In the last post I mentioned that the learning was to make sure that you use the same process for sales and purchases in your books.
In this post we’re going to look deeper into making sure that items are matched correctly in your profit and loss account.
Many people have turned their books of account into a glorified set of cash books.
What do I mean by this?
They post the transactions in their computer records as though they were spending money from the bank. All the money out goes on one side and all the money in goes on the other side and what’s left is money in the bank.
Sounds simple doesn’t it
In fact this is often encouraged by external accountants because business owners with their DIY attitude can often get their accounts so mixed up it takes a long time for the external accountant to unravel the mess when it comes time to file a tax return.
Well everything remains simple until there are transactions which are time critical. The timing of the cash is different to the timing for the profit.
An example would be making a sale on credit and not recording it until the money is received from the customer. How would a business owner know what their current sales are? Receiving the cash could be at a very different time to making the sale.
Another example would be buying a new piece of equipment and recording the TOTAL cost in one month which would not make sense when calculating profitability.
What this means is that TIMING becomes a critical element in working out how much profit a business is making. We all know that intuitively but fail to see how this works in keeping the business records.
The effect of timing can make a huge difference when trying to work out whether you’ve made a profit or not.
In practice, most people get the timing of their sales correct because computer programmes handle the two step process of recording the sale, establishing the account receivable and then later receiving the cash.
The biggest area of confusion is on the purchasing side of the business.
Why do you think this might be?
There are three areas which often cause the purchasing side of a business to use incorrect timing and therefore confuse the reporting of true profit.
They are:
1. Beating the Tax man.
2. Failure to keep up to date with book work.
3. Failure to appreciate the affect of inventory in the business.
The next part of the series will discuss these three issues.
