Category Archives: Accounting

General thoughts on debits and credits.

Fair Market Value or $1 Buyout…it depends.

Posted on by

All businesses will have major purchases of some sort.  These major investments and equipment/machinery can be a big decision.  You need to take into consideration how it will affect the bottom line of your company.  If you are very profitable (I hope everyone is), you may need to think about adding to your expense line instead of the asset line.

If you purchase an asset, you can’t necessarily expense the entire amount.  You will be able to expense an amortized amount, interest, insurance, etc.  A lease will allow you to expense the entire amount.  The usable life of equipment can also help make the choice (i.e. do you really want to lease a computer for five years when it will be obsolete in three or less?).  Your overall financial history, cash position and projections can help make this decision.

There is a big difference between a Fair Market Value (FMV) lease and a $1 Buyout lease contract:

  • A FMV lease generally means that you will have a substantial payment due at the end of the lease if you want to own the equipment.  For example, you lease a truck over a four year period and if you want to buy it at the end of the lease for $5,000.  This is a true lease.
  • A $1 Buyout lease to purchase the same truck will have a higher monthly payment.  However, when the lease term ends in four years you have the option to purchase the truck for a small fee…like $1.00.  Of course you are going to buy a truck for a dollar.

While the second scenario is called a lease, it really isn’t for tax purposes…it is essentially a finance deal because of the relatively low final payment to own it.  Therefore it is classified as an asset, not an expense and you need to communicate this to your tax professional.

No matter how you acquire equipment or other major investments, the factors are numerous in making the decision.  There is no wrong answer, just the right one for you and your business.

Profitablility vs. Cash Flow

Posted on by

I work with business owners of varied educational background.  Even if they have had a formal business class, it’s sometimes been a while. Discussions regarding the difference between profitability and cash flow are frequent.  Let me explain with a very simplified example.

In January, you purchase $1000 worth of paper to make and then sell origami swans.  You have to pay staff, rent, and utilities, too.  Let’s say that’s another $2000.  We have spent $3000 so far.  On January 31, we sell half the origami swans we made for $4000.

At this point, we show a profit of $1000.  We have $4000 in sales and $3000 in expenses for a net profit of $1000.  We don’t actually have that money yet.  The customer who bought the product will pay us in 15 days.  Cash flow is not positive until February 15th when the client pays us.  We have had to invest a bit before making money.

Another simple example is an asset purchase.  I buy a new paper folder for my origami swan business for $5000 cash.  This is a large purchase that has value that I could sell.  I can’t not expense the entire purchase price of the folding machine…it is going to be depreciated over 7 years.  My bank account will reflect that $5000 went out, but there is not a $5000 expense to match.  I will only be able to expense $1200 this year for the machine.  Net result is $5000 less is cash, $1200 more in expenses, and we have about $3800 in assets.

Surely, every business needs to review the Profit & Loss (Income Statement) frequently.  But you must also realize that this reflects only part of the financial status of your business.  The P&L Report must be used in tandem with your Balance Sheet report to get a more accurate picture.  Both of these reports can be run quickly in QuickBooks anytime.

Major asset purchases.

Posted on by

Speak with your tax professional about what minimum limit you should track for major purchases (i.e. items over $500, $1000, etc.).   These are items that could be computers, machinery, office furniture, leasehold improvements and so on.  Usually, these items can’t be expensed all at once.  They are amortized over the course of 3 years, 5 years, 7 years, or longer.

Your tax preparer can help you classify these assets and let you know the schedule of depreciation.  A program like QuickBooks can help with tracking individual assets, too.  You can then setup the monthly depreciation expenses so your financial reports will be more accurate.  Also, speaking with your tax professional BEFORE the end of the year can help you plan whether you should make a major purchase now, or delay into the next cycle.

Also, don’t forget to keep good records about these purchases.  Keep original invoices to archive indefinitely.  You should also keep receipts for freight charges, delivery, installation services (i.e. electrician to wire power for a new piece of equipment).  Expenses directly related to the specific asset may also be part of the deprecation schedule.  Keep good notes and make sure your vendors detail their invoices to you accordingly.

Tax law changes each year, and the qualifications for assets also change.  You probably maintain a maintenance record for major equipment.  Don’t forget to keep thorough financial records as well.

Buried by credit card receipts?

Posted on by

I had a client that had more than eight credit card accounts.  Some of those had multiple card holders.  To make it even more complicated (as if it were possible), the cards were issued for multiple legal entities within the same business.  Oh yeah, and sometimes they used the cards for personal things.

In perfect  “Bookkeeper-Land”, there would be one card for each entity and business owners would never use it for personal things.  The truth is I can’t think of one business I’ve ever had where this has been the case.  And you know what, that’s my job.  I organize the chaos and work behind the scenes to make it look pretty.

I start by identifying each card by the last four digits as it’s “name”.  Seriously, there are multiple Visa cards and they each have a different financial institution behind them so I can’t call it “Visa” because they might be three of those.  Using the last four digits is handy also when the receipts get dumped on my desk.  Why?  Because that is usually the only identifying quality to tell which account the receipt belongs to.

I make notes on receipts as to why a purchase was made and/or what account it will be coded to.  The receipts can sometimes be small, so I staple them to a sheet of paper to write my notes to the side (i.e. Mr. Doe had lunch with prospective client Ms. Smith).  I keep a folder for each of the cards by the last four digits for incoming receipts.  At the end of the billing cycle, I at least have the receipts sorted and I can then interrogate the primary card holder about the other transactions.  No way around it…you still have to track folks down.

I keep a separate short term asset account on the chart of accounts.  That is where I code the personal items of the owner in case they don’t cut a check back to the company right away.  I don’t want that payment to delay my reconciliation of the account but I have to keep track of it.

It’s not always pretty, but it is the reality.  I like the challenge of the credit card puzzle, I guess.

Are you accrual or cash basis?

Posted on by

This is a question that you only have to answer once.  And you want to answer it correctly…once you pick a basis for your business, it is FOREVER.  That’s right.  Once you set up your company’s financial house you will never change this option.

What this means… when do you realize income and expenses?  A sale is made today.  If a business is on ACCRUAL basis the sale is realize today.  However, if we don’t realize the sale until it is actually paid for, that is CASH basis.

Okay, here is an example.  I make origami swans and I sell them in my awesome origami store.  On January 15th, a customer came in and bought $50 worth of swans.  I also sell them wholesale to an origami store in Texas.  They bought $300 worth of my paper creations but will not pay me until February 15th.  Since I am on an ACCRUAL basis, I have $350 in sales on January 15th.

Now, using the same dates and amounts…I sell $50 worth of swans on January 15th, and since it is a retail customer they pay me with cash that day in my store.  Then, I sell the $300 order of swans to the store in Texas.  I ship them and they pay me $300 as agreed on February 15th.  If I am on a CASH basis, my sales are $50 in January, and $300 for February.

Most businesses are going to be on an accrual basis.  A medical or dental office is a good example of a cash basis accounting business.  Why?  They are going to generate charges for a patient, but they must wait on insurance payments, make adjustments, collect the patient portion, possibly resubmit to insurance.  There can be a significant delay in reconcililing all the payments for a single event so a cash basis works better.

The industry you operate within will most likely dictate this decision.  You need to know this when you setup your accounting software from day one.  If you are really confused as to which is more appropriate, speak with your tax preparer or CPA.