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Basic Accounting Skills

Provided by SME Solutions Center - Kenya


Prerequisites

Your proper management of business’ accounting and cash flow issues requires you to do three main things, namely:

  • Acquiring relevant knowledge
  • Undertaking preliminary preparations
  • Undertaking your business’’ bookkeeping tasks      

Gaining Pertinent Knowledge

So as to effectively run your business, you need to be able to undertake accounting and bookkeeping tasks. Registering for accounting and finance courses will enable you to understand small business accounting concepts. Your studies could also familiarise you with computer software relevant for supporting your business.   

Rationale

Your acquired accounting and bookkeeping knowledge enables you to perform a number of important tasks, namely:  

Intelligently discussing your accounting requirements with your bank, accountant, or your employees

  • Assessing your competitors
  • Evaluating businesses you anticipate acquiring
  • Assessing businesses that wish to acquire you   
Sources of Other Businesses’ Accounting Information

To evaluate other firms, you could get their accounting numbers from:   

  • Their yearly financial reports
  • Interviewing key executives
  • Stockbrokers 

Initial Accounting and Bookkeeping Preparations

Some preliminary processes you will go through include:

  • Identifying and hiring an accountant
  • Identifying and employing a bookkeeper
  • Identifying a suitable accounting software 
  • Selecting an appropriate payroll accounting and reporting system 
  • Selecting an accounting method
  • Establishing a record keeping system
  • Developing employee benefits policy

Recruiting Your Accountant

An accountant will counsel before launching your business. Depending on your business’ needs, you could select from three options, namely:

  • Accounting firms   
  • Tax Accountant
  • Certified Public Accountant (CPA)
Accounting Companies  

These firms are usually multi-skilled and thus handle diverse areas.  Their charges are normally high.

Certified Public Accountant

A CPA usually offers accounting counsel as a solo entity. Normally, a CPA offers you assistance in different fronts, including:

  • Giving counsel on organising your business
  • Helping you prepare income and payroll tax returns  
  • Assisting you in dealing with your bank
  • Handling tax liability matters
  • Managing grants
  • Undertaking internal controls
  • Making quarterly returns
  • Reconciling check book  balance with bank statement balances 
Accountant’s Bank-Related Assistance

You need to establish proper banking relations as early as possible. This is because you could require additional funding from your bank. Your accountant offers useful help, for instance by:

  • Preparing cash flow forecast statements that predict your business’ future cash needs    
  • Generating financial statements such as statement of income and expenses and balance sheet documents that are needed by banks
  • Acting as a referee to your bank  
  • Assisting with fine-tuning of your business plan before presenting it to your bank   
  • Assisting with organising financial statements and relevant information into a neat fashion 
Dealing with Tax Liability Matters                                                                                               

Your accountant will help you to handle tax liability issues such as:

  • Preparing income tax returns
  • Filing PAYE tax returns   

Income Tax Returns Preparation

Whether you operate a sole proprietorship, partnership, or limited company, you pay taxes. Your accountant will help you to forecast your tax obligations. This projection will prepare you for your tax liabilities, thus helping to avoid defaults that could see you paying penalties. 

Sole Proprietorship

You report your sole proprietorship accounting status on Form I.T.I (Individual Form). You will pay two categories of taxes, namely:

  • Business income tax
  • Income social security tax 

Partnership or Limited Company

While operating a partnership or a limited company, you pay self-employment tax.

PAYE Tax Returns  

If you hire workers, you accountant could assist in acquiring relevant P.A.Y.E. through which you file tax returns.  

Handling Grants

Grants could originate from the government or from trade associations. Your accountant needs to be familiar with grant management procedures.  This knowledge will facilitate proper accounting and reporting.

Performing Internal Controls

Your accountant can assist in creating suitable internal control mechanisms.  These controls help you to effectively manage business resources such as:

  • Cash
  • Inventory 

Cash

Internal controls ensure that your business’ income is not embezzled via employee fraud, carelessness, or waste.    

Inventory

Inventory could disappear via employee dishonesty or carelessness. You need to institute inventory control policies especially if you operate a retail or manufacturing business.  Your control policy needs to define aspects like:

  • Who controls the release of services or goods
  • Who signs in for services and goods

Preparing Quarterly Returns Reports

Your accountant helps in creating quarterly reports that show your collection amounts. The reports also show that you have remitted the collected cash to the government.  Two major quarterly returns include:

  • Sales tax returns
  • P.A.Y.E returns 

Sales Tax Returns

Based on your sales volume, you need to submit your sales tax cash to the government every one or three months. 

