What Is an Audit? 

The word “audit” can be thrown around a lot in casual conversation. When an accounting professional uses it, it means something very specific. We’ll discuss this and other uses of the term “audit” in this article.

Financial Audit

A financial audit is an official service designed to inspect the accounting records, technology, and processes of an organization. An audit can only be conducted by a licensed CPA that is independent of the organization.

Independence is a special term as well, meaning the CPA who audits the organization must have no relationship with the organization or its owners and employees. For example, if the organization’s owner is the sister of the auditor, that won’t work!

To conduct an audit, the CPA performs an audit program, which is a set of tasks that review the company transactions, balances, and accounting processes. The audit program is custom-designed to the company based on the risks perceived by the audit team, the type of organization being audited and other factors. Once the audit has been completed, the auditor will issue a formal report stating the findings of the audit. The report typically includes a letter, financial statements, and footnotes.

The auditor’s report can be utilized by the company’s management as well as third parties, such as lenders and stockholders.

While there are mandatory audit requirements for large public companies, government institutions, schools, and some larger nonprofit organizations, small businesses are not typically audited because of the expense. That’s when additional assurance services come in handy.

Other Assurance Services

An audit falls under assurance services in accounting, and it’s the most stringent of all. Other types of assurance services include:

Compilations. In this engagement, the CPA performs basic checks on your financial statements and puts them together with a cover letter. It basically tells a third party that you have a CPA, but it provides the least amount of assurance service.

Reviews. In a review, there are a few more checks and tests that a CPA will perform before issuing financial statements. This service provides more assurance than a compilation, but less than an audit.

Agreed-upon procedures. An engagement with agreed-upon procedures is a very specific engagement where one aspect of the business is reviewed in accordance with a specific goal.

For small businesses who are asked for documents from your accountant by a bank or lender, you can often provide one of these lower-level assurance reports and it will not only suffice, but save your money.

Auditing a Class

Auditing a class has nothing to do with accounting! It simply means you’re sitting in on a college course, but not getting any kind of credit or grade.

The Dreaded IRS Audit

The term audit can also be used informally to define an inspection that is narrower in scope, such as an IRS audit or a state agency audit. There is no assurance provided in this type of audit. The purpose of this audit is to produce whatever records you are asked for in order to verify the numbers you sent to the agency.

An audit may be somewhat of a stressful and unpleasant, but necessary, experience. Having your accountant support you along the way can be reassuring (pun intended).

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The Accounts Payable Process

All businesses, no matter their size, have bills to pay. The larger the business, the more formal the accounts payable process tends to be. That doesn’t mean small business owners can’t benefit from a formal accounts payable process. Too many “fake” bills are being sent, and all businesses should have safeguards in place. Let’s take a look at the workflow of accounts payable to see where we can put some controls in place to protect your hard-earned money.

Purchase Order

A good first step is to initiate a purchase ordering process. All spending over a certain amount, such as $500, should require pre-approval from a manager or officer of your company. This can take the form of a purchase order.

A purchase order (PO) is simply a pledge on the part of your company to purchase an item or group of items from a particular vendor. It should include the vendor’s information, the item(s) and quantities, the price that the vendor has agreed to, and who initiated and approved the proposed purchase. It will look similar to an invoice, but it’s not an invoice and should be appropriately marked.

If the price is not standard or the items are custom, there may be an estimate from the vendor that documents the price on the purchase order. The estimate document is written by the vendor, while the purchase order is originated by your company.

While the purchase order is important, it does not create any entry on your accounting records, as no transaction has taken place yet.

Invoice

The invoice is the documentation of the purchase with a request for payment and is created by the vendor you are obtaining goods or services from. It should be recorded on your accounting books once it is received from the vendor.

The invoice should be matched with the purchase order, checking to see if each item, quantity and price match the same on the purchase order. Any discrepancies should be explained.

The timing of the invoice can vary. It may be received before or after you actually receive the goods or services that it covers.

The invoice should not be paid yet (unless prepayment is required). We’ll cover that in a minute.

