A Business Management Skill

Its Relationship To Good Bookkeeping
and Accurate Financial Statements

There are many business management skills to learn when running your own business. Developing these skills will help you beat the odds of still being in business five years from now. If, however, you could only choose one skill to learn this year, let it be ...

... the monthly financial statement review. But I can hear you saying, "I don't have to worry about that, I hire a bookkeeper." Or perhaps you are saying, "I don't need to do a review because I do all the bookkeeping myself."

In both cases, if you want to stay in control of your business, learn this good bookkeeping practice by performing the monthly financial statement review each month.

This article will show you how to determine if your financial statements are accurate so that you can utilize them to make sound business decisions.

Am I on track?

It's a good bookkeeping practice and a good use of your management skill set to put time aside each month to review your actual results with your budget. Why?

• It keeps you aware of what's happening in your company.
• You have the opportunity to hone your management skill set so you can converse comfortably with your bookkeeper or accountant.
• It provides a yardstick to use when you review your financial statement account balances.
• You can be proactive in addressing any potential problems or shortfalls.

How accurate are my financial statements?

To start practicing the management skill needed to do the monthly financial statement review, have your bookkeeper prepare a monthly reporting package for you that has the following (for now, we'll add to this package later):

• comparative balance sheet
• comparative income statement
• aged accounts receivable report
• aged accounts payable report
• bank reconciliation report including bank statement

Got your reporting package? Ready to practice your management skill set? Have a notepad with you so you can jot down your review notes to follow up on and check back on next month.

Just let me make this comment before we start. This practice may seem like it is going to take up a lot of your time. However as your business is small, it shouldn't take very long at all ... and the more you practice this management skill, the better you will become at it.

Where to start your monthly financial review

What you want to do is to be on the lookout for possible errors or omissions and any unusual balances. Keep asking yourself, "Does this number make sense?". You are seeking confirmation that your financial statements are accurate.

First do the most obvious checks.

1. Does your balance sheet balance?
2. Does the net income (loss) line in the equities section match the net income (loss) reported on your income statement?

If the answer to either of these two questions are negative (as in "no"), you need a new bookkeeper ... seriously! :-(

If you are the owner who is doing your own books, pay attention to what I'm saying ... you need a new bookkeeper. It will save you money in the long run.

It's very expensive for an accountant to correct your bookkeeping errors. Having an unbalanced balance sheet shows a definite lack of skill in preparing a good set of books. Get help.

Review the bank account

Under assets, you will see your bank account listed. Is the number listed positive or negative?

A negative number here means you are in overdraft. This means you are incurring bank interest and overdraft charges if you are truly in overdraft.

Let your intuitive management skill kick in so you can ask, "Does the number look reasonable. Is it what I expected?" If yes, move on to the next item. If no or you have no clue then ...

... locate the copy of your latest bank statement and bank reconciliation report in your reporting package (no I don't want to hear that it's not done).

Does the bank reconciliation report explain the difference to your satisfaction? If yes, move on to the next item. If no ...

You will have to use your management skills to do some sleuthing ... better now before you have a real problem.

This quote was found in The Artist's Way by Julia Cameron. Keep this in mind when you go sleuthing.

One bad bookkeeping habit some bookkeepers have is to print out all the vendor cheques that need to get paid, whether there is money in the account to pay them or not. The bookkeeper then holds them in a drawer or file folder until it is time to release them ... I know you would never do this! ;-)

This habit might have started because the owner (that would be you) is not around to sign the cheque when it needs to be sent out. It seems a logical solution and an efficient way to keep things moving but ...

... it makes your financial statements inaccurate and takes away their usefulness to you as a business owner. How?

When the cheque is printed, an entry is made to your books that decreases your accounts payable (the amount you owe others) and decreases the money in your bank account (putting it into overdraft on your books in this case). The entry looks like this:

Debit (Decrease) Accounts Payable (current liability)

Credit (Decrease) Bank Account (current asset)

Printing and holding cheques before you need them affects your working capital and other liquidity ratios, and ...

... when you look at your aged accounts payable report, you think bills have been paid that haven't.

Now you can no longer rely on your balance sheet or your accounts payable report to help you run and monitor the financial health of your company.

