Last week we looked at income and the various types of income as part of our mini-series on the elements of your financial statements. Today we’re looking at a very misunderstood area – the cost of sales.

Many people think that cost of sales is the cost of the goods you have bought (or made) to sell to customers. It is not – the cost of sales is the cost of each product that has actually been sold. This means that if you have paid a supplier for stock, that is not yet sold, the cost won’t be included in the cost of sales.

This is important because of where the cost of sales is reflected in the financial statements. Cost of sales is an expense which reduces your profit, and therefore your tax. Thus it should not be overstated, by reflecting all the purchases during the year. The cost should match the sales, in other words, if you sold 10 items, the sales price for those items shows as income, and the cost of those 10 items shows as an expense. The cost of any unsold items sits on the balance sheet as stock on hand.

What if you don’t sell stock, what if you offer a service? Then according to the accounting definition, you DO NOT have any cost of sales. However, this is where pure accounting and the needs of management differ.

The real cost of making the sale may include any number of expenses depending on your business. For example; a service business may consider their technical staff to be a cost of making sales. What about travel and entertainment? Management reporting could include all of these expenses as the cost of sales to help understand how the business makes money and how well it is doing that. No-one said that the management reports needed to be in the same format as the annual financial statements. The accountants can re-classify the expenses for compliance purposes, as long as management has the necessary information to make decisions.

Next week we’ll look at the net result of sales and cost of sales, gross profit.

If you’re not getting the information you need from your management reports, perhaps they read too much like an accountants report, give us a call to help you re-format them into something useful

Over the next few weeks, we’ll be looking at the various pieces of the puzzle that are the financial statements, so that you understand where to look for something, where information should go, and what you can get out of the information presented. Today we’ll look at INCOME, which is at the top of the income statement, usually the place people start.

Not all receipts (into the bank account) are income. This is important to understand, especially if you are managing your business from your bank account. Some receipts are the payment from your customers for your product/service, but receipts may also be of interest earned, repayments of a loan you’ve given, or reimbursement of expenses you’ve paid. The last two should be set off against the original payment and not recorded as income in your financial statements.

In accounting terminology, there are 3 main categories of income:

• Sales of your product or service (which is obviously the most important for most businesses)
• Passive income generated on your assets, this includes interest on your bank accounts, interest charged on loans given to others, dividends on investments, charges for using your equipment or vehicles, amongst others
• Other income, this is income that is not generated by the business, such as grants or donations or profit on disposal of assets

In your annual financial statements, there will be a line for each of these, if relevant. However, from a management point of view, you may want to break them down further and reflect a number of lines for sales in your management statements. You may have separate product lines, divisions, or locations. It can be useful to see the sales at this level to understand what is working in your business. Many accounting packages allow you to print a report showing the sales per product/service, which can be very helpful to review regularly.

Although income will be summarised in your annual financial statements, management should be engaging with the income at a more detailed level on a regular basis to assist in making business decisions.

Next week, we’ll look at cost of sales and the meaning of gross profit.

‘Cash is king’, says everyone to a small business owner. It’s not a platitude, it is true. It doesn’t matter what your sales are if your customers haven’t paid you.

As a business owner, you have it down to a fine art the ability to pay your creditors at the last minute, while chasing your debtors furiously. You’ve mastered the art of putting people off just a few more days so you can pray earnestly that enough money comes in, just in time. You are the King/Queen of last minute and stretching the last cent.

Imagine, it’s one of THOSE months, and you get a call from your accountant reminding you that your provisional tax is due in 2 weeks’ time. After you’ve sat down, had a zanex or a cup of coffee, you scroll through your contacts list to see who you can call, what plan you can make, how you can scrape to get the cash ready in time. As you know, SARS are the worst creditors, they really make you pay if you are late!

Is this your reality? It shouldn’t be. You know exactly what you need to have in the bank to make it through the month, but do you know what the annual (once a year) costs are, and when to expect them? Things like subscriptions, licence fees, membership fees, provisional and income tax, annual financial statements, etc. The annual costs should be included in your diary at least a month in advance to avoid any surprises.

