Accounting as a discipline has evolved over a period of centuries. In the initial phase, it was thought to be restricted to mere bookkeeping or record-keeping of business transactions. However, gradually the importance of numbers contained in the accounting records of businesses became prominent and experts started generating a variety of reports to assist businesses to make informed decisions. In modern times accounting has thoroughly integrated with information technology to transform itself into a real-time information-based system that serves the needs of a variety of stakeholder groups interested in making an objective assessment of the financial health of a business. However, it is pathetic to know that majority of small businesses still regard accounting as mere bookkeeping and thus they remain oblivion to many of the benefits that modern accounting can render to enable them to make informed decisions.
Since the owner is the primary beneficiary of a business, therefore, it is imperative that he or she must take accounting as an essential support system to monitor the performance of the business from a variety of perspectives. Some of the key dimensions of modern accounting that are ironically ignored by owners of small businesses include the following.
Price setting of your products and services
The majority of small businesses set the prices of their products and services by following a rule of thumb approach or based on gut feeling. However, this is a naïve approach to price setting. Unless a business knows about its costs and their classification into fixed or variable components, a sustainable pricing policy cannot be adopted. Since price is a critical factor in generating sales, therefore, it must be viewed from a strategic or long-term perspective, which is not possible without analyzing the business’s cost structure. A variety of accounting methodologies, such as activity-based costing, marginal costing, absorption costing, and breakeven analysis may be used to determine a realistic pricing policy that ensures long-term growth in sales and profitability.
Proper understanding of profitability and liquidity of a business
For the majority of small businesses, profitability is the key determinant of the success of their business. However, it must be understood that profitability alone is not a guarantee that a business may survive in the long term unless its liquidity or solvency position remains intact. Profitability is the outcome of matching business expenses and receipts, while liquidity focuses on cash generation and the spending capacity of a business. Since cash is the king, therefore, a business with a strong liquidity base is more likely to survive in the long term than a business that merely generates more profits by relying on overtrading.
Knowing about Key Performance Indicators (KPIs) of a business
For many small businesses, the only KPI is the overall profitability of a business. However, if a business is asked how that profitability has arrived, they remain clueless about the factors that are responsible for the profitability or losses of a business. These factors may include classifying business expenses as avoidable and unavoidable, fixed and variable, marginal and incremental; and classifying sales of products and services as profitable and loss-making, stagnant and exponential, retrograde and progressive, etc. By developing and monitoring KPIs that focus on critical factors impacting a business, a successful business strategy may be developed that ensures long-term profitability and growth in the net worth of a business.
Tax impact of capital and revenue expenses:
A proper understating of the tax impact of capital and revenue expenses is vital to arrive at an accurate profitability figure. Many small businesses wrongly classify certain capital expenses as revenue expenses and vice versa. Consequently, the profitability figure may show erratic patterns and the tax liability of a business may be miscalculated.
Real time accounting systems:
Many small businesses keep their record in a conventional manner. However, nowadays many bookkeeping software are available in the market that may be used to develop a real-time-based accounting system that can be connected with spreadsheets for financial analysis.
Submitted by:
Baqar Bhatti LLB, CPA, CMA, CGMA | CEO & Owner of Panacea at Zenith | 289-952-3494 | accountants@pazca.com | www.pazca.com