This is our fourth installment of our ‘Ask The Experts’ series (check out our first, second and third installments here). Once again, we’ve asked our accountants and CFOs for the small business finance questions they’re getting the most and their answers. If you have a burning question, send it to us!
What is the difference between Fiscal Year vs. Calendar Year accounting?
Most businesses use the Calendar Year (Jan. 1 – Dec. 31) for accounting and budgeting purposes. Fiscal Year accounting uses a different 12-month window to better match the business cycle, industry or to align with the competition’s fiscal year for comparison. For example, most retail businesses choose a January 31 fiscal year so that they can have time after their busiest quarter to track those sales, receive returns and close the books. Most nonprofits use a July-June year. If there isn’t an obvious reason to go with a Fiscal Year, it’s probably best to stay on a Calendar Year. Approximately 65% of publicly traded businesses in the U.S. use a calendar year.
Why does cash in not equal revenue?
This is a common misconception- most business owners expect their revenue to equal the cash received. While there are certainly times that these two accounts will match, there are many when it will not. For example, a business getting paid before the service or product is provided would typically record the receipt of cash as a liability. Once the service or products are provided, an entry is recorded to transfer the balance out of the liability account to revenue. Since the cash has been received in a prior period, there is no current period effect on cash which naturally leads to a disconnect in cash vs. revenue for the current period.
Another, simpler way to explain why cash doesn’t necessarily tie to revenue is by factoring in the number of days it takes to collect on invoices issued to customers. If the services are provided on the 25th of the month but the cash isn’t collected until the following month on the 15th, it’s easy to understand why cash doesn’t match revenue in Month 1 (the business hasn’t received any). The same is true for Month 2 (revenue is now 0 from this transaction but cash has been collected).
How long do I need to keep business records?
According to the IRS, you need to keep records for 3 years from the later of the date the original return was filed, or the actual tax was paid. Taxpayers also need to keep records for 7 years if they file for a loss from worthless securities or bad debts. 6 years is also the limit if a taxpayer underreports their tax or taxable income by 25% or more. To make it more complicated, the retention window is indefinitely for someone who does not file a tax return or commits fraud in the filing of their tax returns. Simply put, rule breakers do not get the benefit of a statute of limitations shielding them from liability.”
Can’t I just use Excel as my accounting software?
Excel is a great software tool and is one of the most flexible and powerful applications ever invented. It’s also widely used so naturally business owners are going to try and adapt it to do things it was never meant to. One of those stretches is accounting. Simply put, doing “accounting” in Excel isn’t accounting. At best, it’s a list of transactions more akin to a check register than a proper accounting system, which functions more like a database and reporting package in one.
Businesses who utilize Excel as their accounting system are going to struggle with generating financial reports, doing bank recs, tracking expenses, as well as understanding trends. It also doesn’t have any of the ability to help with workflow like a proper accounting software package has, namely bill due date tracking, check writing, and reconciliation templates.
Our advice is to ditch spreadsheet accounting as soon as possible and either learn how to drive Quickbooks on your own or hire a professional to do it for you. Your CPA and your business will love you for it.
Who qualifies for the Employee Retention Credit, what is the timeline, and how would I go about filing for it?
The Employee Retention Credit (ERC) was originally created by Congress as part of the CARES Act to encourage employers to keep employees on the payroll as these businesses were navigating the unknown and unprecedented effects of COVID-19. The 2020 ERC Program is a refundable tax credit of 50% of up to $10,000 in wages paid per employee from 3/12/20-12/31/20 by an eligible employer. That is a potential of up to $5,000 per employee. In 2021 the ERC increased to 70% of up to $10,000 in wages paid per employee per quarter for Q1, Q2, and Q3. That is a potential of up to $21,000 per employee. The ERC is claimed on form 941 as a reduction or refund of the payroll taxes due on the quarterly payroll tax filings. Most business owners rely on their CPA’s or payroll provider to prepare and file these amended returns.
How come the cash in the bank is low, but the business is showing a profit?
There are many uses of cash once the business has performed the services, collected the payment, and paid the expenses required. The two most common examples of non-income statement cash usage are loan payments and owner distributions. In order to perform services or sell products, most businesses incur some amount of long-term debt to buy business assets. These loans are repaid using profits but don’t get reported on the income statement as an expense. The reverse holds true as well- when the business owner received the loan he/she did not record the new loan as income (or they shouldn’t have!). Also, many business owners take cash out of the business as a distribution rather than through payroll. Since this entry flows through the equity section of the Balance Sheet, it does not affect the income statement. Similar to loan principal, owner distributions do not result in a decrease to net income.