Book Keeping

 
 
 

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Book Keeping

Regardless of the size, type or location of your business, all businesses have very similar financial and book keeping requirements driven by standard accounting practices and the regulated banking sector. This includes the Australian government via the Australian Taxation Office and Australian Securities and Investment Commission, amongst others.

 
     
 

Need for Accounting

Some businesses may choose to manage their own in-house accounting using readily available software products such as MYOB or Quicken amongst the better known packages. Such businesses may already have a good grasp of accounting fundamentals, call upon external accountants for independent audit or advice as needed, and their next development step is business management coaching.

Other business owners, however, may be struggling with a shoebox of dog-eared receipts, be working long hard hours, and feel like they’re paying everyone else with nothing left at the end of every month for themselves. If you can relate to this “working hard but not getting anywhere” merry-go-round, then change is needed.

 
     
 
 
     
 

Taking Control of Finances

Most businesses fail not because the owner or key person is lazy or unintelligent, but because during the start up or early days the owner or key person is the technician, and therefore possessed the key technical skills to perform the businesses core process. What this means is the key person in a café is most likely the barista, a restaurant it's most likely the chef or maitre d', a salon it's most likely the hairdresser, etc.

In other words, the key person or owner are often one and the same, and started off doing the technical work process converting raw materials or labour into products or services that customers want to buy. The catch is the owner or key person may be a great technician (fantastic coffee, gourmet a la carte meals, and a glamorous hair style), but inexperienced on the business side to manage money, resources, cash flow, costs, and margins.

Thus, they helplessly end up on an uncontrolled bucking bronco ride between profit and debt. It may be exhilarating for a while, but no one wants their business and financial future left to the mercy of an uncontrolled bucking bronco. If nothing else, take control of that bronco and start taming it.

     
 
 
     
 

Managing Inputs

Identify your business inputs as raw materials purchased from suppliers and labour from yourself and staff. Other considerations include rents paid to landlords, utilities costs, council rates and licensing costs, if applicable. There are also royalties if you are a franchisee, equipment maintenance or replacement, advertising, cleaning, and more.

Inputs are necessary, as they feed the business to produce products or service for customers to buy. If uncontrolled, they also drain money out of the business.

 
     
 
 
     
 

Separating the Inputs

Fixed costs remain relatively static regardless of whether the business is making sales or not. Examples of fixed costs are rent, salaries for permanent staff, interest on long-term borrowings, and subscriptions that remain unchanged whether the business is having a good or bad month.

Variable costs are those that scale up or down in synch with business activity or can be turned off at the owner's discretion. Examples of variable costs are raw materials purchased to meet sales or production, wages for part time or casual staff that are employed only when there are customer orders to be met, and power and water for those industries that consume a high amount of utilities during production.

Advertising is considered a variable cost not because an increase or decrease in business activity dictates advertising spending, but because the business owner can exercise discretion whether to turn advertising on or off.

 
     
 
 
     
 

Measuring Fixed Costs

The reason for the separation and record keeping of fixed versus variable costs is because fixed costs cannot generally be changed quickly in response to business conditions. You cannot vary rents payable to the landlord just because times are tough, as rent is normally locked for the lease duration.

You can, however, make more efficient use of raw materials by renegotiating with suppliers, reducing wastage or drawing down excess inventory. You can also tighten up staff rostering to reduce cost of idle time.

Managing fixed costs for long term and variable costs in short term will help business efficiency. That starts with knowing what to count, measure, report and compare against your previous business performance, peers and competitors in similar industries and localities.

 
     
 
 
     
 

Opex and COGs

An even more granular view of the business can be obtained by separating business input costs into Operational Expenses (Opex) and Cost of Goods (COGs). Opex is similar to Fixed Expenses, but includes costs consumed by the business itself.

Examples of such costs are cleaning supplies, staff uniforms and laundry, machinery repairs, pest control and building maintenance. Most businesses consume Opex even if such costs are not directly related to any particular sale or customer transaction. COGs, however, are direct inputs into providing goods or services sold to customers.

The benefit of taking this approach is the ease by which the business can compare COGs against selling price, and calculate sales margins by individual product/service or category. It can measure whether the business is not only making enough profit to cover COGs, as well as whether it is making enough to cover Opex and leave a surplus for the business owner.

 
     
 
 
     
 

Performance Analysis

By understanding the difference between Fixed versus Variable costs and Opex versus COGs, the business can start to do “What If” analysis to decided where to focus attention on maximising opportunity and profits.

  • Reduce COGs or Opex but retain current sell price and unit volume?

  • Raise COGs or Opex to produce a better product or service that customers will pay a higher price?

  • Reduce selling price to increase unit sales?

  • What other permutations are possible?

