This series is about discussing how one step thinking can cause incorrect profits to be reported in a business. I want to deal with areas where incorrect recording of purchases can cause incorrect profit to be reported in a business.
1. Beating the Tax Man
There is a well known pastime by most business owners of trying to beat the tax man. This means that people try and write off items as fast as they can and therefore mis-match costs to revenue. Bringing costs forward happens subliminally and causes the Jekyell and Hyde which goes on a business owners mind.
2. Failure to keep up to date with book work
Business owners fail to keep their book work up to date and only records items when they PAY for them which can bear no resemblance to when they were purchased ( refer to part 1 of this series).
3. Failure to appreciate the affect of inventory in the business
The biggest and most common issue is that people do not use the two step process when dealing with stock in their business. There are three common reasons for this:
- This can often be encouraged by outside accountants who are focused on reducing the profits of a business to reduce tax.
- This can also be caused by the business owner never wanting to count stock and never really knowing how much they have on hand.
- This can be caused by the business owner trying to simplify their book work so much that it destroys the accounting view and only produces cash book information.
Let me describe the process and see where you fit in:
When purchases are made in your business do you think of them as Purchases or Cost of Sales?
This makes quite a deal of difference because it will tell you where you code the suppliers invoice.
If you think of them as purchases you will likely code the invoice to STOCK in the balance sheet. This is exactly what happens in practice but rarely in the books of account. Most people code their supplier invoices straight to Cost of Sales.
So if items are bought BEFORE being charged to customers (which is normally the case) then there will be another miss match in the profit and loss account because the cost of sales DO NOT match to the sales.
Think about it, Cost of Sales should represent the costs associated with the Sales in the profit and loss account.
Many times the costs of sales are costs associated with sales in a completely different period so the profit and loss account is completely incorrect.
If you have been coding directly to cost of sales the following is likely to be happening in your business:
- You are in denial about your real profit and rely more heavily on your theoretical costing or job costing which doesn’t have to rely on correct timing.
- You are often surprised by the profits in your business and don’t believe them on a monthly basis.
- You have said something similar to this in the past: “Let’s not worry about monthly reporting. If we look over a quarter then the ups and downs will even out over time.”
This last point is so common in business that we always look for it first when trying to help business owners discover the profitability of their business.
Making this move to accounting for purchases in a two step process will help enormously in getting the timing correct for the transactions in your business and perhaps give you a true profit figure for the first time.
Unless you are happy being in denial on the real profitability of your business, I encourage you to have a look at how you’re doing the recording in your business.
If you would like some further help in this then click on this link where you can see a short video on how this works in practice.
