In an online business advisory session last week, a business owner asked me how she can know whether her business is viable or not. After discussing some of the factors that may make a business viable or not, we dwelt a bit on business profitability. Her concern was that she was making losses and she couldn’t figure out why. In under an hour of talking she realized exactly what she was doing wrong and excitedly came up with action points to what she was going to work on.
When I went offline, I thought some of the issues we discussed maybe worth sharing with other start ups or small business owners. Below are some of the key issues that when not accounted for well in the books of accounts may give the impression that the business is making losses or minimal profits.
1) Initial set up costs
It turned out that she had to put down quite some money as is usual at the start of a business. I informed her that these initial set up costs are one off and will therefore not appear again in the following accounting year. Some of the initial set up costs include but are not limited to; business registration, licensing or special permits. This is why business viability cannot only be judged by its 1st year’s performance.
2) Stock and packaging materials
When stock is all expensed when it was not used as part of goods sold for a period, it may inflate the costs for that period and hence a resultant loss. In order to take advantage of economies of scale, many businesses tend to buy packaging materials in bulk. When these are expensed in a month or so and they are meant for use over a year or 2 years, the expenses for the period of purchase are therefore overstated and may reduce the profits or result into a loss for the period under consideration.
Most businesses pay rent in advance for a number of months, insurance premiums for covers running for 12 months e.t.c. In Accounting, such expenses should be prorated for the period for which they are consumed. Otherwise, expensing them in the month for which the payments were made means burdening that particular month or that period of reporting.
4) Capital expenditure
When a business purchases fixed assets like computers and printers, motor vehicle and motor cycles, furniture and fittings, Equipment e.t.c, these shouldn't be recorded as expenses in the income and expenditure statement. Instead, they should be recorded in the balance sheet and a depreciation charge is calculated for the period of use and passed as an expense. Expensing items that should have been capitalized will give a false report on the performance of the business.
Have you considered all these key issues? You may not be making losses after all!
Here is a link for Small Business Survival Strategy #1:Look out for False profits due to hidden costs
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