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Business Finance 101 – Accounting Standards / Principles (GAAP) – why is it important to have?

Business Finance 101 – Accounting Standards / Principles (GAAP) – why is it important to have?

Accounting Standards / Principles (GAAP) – why is it important to have?

When we do accounting (which is recording the monetary values of financial transactions) there are general rules and concepts that have been developed over many decades that apply. These are called basic accounting standards / principles or guidelines and are the groundwork on which more detailed, complicated, and legalistic accounting rules are based.

In Australia. The Australian Accounting Standards Board (AASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards.

There is a phrase “generally accepted accounting principles” (or “GAAP“) which consist of three important sets of rules: (1) basic accounting principles and guidelines, (2) detailed rules and standards issued by AASB, and (3) the generally accepted industry practices.

When a company distributes its financial statements to the owners or the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company’s shares are publicly traded, federal law requires the company’s financial statements be audited by independent public accountants. Both the company’s management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP.

GAAP is useful because it attempts to standardise and regulate accounting definitions, assumptions, and methods. Because of generally accepted accounting principles we are able to assume that there is consistency from year to year in the methods used to prepare a company’s financial statements. And although variations may exist, we can make reasonably confident conclusions when comparing one company to another, or comparing one company’s financial statistics to the statistics for its industry. Over the years the generally accepted accounting principles have become more complex because financial transactions have become more complex.

The Accounting Standards (GAAP) are split into various categories eg “Statement of Cashflows”, “Construction Contracts” etc and a list with most recent updates/ pronouncements for Australia can be found HERE.

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Business Finance 101 – What are the key financial ratios that help you understand your business financial health

Business Finance 101 – What are the key financial ratios that help you understand your business financial health

What are the key financial ratios that help you understand your business financial health

With several months of transactions recorded and bank and credit cards and loans reconciled, an important business finance task each month is use the hidden value in your bookkeeping to get key financial ratios to track how the business is going, to understand your business financial health.

To save time, use the reporting features to generate some key margins and ratios. These are like a report card for your business. The most common to monitor are –

  • Gross profit,
  • Net profit,
  • Current ratio,
  • Quick ratio and
  • Debt to equity ratio.

Use the Profit & Loss statementTip – in MYOB choose with YTD (year to date), or in Reckon/Quickbooks, modify to include the YTD. This will automatically give you a percent column that is the amount of Gross Profit or Net Profit as a percent of the total sales at the top. See our Business Profit and Loss Statement and Profit Margins post for more detail to understand more and how to calculate manually.

Then compare to your peers – Do you know what your industry Gross Margin % is?

Call us and we can give you a guide for FREE!

Use the Balance Sheet to look at the next ratios, which give an indication of the health of your business –

Current Ratio = Total Current Assets / Total Current Liabilities

This confirms whether the business has enough current assets to meet payment of its current debts (current refers to assets and liabilities that will fall due within 12 months). It includes inventory value, as this will be turned over in less than 12 months.

Quick Ratio (Acid Test) = Cash + Receivables/Debtors / Total Current Liabilities

This is like current assets without inventory which can take time to sell if a fire sale is needed, and is mostly the liquid assets. The higher the amount the more “Stable” the business is. That is, the higher it is, the longer the company can stay afloat.

Debt to Equity = Debt/Equity

Divide the amount of debt usually total liabilities) by the equity (owner’s or shareholder’s). the lower the better, but some debt can help you grow and is called leverage – debt can be beneficial, but it must be manageable – higher than 1 can be a warning to keep a close eye and manage the debt carefully. See more

The key is to see that huge value lies in your bookkeeping records! The books are and asset not a liability or expense – they are an invaluable source, so use your bookkeeping to get key financial ratios to track how the business is going.

Need help? Not sure? Call for FREE 30min advice / strategy session today!

Call 0407 361 596 Aust and also get FREE “Avoid these GST mistakes” – There’s 18 that the Tax Office see regularly – Get them right!

Email info@accountkeepingplus.com.au or call 0407 361 596 Australia


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Business Finance 101 – What is Working capital – and how it can be used

Business Finance 101 – What is Working capital – and how it can be used

What is Working capital – and how it can be used

Working capital is defined as the difference between current assets (CA) and current liabilities (CL) at a specific date. The CA and CL amounts are found on your company’s balance sheet. For example, if your company’s balance sheet has current assets of $150,000 and current liabilities of $120,000 then your company’s working capital is $30,000.

Working Capital = Current Assets – Current Liabilities
Normally we want cash and assets that can be turned into cash within 12 months, such as Inventory, debtors who owe the company etc (ie “Current” means within 12 months) to be GREATER than Current (12 months) Liabilities.

But with a significant amount of working capital, a company can still have a period of cash shortage if its current assets are not turning to cash. As an example, a company with most of its current assets locked up in inventory. Or if a company has a large accounts receivables that are not being collected, but even still, this large working capital situation isn’t much immediate help when you can’t meet the payroll run!

There are also other financial ratios use the working capital components such as the current ratio, quick ratio, accounts receivable turnover ratio, and inventory turnover ratio.

Good management means keeping watch on current assets (receivables and inventory) to keep the cash coming into the bank.

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Business Finance 101 – Current Ratio – What is it and what does it show?

Current Ratio – What is it and what does it show?

Business Finance 101 – Current Ratio – What is it and what does it show?

