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GUIDE TO SMALL BUSINESS ACCOUNTING

Many people think that accounting today is the same as it was in the 13th century when it was first developed. Electronic accounting systems are available at reasonable prices, and Apps are around that monitor your day-to-day spending. What advantages are there to having an outside accountant? When should you hire an in-house accountant? What does having an accountant do for your business?

Accounting is the language of business. Accounting is the way to measure the health and financial stability of a business. When accounting is done on a regular basis, it can be a powerful tool for increasing profits and decreasing costs. Some accountants are also trained experts on the U.S. tax code and can help a business understand what actions to take to limit tax liabilities. An accountant can interpret what is happening to a business as the dollars flow in and the money flows out.

This document covers:

1. The Meaning of Accounting

2. Differences Between Bookkeeping and Accounting

3. Misconceptions of Small Business Accounting

4. When to Hire an Outside Accountant

5. What to Expect From an Outside Accountant

6. Small Business vs. Large Business Outside Accountants

7. CPA firm vs. EA firm vs. non-CPA, EA firm

8. How Often to Complete Business Accounting

9. The Need for Accounting Controls

10.When to Hire an In-Office Accountant

11. When to Use Small Business Accounting Products

Italicized text refers to notes from the author, about the concept, or section. They are inserted to provide better understanding of the entire topic.

Padgett Business Services of Southeast Michigan43122 Dequindre Road

Sterling Heights, MI 48314

(586) 323-2360

1 Visit padgettsh.com for more small business accounting help.

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1The Meaning of Accounting

Understanding the meaning of Accounting requires some understanding its history.

Thousands of years ago merchants used many different forms of controlling their coins, dollars or whatever currency they had. The methodology depended on the currencies used, with no formal structure in place – it evolved within culture and currency. Without any tools, days could be spent adding up the money received and then deducting expenses that were known.

The problem quickly arose that there was no uniform business language that described and communicated the financial situation of a company. Mostly cash flow was used to indicate that a company was stable or not stable. Even back in the Roman days, if a merchant saved coins in the back room of his home, his business was considered doing well.

Debits (Latin for “He Owes”) and Credit (Latin for “He Trusts) became part of the language. In the 13th century, Luciana Pacioli worked out the formula of Assets = Liabilities +Equity with the double-entry system and debits and credits. The concept was adapted and improved throughout history. Parts of Europe had a significant impact on improving its application. Business people worked out Statements ratios that left the reader with a better understanding of the financial position of a company.

Outside Accountants over time wrote GAAP, Generally Accepted Accounting Principles, which established a standard for required reporting of financial data. Certified Public Accountants (CPAs) became necessary for ethical and accurate reporting of Financial Statements and appropriately related Supporting Statements as companies grew.

Accountants understand financial concepts and analysis. From the Balance Sheet to Income Statement to the Cash Flow Statement, the accountant understands revenue recognition, inventory and its accurate reporting methods, long-term vs. short-term liabilities and present value. To properly report these metrics, accounts have to understand them.

Cost accounting and managerial accounting focus on the internal operations of the business and look at operational costs in fractional details to optimize the profits of the company. If a box of cereal is decreased from 10oz to 12 oz., but the retail price and box size remain the same, a Cost Accountant can analyze the cost of production changes with the overall long term additional revenue to report the financial impact to management.



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Accountants understand investments, equity recognition, reporting stock and recording dividends. Tax planning and financial statement analysis are also is done by accountants. Financial Analysts typically have accounting degrees, and some finance, or both.

In order to audit, a person has to understand the detailed scope of accounting. Audit techniques require training and also demand the ethics of the profession for dependable reporting standards.

Mergers and consolidations fall under the accountant’s hat and this is an area of expertise. With today’s tools, accurate reporting is almost a sure thing, but hundreds of years ago, even 40 years ago, it was not uncommon to add the financial results of many locations on an 18-column green ledger paper with the calculator to complete the consolidated statement for management.

Accounting is a universal business language first developed in Europe. No matter what company a financial statement comes from, from whatever country, the language is still the same. All accountants from any country speak the same language of accounting.

2Differences between Bookkeeping and Accounting

Bookkeeping basically is the processing of transactions related to paying the bills and depositing customer checks. Bookkeepers will also complete bank reconciliations. Bookkeepers are overseen by inside accountants, controllers or outside accountants. Bookkeepers do not have accounting degrees. Some have Associates Accounting or business degrees. To call an Accountant a bookkeeper, is like calling a doctor a nurse. The terms Bookkeeper and Accountant are used sometimes interchangeably which is an error.

