When entrepreneurs are asked why they do not keep financial records current, common replies are that they are too busy with day to day operations, they do not have the expertise or cannot afford the staff, and most commonly “I built this business from the ground up. All I need to know about running my business is in my head”.
Without current financial records important decisions end up based on mentally retained or verbally obtained information. Relying on this form of record keeping may be adequate for a small business with simple processes, but for most other businesses maintaining current financial records is necessary.
What are the benefits of current financial records?
There are many benefits:
First it is a management tool. Up to date financial records allow you to measure how efficiently you are using your business resources and whether you are making a sufficient profit to meet family expenses, retirement planning, and other needs and desires. Financial success is determined by profitability. If a business is not profitable it may not be sustainable.
Second it is a planning tool. One of the greatest weaknesses from verbally or mentally obtained information is the inability to do accurate planning. Few people have sufficient memory retention to make operational or financial comparisons. One can usually remember facts and figures from current operations but have difficulty remembering their expectations of previous periods except in a hazy way. Good planning can warn of possible future crises. Steps can be taken to prevent these crises, making day to day operations smoother. A small company can benefit from simple planning as much as a large company can from an elaborate one.
Third, it is a tax tool. Good financial records simplify reporting and help increase after tax income. Relying on memory for certain financial transactions, can cause lost deductions and tax credits.
Fourth it is a tool for raising capital. Properly kept financial records provide bankers and investor with information necessary to make decisions in your favor. It also demonstrates your management ability.
When does it become necessary to keep financial records current?
The answer is “Day One”! Outside of that, there are several telltale signs:
· Forgetfulness – This is not the forgetfulness associated with a total lapse of memory but from fuzziness of memory. One usually remembers the general information but not the details that were provided at the time. The details are now forgotten and no longer available for management use.
· Inefficiencies – It is time to change when you notice that machines or workers are idle despite having back-orders. Other indicators include frequent stock-outs, product recalls and warranty work.
· Inaccuracy – When information obtained verbally is inaccurate to make competent decisions.
· Lack of time – When there is not sufficient time to look up critical information it is a signal that the information needs to be formally developed and easily retrieved.
· Poor cash flow - You are investing more money into the business to keep it operating.
What financial records are necessary? There are two sets of records needed to be kept current. First are the financial reports – The Statement of Income, The Statement of Financial Position and Statement of Cash Flows. These are report cards used as feed back to compare your business's performance against your expectations. They are also used by investors and creditors to make informative decisions concerning the stewardship of your business.
The second set of records/reports is needed to develop managerial analysis and control. These reports have no set format as required in financial reporting but are designed to aid in making important operational and strategic business decisions. Typical reports are used to develop budgets, control costs, establish competitive prices, accept special orders and determine the financial feasibility of capital investments.
However, no one form of reporting system fits every business. Many factors must be considered - the size of the business (large, medium or small); the type of business (manufacturing, retail, service or agriculture); the form of organization (sole proprietor, partnership, corporation, family, etc). It also depends on whether you currently have or anticipate having employees, fringe benefits or pension plans. Having the wrong system can become a less useful tool wasting your time and money.
The best method to establish a financial record keeping system is to obtain the advice of a professional familiar with your business and applicable tax laws. They can set up a system that will provide both the management control and financial reports necessary to run a successful business. Once established you will find your business running more efficiently and profitably.