For many small businesses accounting is the dreaded annual chore of determining the taxman’s bite. And until the accountant finishes (and we adjust the results to better suit our tastes and budgets), the outcome is more suspenseful than a John Grisham adventure.
Income tax might be the most required of accounting’s uses, but it is by no means the most important. Accounting is supposed to serve four parties—management, ownership, creditors, and the tax collector—and they belong in that order. Only when the first does its job will the other three be happy.
Accounting is management’s map. Would we drive a whole year before we look where we’re going? Yogi was right: “If we don’t know where we’re going, we might end up someplace else.”
Month and year-end statements are only summaries of activity and trends we should be tracking continuously throughout the month and year.
Business activity should be posted as it happens. Ideally no entry, audit, or correction needs to wait for month-end.
There’s no reason to wonder how we’re doing when we can press the button and see it now, in time to make adjustments.
Good accounting is by no means an automatic function in retail. We get it only when we commit resources (knowledgeable people, up-to-date equipment, quality software, etc.), establish well-designed systems, and insist on timeliness and accuracy.
Physics’ Law of Entropy applies in accounting also: “A system, when left to itself, tends to a state of maximum disorder.” If we tolerate inaccurate numbers, meaningless reports, and late financial statements, they quickly devolve into new standards. As fewer people find the information credible and useful, accounting deteriorates toward irrelevance. Eventually staff performs the routines without anyone understanding or asking why.
Accurate and timely accounting occurs only to the degree that management appreciates its value, is committed to and insists on its production, and champions its cause.
Accounting conventions like LIFO, accelerated depreciation, and lower of cost and value are tax gifts and accountants’ CYAs, not attempts at correct valuations.
Tax law is full of economic incentives and political pork; GAAP is weighted down with accountants’ conservatism. Together they make it difficult for us or anyone else to get an accurate picture of our companies.
Accountants will argue that their numbers are absolutely correct—they can show us the specific tax laws and GAAP proclamations to prove it. Actual economic value isn’t part of their logic. If we insist on a more accurate picture, they might grant us a footnote on their statement to make our case.
Let the accountants create their tax and GAAP fantasies and tell us what we owe. Meanwhile to run our businesses we have to create statements that show us in no-BS hard numbers where we are and how we're doing.
When we rational humans are faced with news that doesn’t suit us, we often put our talents and faculties to work denying it. In business, financial results are too often the target of our rationalization.
If we don't like our results and an inaccuracy is handy, we and our managers cling to it as evidence that the ultimate conclusions are wrong. Even when the error is small and relatively inconsequential, we reason that it’s representative of more and bigger problems in the data.
Unless our accounting is above reproach, we can interpret it however we like. Poor results become tolerable, the status quo acceptable, problems benign, and no one is disturbed from his comfort zone.
On the other hand, when the numbers are beyond reproach, our thoughts turn from rationalization to strategy. We focus on improving the business.
Creativity is a wonderful asset—but not in accounting.
When financial statements are stretched to suit one of their four masters—management, owners, creditors, and the tax man—there’s a cost to pay to the other three.
Underreporting income to hold taxes down deflates the results creditors want to see. Overstating income to satisfy owners and creditors increases tax liability, sometimes when the company can least afford it. And all inaccurate numbers make it difficult for management to interpret the real condition of the company and establish accountability.
Annual adjustments for shrinkage and bad debts are typically the deadly big surprises at the end of the year. They often change the bottom line significantly, rendering all preceding statements useless and misleading.
There’s no reason to wait for the end of the year. When inventory is counted on a cycle schedule, shrinkage is recognized continuously throughout the year. Reviewing receivables monthly and writing off doubtful accounts according to fixed criteria accrues the effects gradually and reveals their trends.
There’s no year-end rush, no anxiety about “how we really did,” and no surprises. Everyone sees the numbers as they develop, before it’s too late to do anything about them.
There is no feedback, challenge, or recognition more effective than a financial statement. It allows managers and staff to see and understand goals, focus efforts, track progress, and share in the pride and disappointment of results.
We have to get over our concerns that employees can’t handle profit information. Hopefully we haven’t hired anyone so naïve as to not realize that a store must make a profit. Better to acknowledge margins and expenses than to let employees assume gross margins (which they would inevitably discover anyway) simply go into the owners’ pockets. Profit is easily explained as necessary not only to cover salaries and expenses, but for the store to grow, buy more inventory, replace fixtures and equipment, etc.
Staff can see daily revenue and expense opportunities that management doesn’t notice. When they have a clear picture of the objectives and challenges, they can influence results. As a company grows and management functions are dispersed, financial statements provide the ideal feedback and performance appraisal.