My New Book Chapter 1
Jan 27, 2010
I had a restless night the other night and the recurring thought was to write a book to entrepreneurs about small business finance and accounting. I also had some cutesy title, that I can not recall. But that got me thinking, if I was to write such a book, what would be the content?
So my blog for 2010 will cover some of the topics in my “new” book as they relate to the entrepreneur on finance and accounting topics. So hopefully this will help you sleep better at night, even if I don’t!
The difference between Finance and Accounting
Coming up in the school of business, I remember sitting in a finance course and the finance professor saying that you could fund purchases through retained earnings and the accounting professor said, no you cannot spend retained earnings. Who was right? The answer, both!
Accounting is all about creating the numbers on the Balance Sheet, Income Statement and Cash Flow Statement, preferably in accordance with Generally Accepted Accounting Principles. Accounting is headed by either the Chief Accounting Officer (a relatively new role in companies) or frequently in the old school, the corporate controller.
The control function in a company is responsible for assuring the financial policies are enforced in order to control costs and produce accurate and timely financial statements. They produce financial and cash forecasts and help “impel management toward the attainment of the company’s goals and objectives”.
So who does this in your company????? Anyone? Do you have accurate and timely financial statements? If not, how do you run your business? Really, how do you!?!
Accounting tells you where you have been, what revenues were earned, what money has been spent and assures the expenditures and expenses incurred are made in accordance with company policy. Accounting prepares the financial statements and assures they are in accordance with generally accepted accounting principles. They deal with the outside accountants and auditors and are an essential part of businesses large and small alike.
Finance is the function of assuring the business has the capital needed to meet obligations and provide the fuel (Cash) needed to grow the business. The focus is the Balance Sheet. The strength of the balance sheet drives the ability of the company to borrow money, thus the comment by the finance professor. While the retained earnings is not the same as cash and generally not even close to the cash balances, this is the amount of assets over liabilities accumulated over time, and a healthy net equity balance portends a strong balance sheet.
Balance sheet ratios are key to understanding the overall strength of the company. The liquidity ratios such as the current ratio (Current assets divided by Current Liabilities) and Quick or Acid Test Ratio (Current Assets less inventory and prepaid expenses divided by current liabilities) and leverage ratios such as the debt to equity ratio, total debt divided by equity. Number of days in inventory and number of days revenue outstanding in accounts receivable measure how much “cash” is tied up in assets on the balance sheet. And the number of payables days tell how fast you pay your vendors.
This information is used to drive the capital structure of the company. Can the company afford to take on more debt? If so, how much? Can cash be “cranked” out of the balance sheet realistically and if so, how?
So the finance function uses the information provided by accounting to work with the bank and/or investors to assure the company has the funds needed to meet the demands of the business. It looks at the present and future plans and combines these elements into a financing package to meet those demands. Running out of cash is never an option.
So who performs this function in your company? Anyone? If it is you, then who is driving the business? If it is not you, then who? Cash getting tight due to growth? Who arranges the financing?
Editors Note: This is where a part-time CFO can help. Whether an accounting or a finance issue, we have the experience to address your company's needs. In fact, maybe these varied subjects are good topics for my “new” book! Watch for the next chapter!