So if this is happening in your business, put a policy in place to stop it. Make it policy that the cheque date should be the date the cheque is released to the vendor.

Putting policies in place like this one is an effective use of your management skills.

You will have to make yourself available on a regular basis to sign cheques for accounts payable to be paid. I know with your time and management skills that you are up to the challenge. :o)

The frequency of doing a cheque run will depend on the size of your business. For most home based businesses, once or twice a month should be more than adequate.

Each month, take the time to practice your management skill set by reviewing the bank reconciliation report ... especially if there is no segregation of duties (one person is doing all the bookkeeping and has control over posting entries, writing cheques, and preparing the financial statements).

What you want to look for (with your awesome management skills) are any adjustments made to the bank account like :

• Bank errors (increases or decreases the bank statement balance) - Make sure the bank has been notified and that the bank is going to be correcting the error.


• Outstanding cheques (decreases the bank statement balance) - Keep an eye out for cheques that have been outstanding for more than six months as the bank does not have to honor them, unless certified. These are referred to as stale-dated cheques. They should remain on the bank rec unless they are cancelled or re-issued.

  What if for some reason your bank rec has staledated cheques still outstanding from prior years? Transfer them through a journal entry to a suspense account for your accountant to deal with (you have one don't you?). Your accountant may decide to recognize the cheques as revenue.






How To Handle Stale Dated Cheques It is a good policy to cancel the stale-dated cheque by reversing it in a journal entry in the current month. (Do not void or delete.) Making this entry leaves the accounts payable item open so that you can reissue the cheque (making a note in the memo field that it is a replacement) on a timely basis. The journal entry and the stale dated item are now offsetting items that can be cleared in the next bank rec. If you use QuickBooks, you can reverse the cheque by using the bank deposit screen instead of a journal entry. (The Bookkeeper's Tip - If you can get the stale dated cheque back from your supplier, then you can save yourself stop payment charges.) I am not a fan of voiding a cheque that has been issued. Why? Because I like an accurate vendor history of what transpired ... and chances are, my books for the period the cheque was issued have been closed as I have probably submitted one or two GST returns to the CRA since issuing the cheque. QuickBooks takes care of the problem automatically. When you void a cheque in a closed period that is coded to an expense account, it will make three entries. The first one voids the cheque. The second one creates a journal entry on the date of the original cheque effectively recording the transaction you just voided. The third entry is a reversing journal entry in the current period. So I think you may as well use your book keeping / management skills and just reverse the entry yourself in the way I described above.






• Deposits in transit (increases the bank statement balance) - Investigate if the number is growing or the deposits are slow in arriving at the bank. (Deposits in transit are deposits that have been recorded in your books but didn't get posted to your account by the bank yet.)


• Bank service charges (decreases the company's bank balance) - Includes service fees for overdraft charges, stop payments, monthly service charges, interest charges, a new cheque order ... the list goes on. These need to be journalized to your books by debiting bank service and interest charges and crediting your bank account.


• Interest earned (increases the company's bank balance) - This needs to be journalized to your books by debiting your bank account and crediting interest income.


• Chargebacks, returned, bounced or NSF cheques (decreases the company's bank balance) - Look for instructions in your software program on how to enter the non-sufficient funds cheque and reissue an invoice to the customer for the amount including service charges.

Sign the reconciliation as proof you have performed the review. If staff know you are reviewing the bank statement regularly, that may be enough deterrent to keep them honest.

I trust practicing this particular management skill will get easier over time. Who knows, you may even begin to enjoy the task. I know I like managing my money.

One last thing. Make a note to look at your cancelled cheques or cheque images two or three times a year.

Use your management skill to always be on the lookout for possible fraud or embezzlement. When it occurs, it is often a trusted employee who took advantage of an opportunity.

Leaf through to make sure you recognize the supplier names. Glance at the endorsements on the back of the cancelled cheques. Watch for cheques that have second endorsements. If it occurs frequently, it could be a sign of fraud or embezzlement.

If you don't receive cancelled cheques or images, skim through your actual cheque register.

Keep an eye out for funds being diverted. This may be indicated by multiple cheques written to the same supplier around the same date. If all the cheques are on the up and up, you might want to find out why one cheque isn't being printed and sent, saving you bank processing charges and stationary costs.