Accountants are trained to handle complex depreciation, accrual and equity matters. Accountants are able to complete Cash Flow Statements, Amortization Schedules and complex journal entries. Accountants direct bookkeepers on what to complete for the correct production of financial information. A bookkeeper handles the data on the Statement of Operations and an accountant handles the financial information on the Balance Sheet.

Accounting knowledge helps in understanding how to categorize expenses properly. A bookkeeper might book an office supply to the insurance category, which does not affect the business’ net income. But for correct budgeting and financial analysis, the expenses need to be



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properly categorized. The value of accounting knowledge can not be overstated. Mistakes made on the Balance Sheet, improper Assets, Liabilities, and Equity treatment can misrepresent a company’s financial position, which can also lead to legal problems.

Bookkeepers have over time learned many “accounting” functions but are not classified as accountants. Management decisions, plans for expansion, and other business related criteria are pulled from financial statements. Bookkeepers should be overseen by an individual with accounting knowledge. If not, improper recognition of transactions can lead to incorrect results. This cannot be understated.

3Misconceptions of Small Business Accounting

A. All Bookkeepers are Accountants. No. Please read the two sections above “The Meaning of Accounting” and the “Differences between Bookkeeping and Accounting”.

B. All Accountants can be Bookkeepers. Yes. The Accountant has to understand what the Bookkeeper’s responsibilities are to best manage the accounting department and produce accurate financial statements. In many companies, the accountant also performs the bookkeepers task, which is probably why there is a confusion.

C. Accountants should be paid what Bookkeepers are paid. No. Accountants, due to the advanced education, should be paid considerably more.

D. I need an outside accountant, even though I have an internal accountant. Yes. An Outside accountant monitors tax issues which can impact your company and your company’s financial reporting. An Outside Accountant will complete your corporate tax return.

E. I don’t need an Accountant, Internal or External. No. Unless you are an accountant running your own business, how are you going to determine if your business is doing well? (hint: Cash Flow is not an answer). Accountants also understand how to do corporate tax returns.



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F. Anyone can be an Accountant. No. Accounting is a complex profession and even 4 years at the best university can leave a graduate lacking understanding in many, many, many areas.

G. Using QuickBooks makes me an Accountant. If my Bookkeeper uses QuickBooks, it makes them an Accountant. Plain and simply, NO! QuickBooks produces inaccurate results. It is a data management program, not an accounting program. Accountants do use QuickBooks, but they know how to properly reconcile it. But reconciling Quickbooks should not be placed in the hands of anyone who does not know what they are doing. There will be more on QuickBooks later.

4When to Hire an Outside Accountant

An outside accountant should be consulted at your business’ conception and help develop the “plan for action” of your company. Too many individuals plunge into a business without capital, logical strategy, understanding of the market, even knowledge of how to operate their company.

Would you start to build a 10,000 square foot home and then discuss it with an architect and general contractor only to discover you only have enough money for a 1,000 square foot home?

Many times a year we have enthusiastic entrepreneurs walk into our office and ask our advice. They will lay out what they want to do, and then, only then, do they face the financial challenges they may have. Some overcome their challenges and come back.

An outside accountant can guide you at the beginning on important money saving tasks. They can then monitor your growth to recommend entity structures and other changes for tax purposes.

Not paying your taxes correctly is costly. Failure-to-file penalties with any agency, in any state, and the federal government are extremely high and clearly unnecessary. Would you rather pay an outside accountant to complete taxes for you, maybe even pay $200 a month, or pay $250 to a government agency for not filing ONE tax return?

In dealing with “small businesses” (under 50 employees), an outside accountant is hired to prepare all coupons and reports for payroll, sales and unemployment agencies. In addition, they



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should be preparing financial statements that clearly accumulate your financial activity. The financial statements (a balance sheet, income statement) are used for consultation and then the preparation of a corporate tax return, which rolls into a personal tax return.

To walk into an outside accountant’s office years after being in business is clearly a costly mistake. While everyone wants to own their own business, many think they can do everything themselves. We are all not experts in everything. Would you rather spend days understanding how to develop, monitor, and tax and financially report for your company, or spend your valuable time developing your business to succeed, knowing that your accountant is an expert who will not make costly mistakes?