It is also important to plan for these large amounts. Seldom do you have the spare cash lying around just when you need it? It is important to set aside a contribution towards the cost each month. If you provide for it now, regularly and without fail, the money will be there when you need it. And put the provision in a separate bank account so you’re not tempted to use it!

Give us a call if you need some assistance establishing what costs you need to keep track of and how much you should set aside for them.

How do you define performance in a business; more specifically how do you define financial performance? Good performance is very easy to recognise for sports people or athletes. There is a target that they are working to beat; say their last marathon time, or their personal best, or the world record, or even just their rival’s score. It is obvious when they have performed well and when they have underperformed. It’s also obvious from the celebration – the fist pump in the air or the lap with the flag.

What can we learn from the world of sports when it comes to the financial performance of our companies? The most under-rated lesson is to CELEBRATE good performance or even just better performance. We are motivated to achieve more, to do better, when we recognise the work that has already gone into our performance and identify the things that have gone right or are working well. Celebrating also gives us a moment to stop and reflect on what we have changed/improved that has made all the difference, and imagine how to do more of that thing.

Another lesson from the world of sports is how to tell if performance is good or bad. There is always a TARGET that the person is trying to reach. In business we often consider performance to be the profit of the company. In fact, the income statement (showing the profit) is now called the Statement of Financial Performance. Setting a target for the profit of the company is a good idea. However, it is also important to look at the variables/elements that generate that profit, as they all need to work together to reach the target you have set. Consider setting realistic targets for your costs, for your turnover, for specific products. What about the management teams, sales people and internal processes that are necessary to achieve your goal performance?

Set up a meeting with our financial management team and we will help you to identify the cause and effect relationships in your financial flow, to establish where you should set targets for improved financial performance.

When you are asked for your financial information, most business owners think TAX, which is very pertinent at the moment, since there was a tax deadline at the end of January and there is a provisional tax deadline coming up at the end of February.

But financial information shouldn’t only make you think about your taxes and complying with SARS’s requirements. There are so many other important reasons to understand the finances of your business. If you’ve ever watched an episode of Dragon’s Den, you’ll know that Peter Jones always wants to know the numbers of the business, and it is fatal if the business owner doesn’t have the right information at their finger-tips!

You might not be entering Dragon’s Den any time soon but it is still important to know your numbers; what your turnover is so far and in the last month, what profit you’re making, which are your most successful products, who are your worst paying customers.

As creative entrepreneurs, we often shy away from the numbers, but the information tells a picture and sometimes a picture (or graph) can tell the story. We are using graphs more and more when communicating financial information to clients, as it is easy to see what happened and where you are going, without engaging with the numbers.

If you are not getting a clear picture of your accounting system and financial reports, give us a call and we’ll use the numbers to help you tell your story.

Trust is such an important aspect of every part of our lives. We cannot reach our full potential without someone trusting in us and trusting others. However, trust is earned and proven time and again. Would you trust your baby boy to someone you didn’t really know well? Of course not! So why do we trust our business, our resources, our finances, the baby of our blood, sweat and tears, to staff, consultants and suppliers that we don’t know very well?

When you first started out, there were 3 people in your business – me, myself and I. You opened up and locked up, you made all the payments, and you didn’t have petty cash. But as your business has grown, you’ve involved more people in your dream. You’ve put processes in place to ensure the quality of the product or service being delivered, and to ensure the performance of your staff and suppliers. What processes have you put in place to protect your assets and resources?

The following are some things that you may have done, or should do:

– Insurance for computers, equipment, personal income protection and medical

– Log books for vehicle usage to prevent personal use

– Lock away and issue out keys for computer and electronic equipment, supplies, and the office

– Lock away petty cash and give the key to only one person

For all the resources (equipment, cash, access to bank accounts) there should be written authorization that the person is allowed to use the resource. Then if something happens, it is clear who had the keys last and who was responsible.