Packing Slip

If the goods you have ordered are physical and are to be shipped to you, then there will usually be a packing slip or shipping document included in the shipment. The shipping document will have quantities, but may not have prices.  The document should be matched with the actual items received and any shortages or overages should be noted.

A process to stock the items into your inventory should then occur. A transaction should be entered into your system to increase inventory for the goods you receive.

The (corrected) packing slip should be matched with the invoice to make sure everything on the invoice was received. If there is a discrepancy, it should be noted.

Items may come in a later shipment if they have been back-ordered. You’ll need to set up a process for that, noting it on the appropriate documents.

Approvals

As you can see, a couple of processes need to be put into place. There should be a process for each document listed above. There should also be a process for matching the documents, and there should be a process for when there are discrepancies. Last, there should be approval processes all along the way.

Your workflow may vary from the one listed above, depending on the order the documents are received and when payment is required. You may even have a different workflow for different vendors.

Once the purchase order, shipping document, and invoice have been matched and corrected, it’s time to get them approved for payment by the appropriate level of management that you desire. This is something you’ll want to set up in advance: which of your employees can spend and approve what amounts.

Payment

Once your invoice is approved, it is time to look at the payment terms, noting when payment is due. It can then be set up to be paid. This can be done inside a system, using a company credit card, sending a bank transfer or wire, or writing, signing, and mailing a manual check.

Payment affects your books as well, so an entry should be made when payment is issued.

Workflow

A great accounts payable workflow will protect your company from unauthorized payments, missing items, and even hasty purchasing decisions. There are also many accounts payable systems to support the automation of many of the steps, but don’t forget you still need to set up the processes so they work for your company and the vendors you use.

As always, if you need our recommendations, we’d be happy to help.

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Understanding Equity on the Partnership Balance Sheet

The equity section of a business’s balance sheet is the most difficult part to understand. The accounts that make up that section vary depending on the type of entity in which the business is structured. In this article, let’s take a look at what the equity section looks like for companies that are organized as partnerships.

The Equity Section

As a reminder, the balance sheet has three major sections: assets, liabilities, and equity. The equity section focuses on the investments that the owners have in the business. For partners, it consists of their capital accounts. The section could look like this:

Partners’ Capital

Partner A Capital        $25,000

Partner B Capital        $25,000

Partner C Capital        $50,000

Each partner has their own Capital account within the equity section of the balance sheet. A partnership with 100 partners will have 100 capital accounts in the equity section. Computing the balance for each partner is where the work comes in.

A partner’s capital account balance is affected by numerous transactions throughout the year as well as current earnings, which are distributed to the partners based on their ownership percentages. Ownership rules and percentages are spelled out in the partnership agreement.

Items Affecting Partners’ Capital

To compute a partner’s capital account balance, here is the basic formula:

Balance at beginning of period
Plus Contributions
+/- Partner’s share of net income/loss
Less Withdrawals
= Balance at end of period

Contributions to capital includes money that the partner has given the partnership out of their personal assets. Withdrawals are the opposite: this is money that the partner has taken out of the partnership and used for their personal use.

Net income is a bit more involved, with two more steps. First, the sum of the entire partnership’s income and expense accounts must be calculated. This number should be the same number as net profit or loss on the partnership’s income statement, from the beginning of the year to your balance sheet date. Second, the net income must be divided up to calculate each partner’s share based on their ownership percentages. These amounts are then rolled into each partner’s capital accounts.

To make sure the partnership equity section is accurate, good recordkeeping is a must for the partnership as well as each of the individual partners. If we can help you understand more about your partnership, please reach out any time.

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Pricing Methods

How do you arrive at a price for the products and services you sell? While it depends on what industry your business is in, there are only a handful of foundational pricing methods that are useful to know. Here are several of them.

Time and Materials Pricing

Many service-based businesses price based on the time spent performing the service. An attorney usually has an hourly rate. A massage-therapist will charge based on a 50- or 80-minute service. Plumbers charge a minimum fee for the first hour and another rate for subsequent hours. A moving company charges by the hour (they may also charge by truck or have a fuel charge these days).

In some cases, time-based pricing may be loosely tied to the salary level of the person performing the service, but there must be a substantial markup to cover payroll taxes, health insurance, overhead, training, and any materials or tools that are included.