Here’s some examples of what we’ve seen when an outside accountant was not consulted:

1) Two brothers opened a franchise in a bustling, vibrant area. The franchisor “sold” them on the franchise and its location. The franchisee never took the franchise prospectus to a public accountant, or shared their financial situation with anyone. The franchise lasted 1 year.

2) A woman wanted to leave corporate America and pulled money from her IRA to do so. A franchisor “sold” her the franchise in a bad location, on a bad road in the suburbs. She lost all of her IRA money.

3) A couple opened a meat market in a strip mall. The established competition was one mile away in a stand-along building with a much better selection of merchandise. We gave the owner of the business financial reports and advice, which required additional capital that they did not have. They shut their doors after a few years.

4) Two women started an LLC, designed and hand-made baby blankets. They then outsourced them to China. The sales went down. They came to us. They had no hope and went out of business.

Some of our success stories:

1) Tax planning has led to tax savings with clients in the ten’s of thousands of dollars.

2) There have been clients who stopped paying payroll taxes. Revenue officers from all three agencies appeared on their doorsteps. We worked with the officers to set-up installment plans.

[We recommend you visit our Business Plan section for one, or both, of its write-ups. The first Business Plan, the Entrepreneurial Plan, focuses on conception and ideas. The Action Plan is designed for when you are ready to put your company into action or you



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can be an existing company. Either way, you need an Outside Accountant to assist you in the completion of the plan.]

5What to Expect From an Outside Accountant

Our firm, and most accountants, gather information and look for problems to prevent clients from having costly issues.

Have you gone to the doctor about one thing and he/she is looking at something else? Just like the doctor, one word or general circumstances can lead an outside accountant, with their expertise and knowledge, to see and recommend actions, which may seem costly, but can save you money in the long run.

An outside accountant can be hired to:

1) Prepare taxes, payroll, sales and unemployment; corporate and personal tax returns.

2) Consult on business matters and tax issues.

3) Advise on tax savings matters, such as depreciation and vehicle purchases.

4) Assist in tax problems and tax notice resolution.

5) Be proactive in business and tax advice for short and long-range planning.

Don’t be concerned if an outside accountant asks many questions that may seem unnecessary – they probably are required for them to be able to fully understand the state of your business.

The bottom line: Expect more from your accountant than what you ask. Much will depend on the particular accountant, but if you walk away uneasy or unclear, seek a second opinion.



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6Small Business vs. Large Business Outside Accountants

If you are a small business (fewer than 50 employees) and you go to a firm that usually deals with large businesses, not only will your fees be much higher, your work will be turned over to a junior accountant. Just like you wouldn’t go to a cardiologist to have your blood pressure checked, you don’t need all the overhead of services that large business accounting firms have.

Over the years, many larger firms have organized small business departments. The small business owner is in a market segment that deserves special and distinct treatment. The “large CPA firms” recognized this. It’s not wrong for a small business owner to ask a large CPA firm to handle his/her accounting and tax needs. Rare instances do recommend it.

There are also small CPA, EA firms that handles large businesses and small CPA, EA firm that handle small businesses. The size of the accounting firm is not at issue here. It is what type of clientele the firm specializes in. If you are a small business, search for a CPA, EA firm that specializes in small business.

7CPA Firm vs. EA Firm vs. Non-CPA, EA Firm

The name CPA firm means there are mostly CPAs (Certified Public Accountants) on staff. An EA firm means it is no CPAs and mostly EAs (Enrolled Agents). A non-CPA, non-EA firm means there are no licensed accountants on staff. (Yes, there are many out there). Below is a table to explain the differences:

CPA Firm EA FirmNon-CPA, Non-

EA Firm

1. Prepare audited financial statements Yes No No

2. Tax representation Yes Yes No



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3. Prepare corporate returns Yes Yes No

4. Prepare personal tax returns Yes Yes Yes

5. Prepare payroll, all agency taxes Yes Yes Yes

6. Prepare financial statements Yes Yes Yes

7. Complete Certified Business Valuations *

No No No

* The mortgage industry, financial companies and courts are now requiring business valuations be completed by Licensed Business Valuators. While a CPA or EA can do an “accurate” business valuation, it may be rejected if completed by a non-licensed individual.

Typically, a small business owner does not need audited financial statements. However, in cases of a business sale, audited financial statements may be required.

Small businesses, even large businesses, do not need CPA firms. There is a misconception that when an outside accountant is needed, a CPA firm is required.