So often there is the sad story of when the trusted bookkeeper left and a new person started. The new person stole a large sum of money and covered it up in the books. Just because one person is trust-worthy doesn’t mean everyone is. The process of checks should be in place regardless of who does the job. It protects the employee (and the other staff) from undeserved suspicion or blame.

Another reason for checks and procedures is to make sure that the financial information that you are relying on to make decisions is accurate and complete. Some ideas include:

– Written authorization for all payments

– Sequential numbering of documents to easily see if anything is missing

– Supporting documentation that provides evidence of the transaction

– Reviewed bank reconciliations

If you are concerned that you may not be able to rely on your procedures, please contact us to conduct a review of what you are currently doing and provide you with recommendations and changes to help protect your future business.

Do you save your shopping lists? My dining room table is littered with old lists written on the back of envelopes or scraps of paper, which have been pulled out of my handbag when I’m looking for something. Occasionally, I’ll bundle them up and dump them in the recycling. They are no longer useful.

Now imagine if I kept all the lists and each week compared what I bought with the last week? Over time I’d be able to draw some insights from the information, such as how often we bought toilet paper, how much we spent on average over a month, or how much the hot chocolate quantity increased over winter. Now the lists are useful, have value and can help our family make decisions around our spending. This is Financial Reporting and it works the same for your business.

The key element necessary for reporting to be useful is there has to be a comparison of some kind:

– Compare this week to last week to establish trends;

– Compare the reality to the plan (the budget); or

– Compare the income to the expenses to see if the activity is viable.

For comparison to be valuable, the items you are comparing need to be for the same period and for the same thing. If I want to know if the price of oranges has increased since last week, I need to compare oranges with oranges and not oranges with apples. Also, it isn’t helpful to compare what I spent on ink or paper this week with the whole of last month, it is better to compare this month with last month, to gain any useful insights.

We must not forget that the whole purpose of putting together financial reports is to provide useful information to make decisions. If the type of information or the format it’s presented in, does not give insights into the reality of the business situation, it is a waste of time. Choose wisely what you report on, as too much information can also detract from the value of the reports and confuse the decision-making process.

Next week we wrap up this series by discussing how we can reduce our financial risks.

In our series in financial management, we are talking about Recordkeeping this week. Recordkeeping comes in many different forms; people keep diaries to record their day, people keep a record of the statistics for their favourite football team, people record the rainfall on a daily basis. Each of these records serves the same purpose – to summarise information in a way that helps us to make decisions.

The same applies to financial recordkeeping in a business. Whether it is recording cash payments in one of those old-fashioned ledger books, importing bank statements into an accounting system, or typing in the details of your slips on a spreadsheet, the purpose remains, to make sense of the noise and create order from the chaos.

A recordkeeping system in your business takes all the details (payments, invoices, slips) and summarises them in the way that is useful. Typically similar items are grouped together, say, payments in a spreadsheet. These are then categorised in some way – payments for entertainment, groceries, stationery, rental, salaries, etc. In this way, we can use this information to draw out some conclusion, such as, how much are we actually spending on entertainment, how much has the spending on office consumables increased over the last 3 months, how much does leave cost the company?

The objectives of a good financial recordkeeping system are:

– To include all transactions

– To use consistent categories to be able to compare similar transactions over time

– To produce summarised information in the same format as the plan or budget

– To be a data source that is useful and relevant

– To be up-to-date on a regular basis, so the information is useful for timely decision making

Nowadays, a lot of the legwork of a recordkeeping system is automated in an accounting package. A number of accounting packages are cloud-based and inexpensive, taking the hassle out of updating a spreadsheet at the last minute.

If you are undecided or have not yet considered a financial package for your business, then please contact us for some recommendations.

Next week, we’ll look at the output from all this recordkeeping, the financial reports, where it finally starts to actually help you run your business.