Cost-Plus Pricing

Cost-plus pricing is used in the retail industry where goods purchased from a manufacturer or wholesaler and made available for sale. This method is based on the cost of the item. A common example is keystone pricing, where an item is marked up to twice the purchase price plus one dollar.

Other industries that use cost-plus include groceries and auto dealers.

Market Pricing

Market pricing is pricing that is dependent on fluctuating market conditions. Commodities are the best example. Crops, oil and gas, and metals are a few items that are priced by market.

Target Pricing

Target pricing is where you start with a price that you feel customers will be willing to pay, then design a service or product around it. It’s most commonly used in the software industry. As an example, let’s say you come up with an idea for a software application that you feel people will pay $49 per month for. You then build a software development and support team around a budget that supports that price.

Value Pricing

Value pricing is based on what the client values and will pay for. For projects, it can be based on the client’s expected return on investment. Value pricing is used in internet marketing and for some services and products.

There is a fine line between premium pricing and value pricing. Some luxury brands may be premium-priced with some value pricing thrown in.

Pricing in Real Life

In business, determining a product or service’s price is part math and part art. It can be a combination of two or more of the methods listed above, or a method not listed above. Many factors and considerations should go into your pricing decisions.

One thing we can help with is to determine if your pricing is adequate for the profit margins you want. We can also help with what-ifs. For example, if you raised your price by ten dollars, but demand went down five percent, what would your numbers look like?

Pricing is a skill to pick up, just like selling, running a business, and customer service are skills you need. If we can help you with your pricing process, please reach out any time.

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Time Batching

For small business owners, it seems like there is never enough time to get everything accomplished. One tool that will help you get the most out of your time is time batching, also called time blocking. If you haven’t heard of this before, it can revolutionize the way you approach work.

What Is Time Batching?

Time batching is where you group like tasks together on your calendar to gain economies of scale. Almost everything can be batched: answering emails, running errands, customer calls or appointments, employees’ questions, and even meetings.

Here are a couple of examples. Instead of running to the office supply on Tuesday, going to the printer on Thursday, and visiting the warehouse on Friday, why not do it all on Wednesday in one trip? Instead of answering emails throughout the day, plan to answer them for 30 minutes at 8AM, 1PM, and 4:30PM. Instead of having appointments scattered throughout the week, make them back-to-back on Monday.

The beauty to time batching is that your brain will be less exhausted at the end of the day. The reason is interruptions are minimized, as are switching costs. Switching cost is the time it takes your brain to switch from one task to the next. Too much switching strains the brain by making it change gears frequently. Time batching helps your brain get into and stay in “flow,” with more work accomplished in less overall time.

Business and Personal

You don’t have to restrict time batching to your work life.  It’s likely you are already practicing time batching at home and don’t know it. When you prepare the week’s meals on Sunday or wash several loads of laundry in a row, you are practicing a form of time batching.

While some things can’t be batched, like walking the dog, many more can. You just need to be open to the possibilities.

The Highest Payoff

The highest payoff with time batching comes when you can reduce the interruptions that happen to you the most. For example, when an employee has a question, could they write them down during the day and approach you at the end of the day with all of them at once?

Emails and texts are constant interruptions for many. The first thing to do is turn off your email and text notifications so that you’re not interrupted every time one comes in. Then, decide how often during the day you want to check for new items. Aim for three or fewer times if your job allows it.

Phone calls can be another interruption. When possible, encourage callers to schedule a time to call you or let them know how much more efficient email is.

Getting It All Done

Time batching is something that you can practice for years and still get better at. Try implementing one piece of time batching at a time to avoid overwhelming yourself with change. Look intentionally for more items to batch every few months, no matter how long you’ve been practicing.

Time batching will not only help you get home sooner to your personal life; you’ll also be less drained and more energized at the end of the day. Try it and see what you think.

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Understanding Equity on the Corporate Balance Sheet

Your favorite number on the balance sheet might just be Cash. It’s easy to understand and something every business has. But there is a more meaningful number, at least in the long-term sense, and that’s equity. Let’s dive deeper into that part of the balance sheet.