P.A.Y.E Returns 

While filing your quarterly P.A.Y.E returns, you need to accompany the documentation with two categories of tax monies, namely:   

  • The cash that you have deducted from workers’ pay
  • Your share of social security taxes
  • Government income taxes that you have withheld
  • Unemployment tax that you pay to the government

Reconciling Bank Statement with Book Balance

At least every month, your accountant mathematically compares the balance appearing in your check book with the balance on your bank statement. Errors that cause balance discrepancies are corrected.    

Tax Accountant

A tax accountant will advise you on organising your business and help you to prepare income and payroll tax returns.

Hiring your Bookkeeper

You could consult tax accountants or CPAs about suitable bookkeeping candidates. Your bookkeeper will help you with tasks such as:

  • Paying bills    
  • Processing receipts
  • Summarizing business’ bookkeeping activity so as to help your CPA or tax accountant to prepare tax returns   

Selecting an Appropriate Accounting Software

Your accountant could help you settle on suitable accounting software. Other methods you could employ to identify accounting software include:

  • Reviewing trade magazine adverts
  • Visiting booths at trade fairs for ideas
  • Consulting trusted peers for referrals 

Setting Up a Payroll Accounting and Reporting

If your business will employ staff, search for suitable payroll accounting and reporting firms. You could consult your accountant about this. Alternatively, you could outsource this task at a reasonable expense.  

Choosing Your Preferred Accounting System

Before launching your business, you could choose from between two accounting methods, namely:

  • Accrual method
  • Cash method  
Accrual Accounting Method

With accrual approach, you align expenses with income irrespective of whether you have or have not received the money. An expense you incur today appears in your costs section immediately whether or not you have paid out the money. Similarly, sales whether cash or credit, appear in your income section on the day you made the sale. Upon receiving the money, you convert your accounts receivable into cash.    

Setting Up a Record Keeping System

Before launching your business, establish a record keeping system.  The system comprises major business accounts. Your accountant could assist with preparing and setting up your business’ accounts.  These tasks encompass setting up your business’ savings or checking accounts.  

Creating a Worker Benefits Policy 

You need to decide on various accounting-related matters associated with employee benefits. Some Common issues include:

  • Official work hours
  • Recognised holidays
  • Vacation policy  
  • Medical policy
  • Sick leave policy
Useful Information Sources

To arrive at a suitable employee benefits policy, you could consult: 

  • Your lawyer or accountant
  • Your peers in the industry
  • Your own experience and knowledge  
  • Professional organisations

Personally Undertake Your Bookkeeping Tasks

As you perform various accounting and bookkeeping tasks, you understand various business records.  This knowledge could later on help you to train workers and delegate the accounting and bookkeeping roles to them. Meanwhile, you could assume a manager’s status.   

Requisite Knowledge

To effectively undertake accounting and bookkeeping functions, you need to be knowledgeable about some basic financial statements, the major ones being:

  • Balance sheet
  • Cash flow statement
  • Profit and Loss (income) statement
Balance Sheet

This is a snapshot of your business’ liabilities and assets at a particular time. The balance sheet contains two key sections, namely:

  • Assets
  • Liabilities and Owners Equity
Assets

Under assets are two subsections, namely:

  • Current assets
  • Fixed assets

Current Assets

Items falling in the current assets subsection include:

  • Cash
  • Receivables
  • Inventories

Fixed Assets

Some fixed asset items include:

  • Vehicles
  • Equipment
Liabilities and Owners Equity

Under this section are two subcategories, namely:

  • Current liabilities
  • Long-term liabilities 

Current Liabilities

Items in this subsection include:

  • Accounts payable
  • Short-term debt

Long-Term Liabilities

Items such as long-term debt obligations fall in this subcategory.

Rationale

Your balance sheet serves several important uses, namely:  

  • It helps in generating vital financial ratios
  • It helps compute your owner’s equity

Financial Ratios

Some significant financial ratios that you could derive from your balance sheet figures are the:

  • Current ratio
  • Owner’s equity

Current Ratio

You compute your current ratio by dividing your current assets by current liabilities.

Current Ratio = Current Assets/Current Liabilities

Significance of the Current Ratio

Financial institutions use your current ratio to make conclusions about:

  • Your business’ ability to repay loans
  • Your business’ financial strength  

Owners’ Equity

This represents your interest in the business. The equity figure is arrived at after subtracting your total liabilities from total assets. Potential lenders may need to look at your owners’ equity.   

