What Story are Your Financial Statements Telling?
As a business owner, your day is primarily focused on fulfilling your overall mission, meeting customer needs and keeping up with day-to-day obligations. While less of your time is likely to be focused on the accounting policies that your company is using, we’re here to remind you just how important those policies are.
The accounting policies you adopt create the internal reporting standard that’s reflected in the financial statements of your business – all of which impact how you benchmark and communicate success. What story are you communicating to the outside world? How can you report the story in a way that is easy to understand but still communicates who you are, what you do and how you are achieving success?
Focus on Operational Activity, Not Ease of Use
First, when selecting accounting policies to use, your first goal should be reporting operational activity and not necessarily based upon ease of recordkeeping. For example, cash basis reporting is easy as we record transactions on the flow of cash in and out of the organization. But it doesn’t account for the significant operational activity that takes place between the use of cash funds and the collection of such funds. Operational activities, such as the conversion of raw materials to finished goods, are central to our operations but are omitted in this process. In this case, using an accrual basis reporting, which tends to be more complex, would tell your story with more clarity.
Prioritize Book Reporting, Not Taxes
Another missed opportunity is not prioritizing book reporting objectives over tax objectives. Your operational story becomes diluted when you select accounting policies based solely upon your tax strategies. While minimizing tax obligations is important, reduced profitability is not a story you want the outside world to know. You want your story to be one of steady growth and investment. This occurs when you choose accounting policies based upon operational objectives rather than tax objectives.
Here are a few accounting policies your business should consider:
- Inventory and Prepaid Supplies. Record an asset for the acquisition of supplies and inventory to report the investment you are making to procure future sales and perform critical operational activity.
- Property, Plant and Equipment. Record an asset and depreciate such asset utilizing estimated useful life methodologies rather than accelerated tax methods which reduce the net book value to zero at inception.
- Customer deposits. Record money received in advance of the earnings process as a liability as performance obligations are still pending.
- Classify expenses by functional categories such as operating, general and administrative, and selling; including the selection of allocation methods for expenses represented in multiple functional categories. Reporting the functional classification provides useful information to an organization and any interested parties on the nature of the activities performed during a period.
As you review your internal financial statements, take a moment to reflect on the story they are telling the outside world about your business. Is it a story of steady growth and investment? Or is it sending a mixed message? We recommend revisiting your accounting policies to ensure that they convey your operational story in a positive, more accurate light. If you have any additional questions, please contact RBI member Cray, Kaiser Ltd.