Why Accounting Is Important To Your Small Business
And that might be the very reason that many of us balk at the idea of accounting. To many of us, it feels like a boring look at the past.
- How did we do last month?
- What were our sales last year?
- What was last year’s lowest sales month?
For those of us who love plowing forward, accounting can seem like a waste of time. But what if I told you that the future success of your business could be greatly influenced by your accounting efforts today?
It’s true. If you want to bring your business to the next level, you need to start thinking about your accounting processes.
Why Is Accounting Important For Small Business Owners?
My friend, Ashley, saw first-hand how accounting can be the difference between a business thriving or closing its doors. Her dad, who owned a tree service, passed away in April 2013. A month later she was in charge of the company.
Ashley said that her dad didn’t keep good books and was just pouring his own money into the company. By the end of June she could see that without doing something, the company was going to be out of business by the end of the year. Here’s what Ashley said about the discoveries she made about her dad’s business in those first few months.
The company did not make money but my Dad didn’t know it because it seemed like it was making money. Everyone was busy! But I found an application for a $100k loan on his desk when he died. I have no doubt he was going to use that money to fund this business.
Through taking charge of her dad’s books and cleaning them up, Ashley was able to turn his business around. Let’s take a look at why accounting was so important for her dad’s business and why accounting it’s important for yours as well.
1. It Can Help You Find Important Trends In Your Business
Perspective can be hard to come by when you’re out doing the actual work of your business on a day-to-day basis.
When you’re in the trenches finessing a sales call or working late to meet a deadline, the big picture of your business can be hard to see. As the saying goes, “Sometimes you can’t see the forest for the trees.”
That’s where accounting comes into play. It allows you to climb to the top of one of those trees and truly see if your business is moving in the right direction.
Look Back Through The Records To Identify And Prepare For Slow Times
Lawn and AC businesses are hopping in the summer, but typically slow to a crawl in the winter months. On the other hand, retail stores are busiest in the fall and early winter before experiencing a huge dropoff in the spring.
The point? There are very few businesses that experience the exact same amount of income every month. W-2 employees don’t need to worry about that. But self-employed business owners do.
Accounting can help you see those slow times coming and prepare for them. When you don’t have a realistic picture of what your revenue will be from month to month, it can lead to cash flow problems.
Ashley said that getting through the winter months was a major problem for her dad as he ran his business.
He was taking out too much during the summer and then withdrawing money from his retirement accounts to feed the company in the winter. It was crazy.
You don’t want to be withdrawing from your retirement to keep your business afloat during its slow months. Instead, you want to know exactly how much cash you’ll need to get through these periods. Accounting can help you discover what that number is.
2. It Can Allow For Your Business To Experience Growth
Ah, now this is what you’ve been waiting for. I promised that accounting could help your company experience future growth. And it most certainly can. Here are two ways that accounting could help your business grow.
You’ll have actual figures to confirm assumptions in your business.
Many business owners think that “trusting their gut” has been the key to their success. But the truth is for every story of a business that experienced tremendous growth after a knee-jerk decision by the owner, there are five more stories of businesses laid waste because of ill-planned leadership moves.
But when you keep good books, you’ll have actual figures to confirm assumptions in your business. Ashley gave two examples of how accounting helped her confirm hunches that she had about her dad’s tree service.
Her first assumption? They needed to stop offering residential lawn care. She explained the thought process behind why they were doing lawn care in the first place.
When I took over the tree service we were spending a lot of time and energy doing residential lawn care. I had a feeling we weren’t actually making money mowing lawns but the general consensus was that being in the customer’s yard on a weekly basis gave us a leg up when it came time for those customers to have high-profit tree work done. I got the idea. We provide good customer service on these low dollar items, then we can easily get the customer to spend more money with us later. As long as we break even on the lawn mowing it’s no big deal. It’s like free advertising.
But Ashley explains that accounting helped her see that lawn care was, in reality, a big money pit for their business.
I spent that first year really cleaning up the books and when I was done, I could see that between payroll, gas, maintenance on the always breaking lawn mowers, and time spent on customer service we were losing money mowing lawns. And to top it off, only one of our lawn mowing customers ever did any other business with us.
So what did Ashley do?
I dropped the residential lawn service portion of our business and it freed up so much time that we can now spend focusing on services that actually make money.
In another example, Ashley said that she had a feeling landscaping service wasn’t worth their time either. Again, she turned to the books to confirm her assumptions.
My dad really wanted to turn his tree business into a full-scale landscaping business. But from cleaning up his books I could see that landscaping didn’t make as much money as the tree services we did. For one thing, the company was really efficient at the tree work but we weren’t suited to bid and perform landscaping jobs. Our tree customers were always happy with our work, but it seemed like the landscaping jobs always had issues that either led to lower profits or unhappy customers.
Without the good accounting work that Ashley had done, she wouldn’t have been able to prove her theory about the landscaping service. But the data didn’t lie and it made cutting the service an easy decision.
It made no sense to me to stretch ourselves thin on services that made less money. I decided to stick to our bread-and-butter services, the ones with the highest profit margin and stop bothering with anything else. We increased sales by 70% in the first year, had fewer headaches, and happier customers.
You’ll be able to compare changes in marketing efforts.