We recommend steering away from a non-licensed accounting firm. The reason for this is two-fold:

1) The person that signs the tax return is responsible for every number on the tax return. A EA firm or CPA firm may be in the position to redo some of the “non-CPA, non-EA firms” work to validate the numbers.

2) Since non-licensed accounting firms are limited in what they can do, it’s much cheaper in the long run to use a properly licensed firm that has the skills you need.



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8How Often To Complete Business Accounting

This section refers to accounting by an outside public accountant only. Bookkeeping should completed on a daily or regular basis.

Outside accountant’s are drawn into action usually on a monthly schedule, sometimes quarterly. Only having your accounting completed annually restricts the financial health of your business to only a tax return and at that point, a look back. Meaning you are missing opportunities for tax savings with tax planning since your accounting is done only after the fact. When the tax return is complete, no financial changes can be executed for that year.

Look at it this way. Your payment to your outside accountant will appear on your financials, on your tax return under “Legal and Accounting”. Let’s say it’s $3,000. If your outside accountant cannot save you $3,000 in tax savings during the year, they have not done their job. If they bill you for services, and you don’t know what it’s for, that’s a major problem.

When you have monthly, quarterly and annual taxes due, when tax savings can go into effect throughout the year, your outside accountant needs your attention and you need his/her attention in an on-going relationship. Let your outside accountant determine how often they should see you and how often they need your financial information.

Many times, clients will walk in, starting a new company and tell us that they will see us once a year. As the depth of the attention required is unraveled, from sales tax returns, payroll reports and tax saving opportunities, they have to be a monthly or quarterly client.



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9The Need For Accounting Controls

“Ha!” you’re saying. “I don’t need any accounting controls!” Do you have employees take in cash? Do you have employees take your money to the bank? Who watches your inventory? Who balances your bank account?

Small businesses are more susceptible to employee theft than large businesses. They don’t make the news, but they are out there. Why? The owner of the small business wears 10 hats. He is the salesperson, the janitor, office manager, bookkeeper, on and on, and, of course, the president, the key man in the operations of the business.

Some true stories:

Owner of a franchise: The sales numbers are automatically sent each day to the corporate franchise office when the sales register is shut down. Cash was totaled in the register, balanced, the deposit slip is prepared. An employee takes the cash to the bank for the owner. On deposit slips where the amount can easily be changed, she alters it. More and more times less money went to bank. It was not caught. The owner never checked the deposit that went to the bank to the carbon deposit slip. We found thousands less in the bank account than expected from the sales reports for one year.

A plumber took all the cash he received and threw it in a safe at night. The plumber smiled. It was his tax-free nest egg. His trusted and loyal bookkeeper slowly over 5 years, took a little out here, a little there, and finally took over $42,000. (This made did make the news!)

Partner A let Partner B pay the company bills. The outside accountant noticed on the checkbook stubs of some of the vendors that the payee in the checkbook was blank. Partner B investigated the blank vendors and found out that when he thought he was paying for inventory, Partner B was actually writing himself a check.

The owner could not disagree with his bookkeeper when she suggested that they need a second bank account for payroll. It made sense when she said is would facilitate her reconciliation. She knew he probably would not check the payroll account. He’d see transfers from operating to



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payroll and never question it. The owner did exactly as the bookkeeper expected. She took advantage of the situation and regularly wrote herself a check from the payroll account, signed it with his signature stamp, and walked away with thousands.

Accounting controls, smart management and not letting your guard down can prevent costly theft. In all the cases above, the outside accountant uncovered the theft.

Work with your outside accountant, talking with him about your concerns makes business sense. Ask your outside accountant to go over your accounting procedures. Spending hundreds of dollars with your outside accountant can save you thousands.

Keep in mind, the owners in all cases above thought they had loyal and trustworthy employees. Also, be sure you do a background check. Later, in one of the cases above, it was found the employee had a past felony background.

10When To Hire An In-Office Accountant

First of all, an in-office accountant does not have to be full-time. Many small businesses start with a part-time accountant.

Our rule of thumb is that when you, the owners, are spending around 8 hours a week on bookkeeping, you should hire one of the part-time accountants that will come to your place of business. You may say “I do spend 8 hours, but it is a night and on the weekends”. Do you really want to spend so much time on the office bookkeeping when you could spend it on other facets of growing your business, or with your family?

