency into your KPIs. This is the start of your numbers telling you their story.

Cash Flow Projections

Cash flow is NOT sales, it’s not revenue coming in the door. The term cash flow is often misapplied to refer to revenue income. As in “I need to increase my cash flow,” when what you mean is “I need to increase my sales revenues.” Cash flow is not synonymous with gross income revenue.

There’s a financial report called Statement of Cash Flows. This is NOT a cash flow projection. What a Statement of Cash Flows tells you is not what the future cash looks like, but what your past sources and uses of cash were. Big difference.

Cash flow is about projecting what effect your projected future inflows of cash and outflows of cash will have on your bank balance. Period. That’s it. Cash flow projections do not tell you what your profitability is overall, or per job. It does not tell you anything other than the answer to “will I have enough cash to pay my bills in the future?” And if you find that you hit a negative cash situation you will be armed with the knowledge of when and how much so that you can move things around or get some outside cash.

Maintaining a cash flow projection is a bit labor intensive and does require a bit of duplicate work. But it is critical to your peace of mind and confidence, and an absolute necessity report to have when you are assessing your options and making decisions.

Key Performance Indicators (KPIs)

The essential ones, the ones that apply to every business model, are net profit margin, gross profit margin, ROI, and current ratio.

Somebody has come up with list of 136 of these puppies and divided them into four major categories: sales, financial, project management and marketing. It’s an awesome list. Depending on your business model, you need to know about  twenty or so that apply to your business, so focus on those and ignore the rest.

There are a bunch of other important terms to know and the concepts and consequences behind them and when I work with clients we cover all of these:

• depreciation
• amortization
• sunk costs
• opportunity costs
• SWOT analysis (strengths, weaknesses, opportunities, threats)
• exit strategy
• deal ready
• debt financing
• equity financing
• ROI (return on investment)

For more detailed definitions, check out these resources:

• Wikipedia’s definition of KPI
• Investopedia’s definition of KPI

When I work one on one with clients as their CFO, I help them navigate this financial terrain. I help guide the business owner through the mass of data and information and help them choose the metrics and financial strategies that suit them and their business goals. I don’t throw information at them. I inform and interpret it for them so that they can make the best decisions that are in alignment with their vision.

Which KPI would you like to know more about?  Let me know in the comments.