You may be interested in checking out this list for ideas on how to segregate duties to reduce the possibility of fraud.

It will take management skill on your part to ensure you have adequate policies and procedures in place to protect your business from fraud.

We'll keep making our way down the balance sheet.

Let's look at your accounts receivable.

Take your aged accounts receivable report and compare it to the number on your balance sheet (in the asset section). The two should match. If not, get your detective hat out, use those management skills, and investigate.

Watch out for frequent misapplied payments as possible fraud.

Do collections on slow paying customers. Implement collections procedures and follow them faithfully. Consider whether some accounts should be written off to bad debt expense.

Review your invoicing procedures to ensure customers are billed promptly and credit terms are clearly stated. Send out monthly statements on overdue accounts.

Gabrielle Fontaine, PB in "Cash Flow Kick Start" suggests small business owners sign up for PayPal as an affordable way to accept credit card payments from your customers and avoid the usual hefty merchant charges.

How about your inventory?

Inventory is important because it can tie up a lot of the company's cash. Use some of your management skill here to avoid possible cash flow problems. It is not unusual for small businesses to have poor inventory records.

Has your inventory balance changed since your year-end? No? This indicates you are using the periodic method of valuing inventory.

The reporting problem it presents is that it makes your financial statements inaccurate by understating your direct expenses on your profit and loss statement. Your gross profit is not correctly reflected playing havoc with your profit margin. Your working capital will also be affected which in turn affects your owner's equity.

What does it all mean? It's probable you are showing too much profit. In fact, you could be losing money and not know it until your next year-end is performed. :-( Don't worry, we have a way around this problem. I'll explain in a minute.

You will need to ensure a physical inventory count is performed at least once a year to bring this number up-to-date. This is normally done in conjunction with year-end. In the interim, you need a method to make your inventory numbers meaningful and your financial statements useful during the year.

Under a periodic inventory system, your inventory account is only adjusted at year-end. Inventory purchases throughout the year are booked to a purchase account as there is no cost of goods sold account.

When inventory is purchased, the following entry takes place:

Debit (Increase) Purchases (on your income statement)

Credit (Decrease) Cash or (Increase) Accounts Payable (on your balance sheet)

When inventory is sold the basic transaction that gets recorded in your books is:

Debit (Increase) Cash or Accounts Receivable (on your balance sheet)

Credit (Increase) Sales (on your income statement)

Here's how to fix the problem mentioned above ... It is good practice to estimate the value of your inventory at each month-end if you use the periodic method of valuing inventory. There are two methods to estimate inventory.

One is the gross profit method which estimates your cost of goods sold based on your expected profit margin. The other method is the retail method which uses the cost-to-sales ratio to estimate the value of the ending inventory.

How can you tell if your inventory is estimated? (Hint: if the value of your inventory has no cents or a rounded dollar value, chances are an estimate has been booked.)

If you have any inventory items that have a large dollar value, consider doing a physical count on these more frequently than once a year. This one habit could reduce the chance of having a nasty surprise at year-end when you find out your monthly estimates were off target.

If your business has a large volume of inventory transactions or you carry a large inventory, you will want to invest in software for perpetual inventory management to improve the accuracy of your financial statements. A just-in-time system can offer improved cash flow.

With perpetual inventory, your inventory account is updated on an ongoing basis. Purchases are booked through the cost of goods sold account at the time of the sale. There is no purchase account under this method.

When inventory is purchased, the following entry takes place:

Debit (Increase) Inventory (on your balance sheet)

Credit (Decrease) Cash or (Increase) Accounts Payable (on your balance sheet)

When inventory is sold under a perpetual system, the basic transactions that get recorded in your books changes slightly to:

Debit (Increase) Cash or Accounts Receivable (on your balance sheet)

Credit (Increase) Sales (on your income statement)

Credit (Decrease) Inventory (on your balance sheet)

You can see two transactions are booked here at the time of the sale. In periodic inventory only one transaction is booked at the time of the sale.

I just want to take a moment and check in here. Are you having fun practicing your management skills? Looking at this task as interesting and enjoyable will make it easier. :o)

Okay, moving on down, let's look at your liabilities.