There are several financial ratios including the current ratio which shows the proportion of current assets to current liabilities. The current ratio is known an indicator of a company’s liquidity. Put in another way, it shows when there is a large amount of current assets in relationship to a small amount of current liabilities there is some assurance that the obligations coming due will be paid.
As an example if a company’s current assets are $500,000 and its current liabilities are $250,000 the current ratio is 2:1. If the current assets are $600,000 and the current liabilities are $500,000 the current ratio is 1.2 : 1. Clearly a larger current ratio is better than a smaller ratio in comparison to current liability. Generally, a current ratio that is less than 1:1 indicates insolvency, and the preference is at least 2:1, or over 2.
When benchmarking a company, or comparing your own, it is wise to compare a company’s current ratio to those in the same industry. It is also worth keeping a close look at the trend of the current ratio for a given company over time. Is the current ratio improving over time, or is it deteriorating?
The composition of the current assets is also an important factor. If the current assets are predominantly in cash, marketable securities, and accounts receivable, that is more valuable than having the majority of the current assets in slow-moving inventory.

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Business Finance 101 – What is Equity?

Business Finance 101 – What is Equity?

Business Finance 101 – What is Equity?

I am asked at times – what is equity? If we deduct Liabilities from the Assets of the Business (at cost value), we are left with Equity. These are listed in the Balance Sheet financial statement. Another way is –

ASSETS – LIABILITIES = EQUITY

Equity is also sometimes used to refer to as ownership of shares in a company.

In a company Balance Sheet it is the amount of money contributed by the owners/share/stock-holders PLUS the Retained Earnings (Profit/Loss of past years).

Also note – because assets like plant and equipment are entered at their COST amount (less GST) the MARKET value of the asset is not represented, unless an adjustment is made (by journal) to reflect change of value (and increase or decrease of asset value are then balanced in a special sale or cost of sale asset account). Hence the Company Market Value may not be the true Market Value, unless the adjustment has been made.

Equity can be called Owner’s Equity – for Sole Proprietors, or Shareholder/Stockholder Equity for a company (usually with more than one director).

Owner’s Equity may consist of several accounts –

1.     Capital

2.     Drawings and

3.     Current Year Net Income/Earnings

Shareholder Equity may consist of accounts such as –

1.   Paid-In Capital

  • Preferred Stock
  • Common Stock
  • Paid-In Capital in Excess of Par Value
  • Treasury Stock (stock re-purchased from shareholders)

2.   Retained Earnings/Net Income 

3.   Less Treasury Stock

Equity is also used in several important ratios that help determine financial health of the business, such as Debt to Equity and Return on Equity.

Need help? Not sure?

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Business Finance 101 – COS or COGS – Cost of Sales or Cost of Goods Sold – What it means

Business Finance 101 – COS or COGS – Cost of Sales or Cost of Goods Sold – What it means

COS or COGS – Cost of Sales or Cost of Goods Sold – What it means

Cost of Sales (COS) or Cost of goods sold (COGS) is the cost of the product that was sold to customers. It includes the cost of materials and direct labour used to produce the goods ready to sell. The cost of goods sold is reported on the profit and loss at the time/period the sales revenues of the goods sold are reported.

A retailer’s cost of goods sold includes the cost from its supplier plus any additional costs necessary to get the product into inventory and ready for sale. For example, a store purchases a book from a publisher. If the cost from the publisher is $60 plus $5 in delivery costs, the store reports $65 in its Inventory account until the book is sold. When the book is sold, the $65 is removed from inventory and is reported as cost of goods sold on the profit and loss.

COGS is usually the largest expense on the profit and loss of a company selling products or goods. Cost of Goods Sold are deducted from the sales/revenue.

Cost of goods sold is calculated in full, as follows:

Cost of beginning inventory + cost of goods purchased (net of any return stock) + freight-in – cost of ending inventory.

This account balance or this calculated amount will be deducted from the sales amount on the income statement, leaving a Gross Profit.

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Business Finance 101 – What is the difference between Current and Non-Current Liabilities?

Business Finance 101 – What is the difference between Current and Non-Current Liabilities?

What is the difference between Current and Non-Current Liabilities?

Businesses have liabilities – payments that are to be paid soon or later (long term) they are divided into Current and Non-Current.

Current Liabilities are obligations due to be paid within 12 months or less of the date of a company’s balance sheet and will require the use of a current asset (eg money in bank) or will create another current liability if paid by debt or loan.

Current liabilities are usually listed in the following order:

  1. Credit cards and overdraft accounts, loans less than 12 months;
  2. Accounts payable (trade creditors);
  3. The remaining current liabilities such as payroll taxes payable, superannuation, income taxes payable, interest payable and other accrued expenses.

Often, all the parties who are owed current liabilities are called creditors. In special situations, a legal arrangement may be created that gives preference and then those parties are called secured creditors. The majority of creditors are known as unsecured.

Non-Current Liabilities are liabilities that are to be paid over more than 12 months – typically business or vehicle loans and financing such a Chattel Mortgage. Others include Long Service Leave Accruals, and Directors Loans.

Is the business solvent? One overall method that is used to determine if a business is trading in a solvent manner, is to check if the Current Assets are more than Current Liabilities. The amount of current liabilities is used in financial ratios – such as:

  • Working capital (current assets minus current liabilities) and the company’s;
  • Current ratio (current assets divided by current liabilities).

These give an indication of the company health.

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