Accounting & Bookkeeping

Accounting and bookkeeping are two different subjects.  Accountancy defined:

Accounting, or accountancy, is the measurement, processing and communication of financial information about economic entities.[1][2] Accounting, which has been called the “language of business”,[3] measures the results of an organization’s economic activities and conveys this information to a variety of users including investors, creditors, management, and regulators.[4]

Now, bookkeeping on the other hand is the:

Bookkeeping, in business, is the recording of financial transactions, and is part of the process of accounting.[1] Transactions include purchases, sales, receipts and payments by an individual or organization.

 

Accounting for all that it seems dry is vital for a business to be run well – bookkeeping is what you need to do to get the data in the first place.   Once you enter the data, it’s figuring out how to make it work for you that makes a business work.

Management Accounting

Talk to an accountant and they differentiate between financial accounting and management accounting.  Financial accounting reports on what has happened, management accounting is based on figuring out how to use the data that you have to tell you how to run your business.

Over a decade ago, when I was doing my dissertation I decided to focus on the connection between the accountants and the marketers.  The results were appalling – at least for someone who ‘knew’ what should be done.  These days, things have gotten a lot better – with bigger companies.  Smaller companies though still struggle to get the data in the right place at the right time.  Unfortunately, the information is still just not there.

In the Business

So let’s talk about the kind of reporting you want / need.  At the most basic level, you have sales and the cost of goods sold and the inventory you carry.  Then you have your various expenses that you’d want to track.  Assuming you are all tracking the same information (in the same way), the first step is to benchmark your data as best you can – if your expenses are significantly out of line with your peers, you know what to tackle.

Sometimes, that just means making a few phone calls.  Your internet bill seem a little high compared to everyone else? Well, perhaps a little Google-fu and a few phone calls can get you a better deal.  It’s amazing the amount of leeway a lot of account representatives have to provide you a better deal, if you push them hard on it.

The other benchmark to track is your expenses against previous years.  Has something gone up or down compared to previous years? Don’t just look as a straight numerical value but as a % of your total expenses – sometimes, a change is just inflation; while other times it’s because it’s of new charges thrown in that you were not aware of.

After that you can start looking at fixed and variable costs.  Realistically, in the long-term everything’s variable (rent changes too, just in bunches of years rather than monthly) but it’s worth tackling your variable cost immediately.  Those are by definition things that are easy to alter – while fixed costs often require significantly larger expenditures of time and sometimes capital.  Breaking up expenses so that you can watch for changes in either is extremely important.

Now, let’s talk reporting.  Sure, you could get reporting at its highest level (and that is useful for a bird’s eye-view); but really you want to break things down a bit more.  You want to break up your sales to what makes sense for your business – sales categories would be things like RPGs, Board Games, Miniatures, CCGs, etc.  Same with Inventory and Cost of Goods Sold.  Once you have reporting by that level, you can judge how you are doing based off the margins and how much of each type of inventory you have.  You can figure out turn rates and revenue per square footage.  Without that information? You’re guessing.

What other reports do you need? Well, for retail:

  • Shrinkage (aka theft / weird ass disappeared items)
  • Shipping charges
  • Interest charges (oooh, these are important if you have loans)
  • Cashflow statements
  • Accounts payable / receivable (who you owe / what is owed to you – great for figuring out cashflow and what’s due!)

I’m sure there’s more that’s skipping my mind but this post is getting long.  Take a course in accounting, take a few.  Understand what the books are meant for and what you can do with them – and then ask yourself the question – what do I want to know? You make the numbers dance, but only if you know the tune.

 

Check Your Bills

One of the most boring aspects (and one I occasionally skip) is the checking of bills.  Bigger organisations obviously have an accounts payable individual who deals with it, but when you are the owner of a small store like we are; you got to do it yourself.

It’s extremely important for us to check bills coming in because while increasing revenue is hard, driving costs down is even more important.  If you figure net profit to be only 5%, then the other 95% are all costs.  So, if your cost increases by 1%, that’s nearly a full 1% (0.95%) decrease in your profit margin.  Put another way, if you run a $200k business, that’s $1,900 of loss profit.

How can it happen? A number of reasons, and the most common one’s are below:

Intentional

Whether it’s price increases, a new levy or fee or just a supplier attempting to slip one pass you, intentional increases can often add to your cost base on a permanent basis.  These changes are important to catch fast, because a cost increase can sometimes be fought and removed.