Owner’s Equity = Total Assets – Total Liabilities

Profit and Loss (Income) Statement

Your income statement covers a specific, monthly, quarterly, or half-year period. This report lists your revenue and expenses. It then makes calculations, eventually generating your net profit or loss figure. The profit and loss statement enables you to detect irregular developments and to correct them in time.  

Cash Flow Statement

This is a twelve-month summary of projected future cash outflows and inflows.  It helps in forecasting your future cash requirements. It has two key sections:

  • Cash inflow (IN)
  • Cash outflow (OUT)
  • Always make conservative IN estimates and high OUT forecasts
  • Begin your new period with the closing cash balance for the previous period   
  • Add IN figures to arrive at the closing balance
Principles
Uses

You could use income statement to undertake cash flow control. This involves preparing yourself or future cash needs. You can then arrange for financing with your bank beforehand.

Attachments

Business plan template MS Word  

Instructions for filling in the business plan template

  • Each box has a permanent title in CAPITAL LETTERS
  • Below each title is a sentence starting with an "Insert here..." sentence. This will suggest information to insert. The boxes will enlarge as you take up more room so use all the space you need.
  • After completing each box, delete the "Insert here" sentence, which will leave only the permanent title of the box and the information you have filled in.

Useful Tips

While compiling your business plan, include sufficient research findings and background materials. Make it interesting by the use of information such as:

  • Background data
  • Your biography
  • Charts
  • Demographics
  • Research data

When your business plan is completed, print it.

 

Test Your Knowledge

1. Which of the following statements is FALSE?

         1. A balance sheet consists of financial information at a specific moment in time.

         2. An income statement consists of financial information over a specified period of time.

         3. A current liability is debt that is due in six months.

         4. Owner's equity equals assets less liabilities.

 

   2. The first number your banker will probably be looking at in your financial statements will be:

         1. Owner's equity

         2. Current ratio

         3. Current earnings

         4. Cash flow projection

 

   3. As a start-up business, it is better to prepare your payroll checks and manage payroll accounting and reporting yourself.

         1. True

         2. False

 

   4. If you plan to have a business that requires inventory or if you are going to manufacture products, the KRA will generally require that you use:

         1. The cash method of accounting

         2. The accrual method of accounting

 

   5. Where is the best place to find out financial (and other) information about the large public competitors that you must deal with?

         1. A professional stock broker

         2. Annual reports to shareholders

         3. Interviews with key executives

 

   6. Which of the following expenses is a non-cash expense?

         1. Insurance premiums

         2. Interest on loans

         3. Depreciation

         4. Taxes paid

 

   7. In the cash basis of accounting, you match revenue with expense regardless when the cash may or may not be collected.

         1. True

         2. False

 

   8. Once you have prepared your cash flow projection, which of the following scenarios would be the best course to take:

         1. Change (modify) the numbers every twelve months.

         2. Try as much as possible to change your strategy as you go along so the numbers in your projection maintain liquidity.

 

   9. On your cash flow projection, each period of time analysed will include: Starting cash plus cash sales plus any other cash sources, less cost of sales, less all other cash expenses equals ending cash.

         1. True

         2. False

 

  10. In your Business Plan, your one year cash flow projection indicates that after six months you will go negative KES 50,000 due to receivables outpacing your income. You should:

         1. When that future time comes, ask your vendors for longer payment terms to maintain liquidity.

         2. Reduce your prices so as to generate cash to make up for your negative cash position.

         3. Have financing in place before you start, either from vendors, lenders or your relatives in order to provide the cash for this anticipated future condition.

         4. If you experience a negative cash flow due to slow paying customers, you should slow your own payments to vendors proportionately.

         5. If and when the condition actually does arise, make an appointment with your bank, show them your cash flow problem and arrange for supplemental financing.

 

Your success in managing your small business requires adequate knowledge of basic accounting principles. This awareness will enable you to make informed choices about various business issues and scenarios. Sourcing for a trusted and qualified accountant is also essential. The accountant will assist you with routine but complicated aspects of the business such as payroll accounting. A good accountant will also prepare requisite financial statements that are usually needed by your business partners such as banking institutions. You need not allow third parties to perform crucial business tasks such as the signing of checks. As a small business proprietor, you will need to decide on the accounting approach to adopt. Other accounting related issues include the filing of statutory statements such as income tax statements and returns. The services of an accountant would come in handy in such circumstances. You also need to be in the habit of preparing frequent business statements. These statements need to be thoroughly scrutinised for consistency. Based on your careful evaluation, you need to make adjustments on the financial statements. Consistent analysis of cash flow statements will enable you to be well informed about the fiscal status of the business at whatever time.

Copyright 2005-2016 SME Solutions Center - Kenya

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