Accounting is the basis of good business decisions. For that reason, you must familiarize yourself with your financial statements. These include Balance Sheet, Profit & Loss, and Statement of Cash Flow (or Cash Flow Statement).
A Balance Sheet shows the company’s total assets, liabilities, and equity at a particular point in time. Your Profit & Loss (or Income Statement) shows the revenues generated and expenses incurred during a particular date range. The Statement of Cash Flow shows details of the flow of cash (in and out) as a result of the company’s operating, investment, and financing activities.
Not a month goes by without our office hearing from a contractor that discovered an employee was robbing them. The last call I took was from an owner who discovered that a trusted employee had been stealing from him. He discovered that at least $55,000 had been stolen over the course of three years.
Most victims have a few things in common. They are usually companies owned by a single person who has little to no interest in office work, especially accounting. There is a single primary person in charge of bookkeeping and accounting functions. The company does not have an outsider perform basic audits or even perform bank reconciliations.
Be sure your company uses purchase orders for all purchases. Keep in mind, a purchase order is a permission slip to buy something and it is the basis of all good bookkeeping systems for contractors.
Purchase orders should contain specific information about what items or services were agreed upon as well as exact pricing and terms of the sale. When orders are picked or delivered to you, there should be a packing slip. Carefully compare the packing slip to what you are picking up or what was delivered. Sign the packing slip and turn it in to the office. Your next step is to acknowledge receipt of the items. In many software programs, this is called an item receipt. This is where the purchase order (permission slip) is converted to a financial transaction. You can think of an item receipt as a temporary bill.
This process gets the item(s) into inventory quickly so that you can keep your financials up to date and get your invoices out quickly. When the bill arrives, evaluate it against the item receipt and the purchase order. All item numbers, quantities, and prices should match. Many of our clients are very surprised how often there are pricing mistakes — mistakes that are not in their favor.
Purchase orders should also be used for ordering services. For example, if you need to call to have your copier repaired, create a purchase order and tell the vendor to include that PO number on their bill. When the bill is being evaluated for payment, the bill payer will look to the PO for verification. An old trick was for a would-be fraudster to call companies and ask for the model and serial number of a copier, or other appliance. They would then send an official looking bill for repair work. Many times, an unknowing worker paid the legitimate looking bill.
Cash basis is the simplest form of accounting. You recognize and record revenue when cash is received, not when the work is done. Expenses are recorded when bills are paid, not when the item was used.
In the accrual method, revenues are recognized and recorded when earned. Expenses are recognized and recorded when consumed or when an invoice is received. Remember, when using this method, revenues and expenses don’t have to be paid before they are recognized.
Some accounting software allows you to print your reports using the cash basis of accounting. While cash basis reporting can be necessary when paying sales tax or preparing your tax returns, it is a very dangerous way to manage your company. Do not use cash basis reports to analyze your financial performance or to help you make day-to-day management decisions.
Your personal finances should never be mixed with your business finances. Your company should have its own bank accounts, checking accounts, and credit cards. According to Publication 535 from the IRS, a business expense must be “both ordinary and necessary.”
An “ordinary” expense is one that is common and accepted in your trade or business. A “necessary” expense is one that is helpful and appropriate for your trade or business. Don’t be tempted to write-off personal expenses, pleasure trips, or anything else that is not a legitimate business expense.
Would you let your credit card company or parts supplier sit down at your desk and enter their own bills for you to pay? Would you let your banker drop by to enter all of your banking activity into your accounting software? Would you trust their work so much that you would skip the normal process of “checks and balances” to verify these transactions?
Most people would say no. But, that might be exactly what you are doing when you own software that allows you to download banking activity, credit card transactions, and vendor bills. Importing transactions directly into an accounting program can allow employees to skip critical internal control mechanisms that guard against fraud, theft, and errors due to omission.
When is the last time your accountant called you to ask you questions about your financial statements? Most contractors only hear from their accountant when its time to work on their tax returns. In this case, they don’t have an accountant; they simply have a tax preparer. Your accountant should review your financials quarterly and discuss the numbers with you. They should ask you probing questions designed to test your accounting practices and controls. Their job should be to give your company a “financial physical” by checking all of your vital signs.
While absolutely vital to profitability, financial structure and accounting practices are often the least understood elements within a contracting company.
Editor’s Note: For easy help learning to master financial structure, download a free package of training resources, research data, plug-and-play templates and more at EGIA.org/hvacr-financial/.
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