The Equity Section

As a reminder, the balance sheet has three major sections: assets, liabilities, and equity. When it comes to equity, the accounts that are displayed are dependent on the type of entity of your business. Your business could be a sole proprietorship, a partnership, a corporation, or something else. In this article, let’s focus on equity in a corporation.

Every corporation should have at least three equity accounts.

  1. Stock.

This account should reflect the amount of stock issued by the corporation. The amount and price of each share is usually spelled out in the Articles of Incorporation, the initial legal document of the corporation. For example, if the amount of shares the corporation can issue is 100,000, and they have a par value of $.01, then your stock account balance should be $1,000, which was paid in by cash by the corporation’s owner(s).

This account might also be named Capital Stock, Common Stock, or something similar. This account’s balance typically doesn’t change much over time for a small business. It’s only when new stock is purchased (issued), sold, retired or repurchased (by the corporation) that the account will see changes.

  1. Additional Paid in Capital (APIC)

Additional Paid in Capital occurs when investors and business owners pay in more than the par value price of stock. The balance represents the difference between what owners/investors paid into the company and the par value of the company stock.

  1. Retained Earnings

Retained Earnings is where the action is and is an important number to understand. It’s the accumulated earnings of the company less any dividends paid to shareholders.

For a small business, retained earnings will change once a year at the end of the fiscal year when net profit (or loss) from the current year is rolled into the retained earnings account. At this time, all of the income and expense accounts are zeroed out to start over for the new year, and the balance (which is profit or loss) is added (or subtracted, in the case of loss) to retained earnings. Your accounting system automatically does this for you, and you can check it out by running a balance sheet as of the last day of your fiscal year, then running a balance sheet on the following day – the first day on the next fiscal year and comparing what changed.

You can reconcile retained earnings by adding up all of your profits and losses for each year you are in business. Then subtract any dividends paid throughout the years, and you should come out with your retained earnings balance. You can have a negative retained earnings balance.

The retained earnings number is a measure of the long-term value of the business. It also plays a large role in determining your basis, or investment, so to speak, in the company, which is used for tax purposes.

An S Corporation will have an additional fourth account in its Equity section.

  1. Distributions

Distributions represent the money that the S Corporation owner has taken out of the business. This money is over and above the salary that is paid to the owner. It must be tracked for tax purposes, which is why it has a separate account on the balance sheet.  In simple terms, distributions are generally not taxable as long as the owner has enough basis to cover them. In this way, distributions are different from dividends that are issued in C Corporations, since they are taxable.

Last, if you run a balance sheet report in your accounting system on any date during the year, you may see an additional account:

  1. Current Year Earnings

This is the sum of all of your income and expense accounts. It should be the same number as net profit or loss on your income statement from the beginning of the year to your balance sheet date. On a formal balance sheet for external purposes, this number is rolled into the retained earnings account.

The equity section can be the most difficult section to understand on the balance sheet. Hopefully, the explanation above will provide a bit more clarity as well as shine a light on the significance of the retained earnings balance.

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Cool Tech Tools: ClickUp™

ClickUp™ is a versatile new web application that serves multiple functions for a small business. It’s primarily a CRM – customer relationship management – with project management and workflow features built in, and is adaptable across several industries.

ClickUp’s goal for its users is to save time and reduce redundancy by tying everything together in one app. Its integrations, which are called ClickApps, are truly its strength. The 1,000+ integrations set ClickUp apart from other offerings, and for this reason, ClickUp excels at automating processes that use multiple apps, including hard-to-automate processes like customer onboarding.

Some of the items people use ClickUp for include reminders, goals, whiteboards, templates, calendars, document flow, task management, dashboards, marketing processes, and team collaboration and communication.

One of the features that is frequently mentioned is the ability to create custom views exactly the way you want them. Views provide a summary of your work and come in many flavors. You can create task views, list views, boards, calendars, Gantt views, workload views, and box views.

If ClickUp has a weakness, it would be its complexity. You really need to be somewhat tech-savvy to get everything set up. The learning curve can be intimidating, but once you get through it, there is so much power in having everything customized and in one platform.