An example – phone lines.  If you’re Canadian, you understand what I’m talking about.  Watching for sudden increases or new charges is important, especially when you are a business.  Sadly, they like slipping in charges for businesses more often than not.

Unintentional

More often though, the charges that you are looking for or the increases are unintentional issues.   This is especially prevalent if you have non-standard contracts with the companies – whether due to negotiations or some other reason.

Here’s a few examples from the game trade – interest charges on mistakes made in the accounting department (e.g. invoices indicated unpaid even if they are) or cash discounts that are removed when they shouldn’t be or just product discounts that are calculated wrong.

Don’t get me wrong – you won’t always catch mistakes that are in you favour. Sometimes, it won’t but I’ll leave it up to you to decide what you want to do then.  Still, in my experience when mistakes happen it generally is in your disfavor, which is why it’s worth checking.

How much can it work out to? Well, our most recent error catch was in the $500 region – though if we had been doing our job properly, it’d have been a lot lower (i.e. caught faster).

The Profit Mirage

Finally! You broke-even and are now paying yourself a salary. Heck, you’ve got even a little profit.  It’s over, you’re good to go and you can relax now. Right?  Not quite.

What is Profit?

Before we go any further, let me define profit for you.  I’m going to use Profit in the Accounting definition; that is – what you see when companies release their ‘Profit & Loss Statements’ for the year.  I’ve briefly discussed Gross & Net Profit before, but suffice to say that Gross Profit is after you take the Cost of Good sold (i.e. what you bought the game for) away from Revenue and Net Profit is what happens when you take away all other expenses.

However, Profit isn’t cashflow (or cash in bank) as I’ve mentioned before.  Profit really only tells you how much you ‘should’ have extra after you pay all your expenses.  It doesn’t cover the capital expenses you incur (which are treated differently in accounting terms), nor does it deal with repayment of loans.  Capital expenses can include purchasing a vehicle, a building or (most relevantly) more stock.

Making Money Work

When a business generates a ‘profit’, they start having to pay taxes.  If you are a small business in Canada, your tax rate is only 12%.   So set that amount aside.

What can you do with the remainder profit?

  • pay it out to your shareholders (generally as a dividend)
  • invest in capital items (e.g. buying a vehicle).  The amount you paid will be depreciated over-time which will show up in your P&L statement as depreciation in later years.
  • invest in new stock
  • repay loan(s)

The Mirage

All that above sounds good right? Except… if you are continuing to grow, you often have no choice but to invest that amount in stock.  Here’s why:

Let’s start with some simple assumptions – last year, you did $200,000 in sales.  You now are generating $240,000 – with a net profit of 5%.  That means you generated a net profit of $12,000; after tax profit of $10,560.

Let’s further assume, you did that with a turn rate of 4 (i.e. you had $50,000 in goods) last year.  Now, this year if you ‘keep’ to a turn rate of 4, you need $60,000 worth of goods (4 * 60,0000 = $240,000).  So, of that after tax profit of $10,560 you just dedicated nearly all of it ($60k – $50k = $10k) to increasing your inventory to handle the increase in business.

Why increase inventory? Well, if you didn’t your customers start seeing stockouts much more often – items they want are never in, no matter when they arrive.  You miss out on sales on regular bestsellers and on hot new games because you don’t have the inventory to keep up.  This can be the start of a nasty decline.

This is why profit can be a mirage.  Sure, your company is profitable – but if you keep having to dedicate more funds to the business to keep up with its growth, the profits never really end up in your pocket.  It’s why capital is so important, having adequate amounts and having access to other forms of capital (e.g. investors & loans).

The business of keeping the business running

It always amazes me the sheer amount of work required to keep a business running that customers never see.  Before I got into business for myself, I never really had a clear idea about the sheer amount of work the business of running the business would entail.  I’m not talking about marketing or design or shipping the orders out; but all the small niggling administrative details that keep the business running.

