Fortune magazine named one legendary business “Americas Most Innovative Company” six years in a row prior to its shareholders losing $74 billion as a result of its accountants keeping huge debts off the balance sheet. I agree that Enron was an accounting scandal and not an accounting “mistake”, but statistics show that about 50 percent of new small businesses fail within their first five years of operation… and the number one cause of failure? Poor financial management.
With this in mind, here’s a list of the top three ghastly accounting mistakes that I have seen over the years:
- Mistaking Profits for Cash – On one hand, if you have a lot of credit sales, your company could have large profits (and a tax bill) and have no cash. On the other hand, sometimes companies will take deposits from customers prior to delivering a product or service and record them as revenue. Customer deposits are not income until you complete the job. The improper recognition of revenue could result in the overpayment of income taxes and a false sense of profitability.
- Expensing Large Purchases – Buying equipment and leasehold improvements with cash does not allow you to expense them immediately. There are tax rules that dictate how quickly such items can be written off for tax. In many cases, obtaining long-term financing to acquire long-term assets makes more sense than using your working capital. Similarly, inventory is not a deductible expense until you sell it, but adding inventory does tie-up your cash. Don’t tie-up your cash by overstocking inventory reserves and be sure to track how many days it takes to sell your goods. Obviously in this case, the quicker the better.
- Leaving your financial matters to others – just because you are not an accountant, don’t shy away from learning about and understanding your monthly financial statements. It’s your business and you have to make timely decisions regarding pricing, budgeting, hiring, etc. that rely on the numbers. Ensure you hire qualified people to provide you with good bookkeeping including a monthly reporting package. You should also ask your accountant to train you in what to look for when analysing this information so you can make educated decisions about your business.
Feel free to share if you have made a financial mistake you learned from or if you have any questions about these ghostly, ghastly pitfalls – and have a happy Halloween!
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