ClickUp does have a following of power users, and a certification of sorts is offered. Becoming ClickUp Verified means that you’ve earned expertise in the product. If the learning curve is too much for you or your team members, you can hire one of these ClickUp consultants to do the setup for you.

As of this writing, ClickUp hosts 4,000,000 users, including the ones on the free version that is for personal use. Monthly pricing for business users ranges from $5 to $19 per user, depending on the features you need. Enterprise options are also available.

ClickUp was founded in 2017, is headquartered in San Diego, CA, and has raised three rounds of funding as of this writing. You can find out more at clickup.com.

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When Your Remote Employee Lives and Works in Another State

Remote working has exploded in the last few years, especially in professional services. Now that companies are seeing the benefits of remote working, they are also seeing the benefits of an expanded pool of potential employees. Some firms are hiring employees that live several states away from where the office is located, which comes with quite a few ramifications for the business.

Let’s say your business is based in Texas. You already file quarterly payroll reports and pay federal payroll taxes for your Texas-based employees. You also already file all the required state payroll reports and have Texas workers compensation. In May, you hired an employee that lives in Cleveland, OH. And in June, you hired an employee that lives in San Francisco, CA. You’ll need to get set up to pay employees in each of these states:

  • You may need to get set up as a Foreign Corporation in these states (the exact paperwork depends on your type of entity as well as the state’s requirements and where your business originates). This means filing legal paperwork as well as complying with annual tax filings and statements of information. You may also need to hire a firm who can be your registered agent and legal contact in that state.
  • You must get workers compensation in those two states.
  • You must sign up with the unemployment agency in those states. For California, it’s the EDD (Employee Development Department), and for Ohio, it’s the Ohio Department of Job and Family Services.
  • You’ll need to work with your payroll provider to give them your account numbers so they can accurately create the paychecks with the appropriate state withholdings.

We’re not quite done yet. You’ll need to make sure you file the correct quarterly payroll reports in addition to your federal ones. Continuing our example: in California, this consists of Forms DE-9 and DE-9C, Quarterly Contribution Return and Report of Wages. In Ohio, there are multiple forms: one for SUTA, IT 3, IT 941, and IT 501, all with exacting filing requirements.

Some states that are small and close together may have exceptions that you can follow to save time.

Nexus

Having an employee in another state creates nexus for your organization, which means that you may have additional tax and legal requirements beyond payroll taxes.

  • If you have sales in these states, you may also need to collect and remit sales tax on those sales and file sales tax returns. The first step is to register with the sales tax agency in the state.
  • As the business owner, you may even need to file a state income tax return and pay state income taxes as an individual, even if you’ve never set foot in that state!

Hiring a remote worker is so easy, but the paperwork that comes after it is anything but easy. Make sure you stay in compliance with all the tax and legal requirements of hiring an out-of-state worker. There can be some lead time in getting all this set up, so be sure to plan for this prior to your new employee’s start date.

As always, if you need help with any of these overwhelming tasks, please feel free to reach out to us any time.

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Is Your Best Skill Aligned with Your Business Model?

When starting a business, most entrepreneurs excel at the specific technical skill set they need in order to deliver their services and products to clients.  For example, if you own a bike shop, you are pretty great at all things related to bikes. If you own a law firm, you are probably good at practicing law. This skill is your core skill.

As your business grows, you need different skills beyond your core skill in order to thrive. That skill depends on the type of business model you want to succeed at. Here are some examples of business models and the key skill you need to be outrageously successful.

People-Based Business Model = Leadership

If your business is one of the 25 percent of small businesses that have employees and you have a team that serves customers, then you most likely have a people-based business model. The revenue you earn is dependent on how your people perform and serve clients.

Some examples would be a mid-sized law firm, a nail salon, a marketing agency, and a mid-sized plumbing company. Each one has a team of people that generate revenue.

These people need to be hired, trained, and motivated, and that is where the skill comes in.  If you have a business model like this, you need to excel at leadership, which includes managing people as well as hiring and firing. You need to be great at developing a productive, happy team in order to reach your highest pinnacle of success. Your core skill is still needed, but without leadership skills, you won’t grow as much as you could.