Are there any negative balances? It's a sign that your financial statements are inaccurate. It means that an entry or entries has most likely been entered incorrectly or missed. Use your management skills to investigate each account with a negative balance (in the liabilities section, this means it is a debit balance in your general ledger).

One way to quickly look for obvious errors, if the account balance is not what you expected, is to take a look at all the transactions in your general ledger for the month. Look for the transaction that doesn't seem to fit or looks odd. It could be as simple as an entry booked in the wrong direction (should be a credit but was posted as a debit.)

(As an aside comment - Hopefully your problem transaction isn't caused by someone posting an item to a prior month. To avoid this, make sure after each month-end is complete to set the closing date so that entries can't be posted to it anymore. This forces all transactions that occur in the month to be posted to the current month. Correcting entries should be done by posting a journal entry.)

Pay particular attention to your tax accounts. A negative number for GST or income taxes means you are expecting a refund. Is this reasonable?

However, when you look at your payroll taxes, it would be highly unlikely you are receiving a refund, so this balance should not be negative.

Look at the "Change" column on your balance sheet. Have any accounts changed substantially when compared to your prior period? Do you know why? If you don't know the answer, you guessed it ... practice honing your management skills and determine what is causing the change.

Verify any loan balances to your statement from the bank to ensure the interest portion of your payments has been expensed.

Is there any balance owing to you, the owner? Is the balance what you expect?

If possible, be the one to hand out pay checks. Make it a habit to scan the payroll register especially if your employees go directly to the work site.

Remember, keep notes to follow up on and to look back at next month ... and file it instead of throwing it away when done. Make sure you take time to write follow-up notes beside each item as well. Why? Two words ... audit trail. Okay make it four words ... and accountability.

Still in the liabilities section of the balance sheet.

Let's look at your accounts payable.

Take your aged accounts payable report and compare it to the number on your balance sheet (in the liability section). The two should match. If not, you have some sleuthing to do. Your management skills are getting a good work out today, aren't they?

Also refer to the discussion above about the bad habit of printing and holding vendor cheques. Keep this in mind when reviewing your payables.

Three or four times a year, exercise your business management skills by taking some extra time to look at your vendor statements. One way to do this is to choose a day to open the mail yourself.

Always investigate long overdue invoices. A good practice is to ensure vendor statements are reconciled to the individual accounts payable on a regular basis to ensure no invoices have been missed or payments redirected.

Let's move to your income statement and very briefly review it.

I like to have my income statement print out with my largest expenses reported first followed by smaller expenses. QuickBooks makes this easy to do with a sorting feature option on every report. I can clearly see where my largest cash outlays are.

I also like to have the report print a column calculating the percent of income so I can easily compare my company to other companies regardless of size. I can also see if any expenses are increasing or decreasing with the volume of sales. Keep a sharp eye out to make sure your expenses do not start increasing faster than your sales revenue. Now ...

Are your sales better or worse than last year? Are they in line with what you were expecting? (Check your budget.) Or is something happening there that needs to be investigated? ... Okay, I can't help myself. You know you have to roll up your sleeves and exercise those management skills of yours! :o)

Do your expenses jump around all over the place from month to month. It probably means your bookkeeper (is it you?) is not matching expenses with revenue. Check for missing or absent entries in one month and a doubling up in the prior month. You are aiming to have your income statement fairly represent your business operations for a specific period, in this instance the period is one month.

For example, many of your overhead (selling and administration) expenses are fixed. The expense can be anticipated and should be booked each month - by accrual if the invoice has not been received. This gives a more accurate picture of whether you made or lost money in a month.

When investigating unusual or unexpected account balances, look in the general ledger at the type of entry found in the account. Does anything stick out? How about the dollar amount? Does any one amount stand out as too large or too small for the account?

Make a note and follow-up. The ability to follow-up is a great management skill to learn if you want to be effective.

A basic principle in accounting is to recognize revenue when the transaction is complete. This requires using the accrual basis of accounting.

Another basic principle in accounting closely related to the revenue recognition principle is to match costs with revenues in the period the revenue was earned to fairly represent the operating results.

Say it with me ... I like practicing my management skills.

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