Think that ad you ran in the newspaper made a big difference in your revenue? It could have, but you won’t really know the true effect that it had (if any) without accounting. With accurate bookkeeping, you can look back and see if you actually did more business while the add was running.
Good books can also help you see how much of a discount you can offer on a product or service and still make money. Ashley said that accounting helped her decide exactly how much of a discount to offer customers during their annual marketing push.
We also run promotions in the spring to bring in new customers. We know exactly how much we can give as a discount on certain services because we know what our profit margins are.
Accounting can also help you identify the services which are most likely to lead to long term customers. For instance, in the tree business, Ashley discovered that it was better to advertise their tree spraying pest control services than their tree trimming…even though tree trimming generates more profit. Here’s why.
Our highest profit margin service is tree trimming. But tree trimming is a one time deal. People don’t need to get their trees trimmed every three months. But pest control spray is a repeat customer every few weeks. Also, by looking at our books, I can see that pest control spray customers often get their trees trimmed with us. I can offer one free pest control service when you sign up for the summer and still make money. AND as an added bonus we will likely also trim their trees.
Do you see now how accounting can bring you to a different level of marketing strategy and planning? If you love growth, you need to fall more in love with accounting.
3. It Can Help You Qualify for Loans
Being self-employed can make it difficult to qualify for loans. But good accounting practices for your business can help you approach a lender with confidence.
Does your business need capital? Would a $50,000 business loan make it possible for you to invest in needed equipment or buildings?
If so, how are you going to prove to a lender that your business is growing and profitable? You can sell your vision all you want to a lender, but at the end of the day, they’re going to want to facts.
Have you ever watched “Shark Tank?” What happens to the entrepreneurs who don’t have the answers to the “Sharks” financial questions? They get destroyed. And they don’t get the investment they’re hoping for.
They may have a great idea and may have great charisma, but the “Sharks” want to hear numbers. The banker at your small community bank is going to want to see numbers too.
And not revenue numbers. You also need to be tracking expenses (at a minimum). But if you really want to take your accounting to the next level, you should be tracking your advertising campaigns, your cost of customer acquisition, and income per customer.
Income verification is one of the hardest parts about qualifying for a mortgage when you’re self-employed. Why? Because you don’t get a W-2.
Without a W-2, how are you going to nail down exactly what your business brought in last year and how much profit you actually realized? The only way is by keeping accurate books each and every month.
As a self-employed freelance writer who recently launched out full-time. This is something that has hit close to home. My wife and I have been saving up for a while for a down payment on a rental property. We finally decided we were ready to make our move and called up our real estate agent.
He informed me that since I had just quit my day job to launch out as a freelancer, I would most likely be unable to qualify for a mortgage.
He was right. I called up a lender to find out what I would need. He said, “You’re going to need at least 18 months of income history and the loan that you’ll qualify for will be based off your profit (not gross income) during that period.”
And what the lender’s parting advice to me? Hire an accountant so that you can make sure that you get your financial “house” in order.
Hiring an accountant may be something that I decide to do as my business continues to grow. But in the meantime, I’ve taken a few steps to help me track my income and expenses.
If you aren’t doing any accounting yet in your business, the ideas below would be a great place to start.
Need To Improve Your Small Business Accounting? Here’s How You Can Get Started
Getting started with accounting doesn’t need to be complicated or intimidating. Here are a few simple steps that you can take.
1. Open A Business Checking Account
Your first accounting baby step needs to be opening a business checking account. Once you do, ALL income should be deposited there. And all expenses need to come from your business checking account as well.
2. Open A Savings Account For Your Tax Withholding
It’s common for small business owners to highly underestimate the taxes that they’re going to owe on their income. Again, when you’re a W-2 employee, this isn’t something that you need to concern yourself with.
But when you’re self-employed, staying disciplined is key. You can’t spend every penny that you earn. One way that you can stay on the good side of the IRS is by saving 25% of every dollar that you pay yourself in a designated tax withholding account.
If you decide to pay yourself $1,000 from your business checking account, $250 needs to be transferred to the savings account first. I know this will be painful, but trust me, it’s a lot better than having the IRS breathing down your neck for money that you owe them.
3. Choose A Capable Accounting System
By taking the two steps above you’ll be able to see how much profit you made in a given year. But such a simple accounting system won’t be able to give you any deeper insights.
The kinds of insights that Ashley was able to discover about her dad’s tree business required a more in-depth level of bookkeeping. And you’ll eventually need to find an efficient accounting system that can give you those kinds of insights as well.
How do you that? Well, you could hire an accountant. That’s the route many business owners take. But if you can’t afford an accountant right now or simply want to be hands-on with your accounting, you’ll probably want to buy some accounting software.
When it comes to your business, ignorance is definitely not bliss. That was something that Ashley emphasized.
Knowing where you stand is hugely important. Being a seasonal business, cash flow is a big deal to us. We have to save up enough money to make it through our slow times. If I was to guess how much cash we needed to get through the slow times, I’d estimate about half of what we actually need. I know what we need because I can see what we needed in past years.
And because Ashley was able to make informed decisions for her dad’s business, it’s now in great financial shape.
I did everything I could to save this business and it’s still going strong!
That’s the difference that accounting can make. And it’s why you need to make it a priority for your small business.
Here at Cloud Friday, we provide accounting services to all level of businesses. If you need help with your accounting you can learn more about our services here.