I had a full day today of back-office work, and after the day finished; I started wondering where all that time went.  I started breaking it down, and figured you all might find it amusing to read too:

8am : Deal with Distributor’s mistake
8.15am : Deal with box shipment delivery attempt #1
8.15 – 9.00am : E-mails
9am – 10.45am : Check stock levels and place distributor order for shipping today
10.45am : Deal with box shipment delivery attempt #2
10.45am – 11.30pm : Locate and fix bug on Starlit Citadel
11.30pm – Noon : Lunch & Read BoardGameGeek (Btw – whoa Kickstarter posts!)
Noon – 5.15pm : Accounting
5.15pm – 7pm : Break & Dinner
7.15pm – 8.30pm : Update site stock & Write this blog post

Best Practices : Cashflow is King (5)

Businesses do not go out of business because they are making a loss – they go out of business because they no longer have the cash to meet their obligations.

The main point about this article is to highlight the various variables that affect the amount of cash you have on-hand.  This is not about mitigating your loss; most businesses will make losses in the first year or three.  That’s not an issue, you can easily run a business with losses if, for example, you have a line of credit or loans or sufficient capital to deal with the losses.  The goal however is to never run out of money such that you can’t pay your bills.

When thinking of cashflow, it’s worth thinking in terms of both your cash-on-hand (your start-up capital & any retained earnings and the like) and the total lines of credit available (e.g. your credit card limits, your LOC limits & your loans).  It’s also worth working out how many (average) months of expenses you have using both those figures.  If you have enough cash on hand to manage 2 to 3 months of expenses, you are quite set.  If you’re dipping into your lines of credit with only a month left; you are in a seriously dangerous zone.

The other area to consider when thinking about cash flow is fixed and variable expenses.  Certain expenses (e.g. rent) are pretty fixed while others (e.g. marketing costs) are highly variable.  It’s worth taking a look at your financial sheets regularly (at least annually) to understand which of those expenses are fixed or variable.  When you are down to a month left of  funds, you’ll seriously need to look at what you can cut.

There are also other factors that affect what your cashflow is like.  Here’s some areas that you might not even have considered:

  • Upfront costs

You are going to have quite a few.  Incorporation costs, interior design costs (shelving, desks, etc.) and office equipment all need to be purchased before you begin pulling in revenue.  In this case, it’s rare that you can do much to reduce the outflow of cash but you need to plan to have sufficient capital to deal with these upfront costs.  In our case, we had 4 months of no revenue while the site was being set-up but we continued to incur expenses during that period.

  • Inventory, Suppliers & terms

Depending on your suppliers, you either pay immediately or receive terms (e.g. 5, 15 or 30 days after the invoice).  If at all possible, you will want to receive terms.  (Side note: to reduce cost, it’s cheaper and better to pay by checks since most companies charge a credit card use rider which can range from 1 – 2%).

Terms give you more time to receive and sell your stock without ‘paying’ for it – which can be useful if you are stocking up for high sales periods (e.g. Christmas).  Quite often, when a new game releases a surge in sales will occur and then sales will peter out.  As such, while you might order 6 copies in the beginning, you might only want to have 1 copy in-stock for the rest of the yea.  Terms allow you to order those 6 copies, keep the revenue for the sale of the copies and re-order your 1 ‘permanent’ copy; without touching your working capital.

  • Gateway Processing Times

This affects us an online business the most; but it is something to watch while you’re running a b&m store.  Most businesses take credit cards, which are processed through a merchant gateway.  These merchant gateways can take between 1 – 2 business days to process your funds and send it to you.

PayPal is notoriously bad for this – they don’t send you your funds until you request it; and also charge a fee for amounts less than $150.  In addition, it can take up to 5 days after your request for the funds to be deposited.  So even if you’ve sold a game, you might not receive the money till a week later.

  • Payment methods

Anything paid via cash or Interact is immediately debited.  Payments by check can take up to a week (especially if you’re paying a US supplier) from the moment the check is cashed by the supplier to it clearing on your side.

Credit cards on the other hand can provide up to 44 days of free credit; depending on the closing date of the statement and the charge.  This is almost ‘free’ money; so long as you pay the credit card off completely.

  • Taxes

Again, this can be quite a boon for businesses as taxes are often remitted quarterly or annually.  Before the switch to the HST, PST was collected on a quarterly basis.  As such, we ‘collected’ the PST charges to customers regularly in our bank account and only had to pay it out 4 times a year.

With taxes, the biggest danger is not setting the appropriate amount aside.  Employee EI & Remuneration is  one of the few things that a director of a corporation is personally responsible for.

Well, outside of sales; but that’s a different article entirely.  The longer (legally) you can keep from paying a charge, the better your cash flow looks.  However, just because you’ve delayed a payment doesn’t mean you don’t have to pay it!