Acquisition-Based Business Model = Negotiation

Some companies grow through acquisition of other companies. In this case, your top skill should be negotiation; you will need to make excellent deals to keep your business growing.

Project-Based Business Model = Project Management

If your job revolves around delivering large projects, such as construction, possibly IT companies, and some real estate, then your business model might be project-based. While knowing how to be a general contractor might be your core skill, your top skill should become project management.

How well you manage the project timeline, delivery of materials, and management of the right number of people with the right skill at the right time all factors into completing the project as quickly and profitably as you can, with the quality needed so you can move to the next one.

Volume-Based Business Model = Merchandising 

If moving high quantities of products or services is your business model, then your revenue depends on volume and how much you can sell. Some examples of these types of firms include grocery stores, software companies, some retail stores, and wholesalers.

How you display and market your products will affect how many customers you can get in the door and how fast you can sell. Your top skill should become merchandising and all things marketing.

Your Top Skill Is No Longer Your Core Skill

These four types of business models serve as a sampling to show that once you achieve some level of success, your core skill will no longer be the keystone to further success. Developing skills beyond your core skill will take you farther than you ever imagined you could go with your business.

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Five Subtle Ways to Carve Out More Business Profit

Whether we’re headed for a recession or not, it’s always a good time to squeak out more profits from your business books. We’re not talking about drastically slashing expenses or spending a lot to raise revenue; the tips in this article are long-term ideas to gently lift up your profits.

Timing on Capital Purchases

The timing of asset purchases, such as equipment, a truck, or even a PC, can be tricky. Understanding the best timing for asset purchases and replacements can make a difference in your profits.

When purchasing a new asset, gain a good understanding of the return on investment so that you’re prepared from a cash flow standpoint. With more complex businesses, it’s a good idea to hire an accountant who knows your industry and has capital expenditure experience.

When replacing an asset, it should be timed so that the asset is replaced before you have to spend a lot on repairs, but not so soon that you don’t get good use out of it.

Rent and Utility Contracts

When rent and utility contracts come up for renewal, this is the time to bargain. If your landlord hasn’t fixed something, you can at least use pressure to get the repairs accelerated.

For utility contracts, especially internet and phone, the price often goes up when the contract runs out. This is the time to get it lowered back down by asking for a new customer deal (it never hurts to ask!). Communications companies are constantly creating new deals and packages, so you should be able to jump into one of those to keep your costs from going up.

Profit in Leftovers

What assets have you got lying around that aren’t working for you?  Put them to work!

Here are some examples:

  1. Cash – make sure your excess cash is safely invested or at least in an interest-bearing account.
  2. Extra space – rent out space that you are not using or only using some days. This solution can have many different looks to it beyond the monthly renter. As an example, virtual workers looking for a conference room for a day could be a money-maker for you.
  3. Manufacturing firms can sell the scrap from their assembly lines as well as their obsolete inventory.
  4. Excess construction materials can be sold, donated, stored for the next job, used on a new small project, or used as firewood.

Training

If employees are wasting time, they are wasting money in the form of salary you pay them. There are three good solutions:

  1. Offer training – perhaps they haven’t been shown what to do correctly or how to do it efficiently. Or they may need to break bad habits.
  2. Re-energize employees with incentives, new benefits, or motivational training and events.
  3. Redesign your processes and automation, then retrain – it could be your workflow needs revamping to make it more efficient.

If these options don’t work, it could be your employee is a bad fit. You know what you have to do in that case.

Stop the Subscriptions

Those recurring monthly charges just keep adding up. The average small business uses dozens of apps, meaning they also likely have dozens of $20 to $50 automatic monthly charges going on a credit card somewhere in your business. This includes magazines, memberships, dues, conferences, newsletters, gadgets, and software.

If you’re making a lot of money, you may have trouble finding the time to research what subscriptions you really need versus what you don’t. But in the long run, you will make more the sooner you sit down and examine this area of spending. Stop the $20 to $50 madness by reassessing what subscriptions you really need and cancelling the ones you don’t.

Try these five ideas to give your profits a permanent, long-term boost.

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