Small Business Tip Audit Proofing Your Business Financials Part 3

Today I’m talking about…

Hey there. Today we’re talking about accounting policy. What are accounting policies? Those are the rules you follow when you keep your records. Now there’s some policies you need to have in place because they’re required by the IRS. For example, you need to have in place a policy for how you capitalize asset, you need to have in place for reimbursements, you need to have a policy in place for if you have retirement benefits, you know… So, there are a couple of requirements that it specifically says you really need to have a documentation of policy in place to have this special privileges. Now there are those requirements and then there are some policies that are not required for you to have, but I recommend that because in the case of an audit, if you have a policy that you follow, it makes the audit flow a lot smoother. Now, we’re going to talk about policies you have in place for revenue, expenses, inventory, cash management, fixed assets, capital or loans and employee benefits, payroll, contributions, promissory notes, financial reporting, and your annual meeting process.

So, involving your policies, the first thing you do is start with a general purpose. The purpose of a policy is to establish rules that guide you, so you can help safeguard the business assets and increase accuracy of accounting records and to promote consistency in business operations and improve internal control. In other words, it makes it easier for you to delegate your accounting because now you have established processes, and it’s very easy for whoever takes on the books to see how it’s done, and when you see a number, you understand what that is because you have policies established in place of how you do that.

The next thing you want to do is you want to determine what basis you keep your books. If you want to do the accrual basis or the cash basis. If you mostly collect cash, go ahead and be the cash basis. If you’re a small business, being on the cash basis might be easier, but there are some circumstances where being on the accrual basis might be good. So just figure out, so if you want to be a cash basis, accrual basis, just choose that. Then, also basis of tax accounting. So you can choose to be cash basis internal books, but when it comes to your tax, you could be on a cash basis. You don’t have to be on the same basis, but however, if on different basis you have to make sure you reconcile your books to tax for the difference.

So, let’s start with the revenue. The first thing you want to do when you’re developing your revenue policy is, first of all, identify your sources of revenue. You can have revenue from monthly recurring clients, one-time services, sale of electronic products, sale or actual products, whatever it is, whatever your sources of revenue is, identify those and define them. You can see how beginning to just sit down and even think about this, develop a policy, can actually help you streamline your processes. Then the next thing you want to do is when do you recognize revenue from this sources?

Some examples is revenue from selling goods is recognized on the date of sale. Revenue from services is recognized when the service is complete. Rent income is recognized the first day of the month, so you just kind of develop a policy, when do you recognize revenue? In general, the rule is, revenue’s recognized when it is earned. So, in other words, if it’s a sale, when the sale is complete, if it’s a service, when the service is complete. There’s a percentage for completion, but we’re not going to go into all those complex revenue recognition techniques, we’re just keeping it as simple as possible.

Then you want to talk about your revenue cycle. What happens? Monthly recurring clients, how do you recognize revenue every month in your monthly recurring clients? You want to make sure you have a good system in place so you’re not losing money. When does the revenue cycle start for your monthly recurring clients? How do you collect it every month? When do you invoice them? And do you have a recurring system, an automated system? If you have an automated system, how do you check if there’s a mistake? What are your checks and balances? You want to define all of that for all of your revenue sources. The reason you want to do that is because you want to make sure you have checks and balances in place, so if something goes wrong in the revenue recognition, you can correct it, and if you have to, if you start getting so big and you need to delegate this function, there is a process for someone coming after you to follow in recognizing revenue.

Now let’s move to expenses. What kind of expenses do you have in your business? You want to define that. If you have fixed expenses, you want to define what they are, when you generally pay them, variable expenses. And then you also want to have a list of approved vendors because those vendor relationships come in very handy because you get great deals when you patronize a vendor. How do you pay for fixed purchases? What is your process? Remember, you’re not always going to be the one available to do this, so you need to have a process in place. You might be if you pay for it, however you do it, there should be a process. Here’s the thing, here’s the funny thing, when you have a process in place, cash flow seems to go a lot smoother because you’re not just randomly doing stuff as it comes along. I mean, you have a process in place that makes it easier for you to manage cash flow. Because you know what? This is going to happen exactly this, so I know I can plan my cash accordingly.

How do you pay for variable expenses? How do you pay for credit cards? How do you initiate contract with your vendors? How do you check your accounts payable? How do you take care of vendor invoices? How do you pay for sales tax? All of those things, reimbursement for purchases, all of those things you do want to make sure you have in place. Like, what’s the process for doing A, B, C? As you start getting busy, if you need, like I say, if you need to delegate this, if there’s a process in place, it just makes life so much easier. Then, if you’re going to have an account reimbursement plan, the IRS requires you have a plan in place. You can’t just say, “Oh, I’m just going to make this… Adopt an accountable plan,” without having a documented plan in place. So, this is a plan, there’s actually a requirement by the tax code.

Also, if you carry inventory, there should be a plan for how you account for it, how you account it, when you have to order, how much inventory you have to have in place. Inventory management is so vital because this is one of the place where cash can easily… It’s one of the most common places where cash hides in unsold inventory, so you don’t want to carry excess. What is your policy from making sure you don’t have excess inventory? Same thing for cash management. How do you treat petty cash? How do you treat your bank account? When do you do bank reconciliations? If you have different basis, between tax and books, how do you bank your accrual basis adjustment? Or if you’re using the cash basis all year, and you need to make accrual basis adjustment at end of the year, you know, you need to have a process in place.

Cash report. How’s your report or how do you do the forecast? Same with the fixed asset. What is your capitalization policy? If you’re making a de minimis safe harbor election, as I’ve talked in an another video, you do need to have this policy in place; it’s a requirement by the law. When and how do you dispose a fixed assets? How do you record fixed asset? And here’s a template for the de minimis safe harbor election. Also, you want to have a policy in place for cash from owners or cash to owners. The capital account, how does that maintain? How/when an owners required to contribute? When are distributions made? How do you tell when the capital are loaned? The loan shareholders, how is that treated? How is that documented? Also, you want to have a system of trading your chart of accounts. How do you determine that? What kind of numbering system do you use? And if you have benefits, you need to have policies in place for when those benefits are administered and how your employees are notified. And then also, you want to document how and when you want peril. What’s your peril cycle?

Here’s a log for logging in your contributions, like so if you have contributions in your business, you can log that here. And then, if you decide to take a loan out from your business and give a loan to your business, here’s a template for promissory notes. Finally, the last policy you want to have in place is your financial reporting policy. What kind of statements are generated? How frequently are they generated? You want to make sure you have a policy in place for that. You also want to have a policy for when and how your annual meeting is run. I already talked about pre-annual meeting in another video, so make sure to look at that. And I also have here some templates for you, agenda and minute.

Just to wrap things up, having policies in place is so vital because it just makes it so much easier to run your business. It might be a pain sitting down, trying to get all these policies in place, when the long run, it’ll really benefits you. You can get free access to this course by clicking the link below. In this course, you’ll learn different techniques to audit proof your business. It goes beyond the accounting policies and shareholders, the other topics we also talk about. So go ahead and check out the course. Go ahead, click the link below now. Like what you see? Go ahead and click the subscribe button on the very bottom of this video. I look forward to seeing you in future videos.