Eight hours is used, as that is how much work a bookkeeper can complete in a day. You cannot hire a bookkeeper for a day when you have 4 hours of work a week.

Consult with your outside accountant about this. They may have recommendations that can facilitate this transition or know people to assist you.

Also, don’t miss sales because you’re the back office bookkeeper. Your goal to save money, can cost you sales!



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11When To Use Small Business Accounting Products

Starting in business or now feeling ready for a software product? You’ve heard a lot about QuickBooks, but you probably know nothing about it. Right?

If you want to produce customer quotes and billing with maintaining their receivables balance, then QuickBooks is probably one of your best options. Peachtree and other products accomplish similar results but if you decide you will need a bookkeeper or an outside service to maintain your inventory, complete invoices, there are more individuals trained in QuickBooks than any other software on the market.

If you only want to print vendor checks and pay bills, you have many options besides QuickBooks. There is also online banking. Check out your bank’s online bill pay system. Often you’ll find it satisfies what you are looking for. But remember not all banks’ online systems are the same. Shop around.

Generally though, online banking is not recommended for businesses. Proper business management requires on-going bank reconciliations and due to this, QuickBooks or similar products are recommended. Using only online banking can lead to many NSF’s unless a spreadsheet or ledger are also maintained to monitor the actual cash balance, not the bank balance.

Most business owners are not degreed accountants. Most bookkeepers are not degreed accountants. The QuickBooks information must be input, reconciled and controlled by degreed accountants to assuredly sit back and look at QuickBooks financial statements and use those statements for financial decisions. Otherwise, you probably are looking at “cash flow” statements.

QuickBooks is user-friendly. You have the ability to use the optional Navigation windows to guide you in the necessary steps to work in and around the program. It has become a technical, robust, feature-filled product and for the money, it is the best product on the market for the typical small business. There are webinars, local training classes and technical support available (for additional charges).

Again, there are many products available. But work with your accountant to select a product that is best suited for your business. Many outside accountants use QuickBooks themselves, and due to this, would prefer you use it. But it may have its weaknesses in an area you need a software product for – so again, ask your accountant.



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QuickBooks is not an accounting program. It is a data management program with very poor accounting controls. It takes someone that knows that they are doing to keep it in balance.

* * * * *

This Guide to Small Business Accounting was written to assist you in understanding accounting. It was written as a guide to develop how accounting can be understood and utilized in your company.

If you have a company that has been around for awhile and you are reading this with questions about how “accounting” relates within its operations, the chances are, you are reading this to solve a problem you have. Do you question what your outside accountant is doing? Do you need to improve your operations?

If this document answered your questions, then we have accomplished our goal. If you have more questions not answered here, please email me at: [email protected].

Best of luck with all your accounting endeavors!



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About Padgett Business Services

Padgett is a leading accounting and tax firm that specializes in small business in SE Michigan. This local Padgett office started in 1998. We are proactive in financial and tax planning. Our list of services include IRS problem resolution, 941 issues, Offers in Compromise, State of Michigan sales tax issues, MBT, non-filed taxes, bank loan preparation assistance, full-service payroll, tax entity classifications, etc.

This publication suggests general business planning concepts that may be appropriate in certain situations. It is designed to provide complete and accurate information to the reader. However, because of the complexities of the tax law and the necessity of determining whether the material discussed herein is appropriate to your business, it is important you seek advice from your Padgett office before implementing any of the concepts suggested in this article

About Christy Federspiel, EA

The article is written by Christy Federspiel. Christy is an enrolled agent, a member of the National Association for Enrolled Agents, and is licensed by the Department of Treasury of the Internal Revenue Service to Practice before the IRS. In doing so, she represents the interests of clients and their companies in dealing with all IRS issues and concerns.

She graduated from Villanova University with a BS degree in Accounting and a minor in Computer Science. Additional academic degrees include an MBA in Management from St. Louis University.

After years in computer auditing, Christy began her own consulting and accounting firm around 1982. She was Editor and Publisher of the EDP Auditor Quarterly and authored the CISA Review Manual, a guide for individuals studying for the Certified Information System Auditor exam. At that time she passed the CISA exam.

Christy focused her consulting time on installing accounting software, often replacing manual or DOS computerized accounting environments. She has consulted with large associations to small businesses.

Christy and Jack have assisted over 100 small businesses start from the ground up. Few were told to not start. They work with the visionary to develop a Business Plan (under the Action Plan) and move into entrepreneurs.



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http://padgettsh.com

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