Bridging the Gaps in Business

•  Bookkeeping involves the day-to-day recording of financial transactions like sales, purchases, receipts, and payments. It's the foundation for accounting.
• Accounting involves interpreting, analyzing, and summarizing this data to provide insights and financial statements that are critical for decision-making, tax compliance, and attracting investors.

Accrual accounting is generally preferred for growth companies, especially those seeking investment or bank financing. It matches revenues and expenses to the period in which they are incurred, offering a more accurate picture of financial health. Banks and Investors will want your reporting on accrual method. 

Cash accounting may be simpler but is less reflective of the company’s financial obligations and prospects.  

Recommendation:  We recommend maintaining your books and continuing to report on an accrual basis. However, for tax purposes, you can use a "modified" cash basis. It’s important to understand that while managing on a "modified" cash basis, you must be mindful of tax implications, especially in Q4, until you exceed $25 million in gross receipts over the past three tax years and must convert to accrual basis for tax.

If you elect cash basis for tax purposes, in Q4, you can delay taxes owed by utilizing prepaid expenses (if the cash is spent and the activity is completed within the year) and credit card activities, thus incurring costs without a cash outlay in December. This requires careful cash management as you plan for the next year's budget and forecast cash flow for Q1 business cycles.

 To meet the small business taxpayer exemption, Section 448 (c) provides a gross receipts test that is met if a taxpayer has average annual gross receipts not exceeding $25 million adjusted for inflation for the three prior tax years. 

You will need to be aware that there can be a significant tax liability when moving from Cash to Accrual for tax filings as you have to bank all the Accounts Receivable ("AR") balance to revenue on conversion.  This means if you have AR of $3MM, then you are carrying a ~$1MM tax burden due upon conversation if your Accounts Payable balance s maintained low. You must plan for this conversion liability and how you are going to pay for it.

- Financial transactions (sales, expenses, receipts, etc.)

- Bank statements

- Invoices (both payable and receivable) 

- Payroll records

- Contracts and agreements

- Tax filings

Maintaining detailed records will not only help during audits but also improve investor confidence and facilitate bank loans.

  A simple monthly reporting package for investors and banks should include:

- Income statement (P&L) Reported

- Income statement (P&L) Adjusted

- EBITDA 

- Balance sheet

- Cash flow statement

- KPIs relevant to growth (e.g., revenue growth, customer acquisition costs)

- Budget vs. actuals (comparison)

- Accounts receivable and payable aging reports

- Headcount data and employee retention

- Bank covenant calculations

- Cash Forecast for 13 weeks 

• The close process for a growing company should aim to be completed within 5-10 days after month-end to provide timely insights.
• Account reconciliation should occur monthly to ensure that bank balances, receivables, and payables are accurate and any discrepancies are promptly addressed.

 For detailed information and charts on the appropriate stages to involve each role, please refer to our Financial Oversight guide here:  Financial Oversight 

 The primary guideline is to avoid comingling personal expenses with business finances. While this may seem straightforward, lines can become blurred when considering the "company benefits" related to entertainment and business development costs. We advise seeking professional advice for accurate expense classification to prevent any unexpected issues during the valuation process.

Moreover, it is crucial for an owner to thoroughly comprehend the potential expenditures that may arise and not impact EBITDA. These expenditures could encompass start-up costs, non-recurring expenses (such as signing bonuses and third-party recruiter fees), and infrastructure implementation costs, among others  

Lastly, Growth-focused owners should closely monitor cash flow, ensure expense categorization is accurate, and have clear visibility into both fixed and variable costs. This helps in controlling burn rates and improving profitability.

Investors and banks will look for efficient cost management and strategic investment into growth drivers.

 See our article The Evolving CFO for insights into AI automation that you can implement now in your business.

- Failing to reconcile accounts regularly

- Incorrectly categorizing expenses

- Missing invoice payments or tracking receivables

- Not maintaining backup documentation

- Neglecting to track sales tax or payroll taxes

- Implement a collections policy for follow-ups at regular intervals (30, 60, 90 days overdue).

- Offer discounts for early payment or consider penalties for late payments.

- Use accounts receivable aging reports to identify problem areas and, if needed, hire a collections agency for persistent delinquencies.

- Implement internal controls such as segregation of duties, authorization of expenditures, and regular audits.  

- Use audit trails in your accounting system and regularly review financial records.

- Encourage a whistleblower policy and conduct background checks on key financial personnel.

See our Internal Controls Grid for detail segregation of duties by staging.

Auditors will focus on:

- Revenue recognition practices to ensure they comply with applicable accounting standards (like GAAP or IFRS).

- Timing of revenue to ensure it’s recorded in the correct period.

- Completeness and accuracy of recorded revenues, ensuring no omissions or misstatements.

- Existence of supporting documentation (contracts, invoices, and receipts) for significant transactions.