Methods of Accounting

Before you start, you will need to decide what form of accounting your business will use.There are two major types:

Cash Basis Method 
This is what the name implies; you recognise income when you receive the cash and you recognise expense when you pay the bill. Most service businesses operate on the cash basis because it is much simpler to understand.

Accrual Method
 Here you match revenue with expense regardless when the cash may or may not be collected. If you sell a product to a customer and he doesn't pay you for 30 days, the sale is recorded in the books on the day that you made the sale. When the money comes in the "accounts receivable" is then turned into cash. The same with expenses: if you incur an expense on one month but don't pay until the next month, the expense will be recognised in the month in which you incurred the expense. If you're in manufacturing or deal with stock, the Inland Revenue Department generally requires that you be on the accrual basis.

Keeping Separate Business Records
Even in a small business you should, before you start, set up a business account even if you're a sole proprietor. It will be important to keep your business records separate from your personal records. This will make it easier for you and your accountant to pull records together for income taxes when the time comes

Bank Account Reconciliation
We suggested earlier that you set up separate business accounts to make it easier to track expenses and business income. This bank account needs to be reconciled at least once a month when you receive your bank statement. You can save money by learning to do this yourself, and your accountant can teach you if you don't know how.
Reconciliation refers to taking the balance in your cheque book and reconciling or mathematically comparing it to the bank balance. You must also take into account any difference in those two balances that are due to cheques that you have written that have not yet been presented to the bank. If this is the case, your cheque book balance will be lower than the bank statement because the bank has not yet received some of the cheques you have written. So it is important that these outstanding cheques get subtracted from the bank balance and the resulting number be compared to the number in your cheque book. When the two match, we say the account has been reconciled.

Internal Controls
"Internal controls" refers to what is needed in the handling of funds, where money in the form of cash, checks or credit cards, is exchanged for goods and services. The goal is to make sure that the business receives all of its income without any of it being siphoned off by waste, fraud, dishonest employees or just through carelessness. Even a business that is healthy in all other respects can be very vulnerable to failing from the inside through lack of internal controls. Your accountant can help set up appropriate controls for your particular business.
If you are in a manufacturing or retail business you will need to set up inventory policies and controls because inventory, similar to cash, can disappear very rapidly through carelessness or employee dishonesty. You need to have safeguards in place very early on in the process by setting up controls as to who can sign for goods and services and who controls the release of goods and services out the door after the processing has been completed.

Income Statement
The income statement (also called the "Profit and Loss" statement), unlike the balance sheet, covers a period of time monthly, quarterly or yearly. Usually year-to-date figures are also presented to show how the business is doing during the current accounting year. The income statement and the balance sheet tie together. Your income statement will disclose valuable information. You will see a section for sales as well as a breakdown of all your expenses, leading down to the net profit for the period.

Cash Flow Control
Cash flow control is a simple method of projecting your future needs for cash. It is an income statement covering future periods of time that has been changed to show only cash: cash coming in and cash going out and what your balance of cash is at the end of designated periods of time. This is a great tool because you can predict your future needs for cash before the needs arise.

Balance Sheet
The balance sheet is a "point in time" statement. Think of it as a snapshot. It is a listing of all of your assets as well as your liabilities, and the difference between these two numbers is your equity in your business. The balance sheet is divided into two major sections. The first section is "Assets less Liabilities" The second section is Capital. One reason this particular financial statement is called a "balance sheet" is that assets always equal your liabilities and owner's equity. This is called double-entry bookkeeping, and is the type done in nearly every business. The reason double-entry bookkeeping is the accounting gold standard is that it serves as a check to make sure a transaction has been properly recorded When your bank looks at a financial statement, they are interested in various financial ratios. Ratios help indicate the financial strength of a business and how the business can handle payback of loans. For example, current ratio is current assets divided by current liabilities. If your current assets are less than your current liabilities, a red flag will go up because it would indicate a risk of insolvency during the present year

Accounting and Cash Flow Punch List
• Prepare frequent financial statements, at least quarterly.
• Keep track of key income statement percentages. If you're in manufacturing, your cost of goods sold percentage should be relatively the same as competitors in your industry.
• Compare your income statement with prior periods.
• From the beginning, maintain good internal controls. Learn from the practices used in your industry to prevent dishonesty and shrinkage. Shrinkage includes shoplifting and other types of stealing, which results in the "shrinkage" of your inventory. • Do not delegate the authority to sign cheques or purchase orders.
• Don't use money that you have withheld for payroll (PAYE) or VAT for other purposes. You will be a trustee of funds belonging to the Internal Revenue Department and VAT Dept.
• Keep in mind that liquidity is not the same as making money. You can be making a profit and still go broke by running out of cash. Learn and practice cash flow control.
• Look ahead and write out your list of projected financial requirements including premises, equipment, staff and working capital.
• Arrange for financing well before the need arises.