  • At what point does the business reach breakeven?
Once the business reaches breakeven, there is no loss but also no profit. Provided there remains enough business days left in the accounting period (typically a calendar month) after breakeven, this is the remaining window of opportunity to make real profits.

A good business reaches breakeven quickly and gives itself maximum time to make profits. A poor business doesn’t reach breakeven or too late with no time left to make profits.

The simple use of an Acer PC and a spread sheet program such as Excel for simple cashbook management can achieve much of the above, giving the business greater control, more immediate feedback how the business is tracking and therefore time to adjust if necessary. Data files from the simple cashbook management can be emailed or shared with a professional accountant for the preparation of Profit and Loss statements, balance sheets and taxation reports that may be beyond the skills or capability within the business itself.

 
     
 
 
     
 

Monitoring Cash Flow

Cash flow is about monitoring when your bills are due to be paid and have you collected enough money to pay on time. Unless it is an entirely cash sale business or has deep pockets, most businesses need to collect enough payments from trading term customers in order to pay bills. If the timing of collections from customers is not enough to meet bills when they are due to be paid, then the business is experiencing cash flow stress.

Businesses experiencing cash flow stress often turn to short term borrowing, and the most common sources are Owner Equity or bank overdraft facility. Owner Equity is when you the business owner put in more of your own money. Whilst this provides short term relief, the risk is if steps are not taken to improve cash flow management, then there may be further ongoing requirement to inject more Owners Equity over and over again.

In addition to draining the business owner's personal savings, the ongoing injection of Owner Equity tips a Key Performance Indicator (KPI), the Return on Owner Equity (ROE) into poor condition. This devalues the marketable value of the business should the owner ever decide to sell and cash out.

Bank overdraft, on the other hand, is a preapproved standby loan and the business pays an interest rate for borrowings. Continued or ongoing dependency of bank overdraft, however, adds another cost to the businesses' input costs that can otherwise be avoided by better financial management. If the business is too busy paying off bank overdraft, then that business is not paying the owner a profit return.

The most basic steps to improving cash flow is monitoring when the business' bills are due to be paid and comparing to when the business collects payment from trading term customers. Also important is to monitor how much inventory you buy into the business, what your trading terms are with your suppliers, and compare these dollar values and payment dates against your sales and collections.

Get the mix right and the business will fund itself from the generosity of suppliers and patronage of customers.

 
     
 
 
     
 

Useful KPIs

Key Performance Indicators (KPI) are used by accountants and business management professionals to measure the health of the business. Regular monitoring of KPIs is like having ongoing health or fitness checks to ensure you are physically in good shape, ready and able to take on whatever the world throws at you.

At first you may require help from your accountant or business coach what to check, how to check and what do the results really mean. But if you're willing to learn, then you will eventually be able to do these checks yourself and take better care of your business health.

There are many KPIs but always easier to start small and simple with the basics.

Ratio Indicator of Method What does this mean compared to industry benchmarking?
Gross profit margin % of gross profit on sales (Gross profit x 100) ÷ sales Too small a Gross Profit Margin and the business risks going broke. Too high a Gross Profit Margin and the business risks being uncompetitive.
Net profit margin % of net profit on sales (Net profit before tax x 100) ÷ sales If Gross Profit Margin is healthy but Net Profit Margin is low then the business is inefficient.
Material to sales % of sales dollars spent on materials (Direct materials x 100) ÷ sales A low ratio means the business adds value to the materials and sells the Output for healthy profits. A high ratio means the business adds little value and sells the Output for low profits.
Labour to sales % of sales dollars spent on labour (Direct labour x 100) ÷ sales A low ratio means the business has either very efficient labour management or Output requires very low labour input.
Overhead expenses to sales % of sales dollars spent on overhead expenses (Overhead expense x 100) ÷ sales If this ratio is high then the business is burdened by high Opex or Fixed Costs.
Stock turnover Number of times stock turns over Cost of goods sold ÷ (0.5 x opening + closing    stock) Ideally stock turns should be within supplier trading terms and sufficient to meet Customer orders in timely manner. Well managed stock turns reduce stock obsolescence or spoilage and frees Working Capital.
Debtors turnover Average time to collect debts (Debtors x days in period) ÷ credit sales Collecting debtors on time or ahead of time improves cash flow, reduces borrowing costs, improves liquidity and Return On Equity.
Working capital Liquidity of business Current assets ÷ current liabilities A high ratio indicates the business is resourced, has a high level of Owner Equity and able to pay debts. A low ratio indicates the business may be financially stressed or dependent upon borrowings. A negative ratio indicates the business may be insolvent.
Liquidity (also known as quick assets ratio) Solvency of business Current assets (minus stock) ÷ current liabilities Quick ratio is an indicator of the business ability to pay bills assuming inventory stocks will be slow or difficult to sell.