SME's in Ireland don't fully utilise bookkeeping. We breakdown what bookkeeping is and what value it adds to a business.
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This is the first part of a 5 part series on various different aspects of bookkeeping.
Bookkeeping vs Accounting: What’s the difference?
Bookkeeping is the practice of recording and tracking the financial transactions of a business. Bookkeepers regularly summarise this activity into reports that show how the business is doing. They may also perform wider tasks such as invoicing, paying bills, preparing tax returns, monitoring key performance indicators, and providing strategic advice.
Accounting is the systematic analysis, reporting and presentation of financial statements. This analysis may add more value to a business and provide a greater insight into the business itself. Bookkeepers can also contribute significantly to the understanding of a business.
What does a bookkeeper actually do?
A business is constantly moving and changing over time. Some businesses are growing while others are struggling to stay afloat. Bookkeepers provide accurate and timely financial information to business owners, allowing them to make decisions that will influence the trajectory of their company.
In order to ensure this information is accurate and timely, there are several duties a bookkeeper must complete;
Bank Reconciliations: Cash comes in and cash goes out. These flows of cash are the cornerstone to a set of financial statements and are the essence of any business. A bookkeeper is required to reconcile (agree back to Invoices, receipts, etc) to ensure all transactions are accurate and complete.
Data Entry: Every transaction a business completes needs to be appropriately recorded. This can include invoicing customers, paying for items, paying staff, taking loans, putting money into the business and much more. If a transaction is not correctly recorded it doesn’t give a business a true picture of their situation which may in turn result in poor management decisions.
Monthly Reporting: After reconciling banks and completing data entry, a bookkeeper must compile this information and report it to key decision makers. The fundamental reports include Profit & Loss, Balance Sheet and a Cash Flow Statement (more on these later).
Payroll: A lot of bookkeepers also manage the payroll cycle for small to medium size enterprises. Even for small limited companies, any payment made to staff or directors must go through the PAYE system and be correctly reported to Revenue. If this is not completed correctly, Revenue will apply fines. Bookkeepers can also correctly capture the recording of this transaction, which involves multiple financial journals.
Credit Control: A bookkeeper records when an invoice is issued to customers. They are also well placed to chase that overdue debt, issue statements and send chaser emails where required.
Accounts Payable: Bookkeepers will record invoicing coming in from suppliers and when they must be paid. A bookkeeper will also have a feel for the cash cycle of a business and can manage when to hold certain payments or when they can pay early.
End of year reporting: A bookkeeper can assist the accountant in preparing the financial statements which must be reported within the CRO.
Tax filing: Bookkeepers can prepare and file certain tax returns such as VAT and RCT.
The value of bookkeeping for SME’s
- Profit & Loss
A Profit & Loss (P&L) statement shows a business if it is profitable or not. If produced in a consistent and sufficient manner, it will also show how a business is making money and where it is spending money.
It may be surprising, but a lot of SME’s in Ireland do not produce a monthly P&L, therefore, the business that does will have a far greater insight into their business and the industry as a whole. Some clear benefits are as follows;
o Profit Generation: A correctly produced P&L will not only show where the business is generating revenue, but which area of the business is most profitable. This may dictate where the business wants to grow, focus time or spend on marketing.
o Cost Control: If you are not tracking your costs you cannot measure if your spend is warranted. A P&L will show you exactly where money is being spent in your business and will allow businesses to challenge if that expenditure is required.
o Seasonality & Patterns: A P&L will show what products or services sell and when they sell best. While most businesses know that seasonality impacts their revenue, they tend not to know exactly when this occurs and the significance of this impact. A consistently produced P&L will take away the anecdotal element of forecasting and will allow a business to manage and plan to a level of certainty.
o Targets: The quote of “If you can’t measure it, you can’t improve it” is well worn in business. A P&L will let you measure a businesses growth, change direction or focus on what is working. Measuring these changes over time is a powerful tool to any SME.
- Balance Sheet
A balance sheet tends to be slightly neglected in comparison to the P&L, but both should be reviewed in tandem. The purpose of the balance sheet is to reveal the financial status of a business as of a specific point in time. The statement shows what an entity owns (assets) and how much it owes (liabilities), as well as the amount invested in the business (equity).
Again, most SME’s in Ireland will only produce a Balance Sheet once a year. As a result, it is a missed opportunity for a business to really understand the financial security of a business.
The benefits of producing an annual balance sheet is as follows;
o Short term requirements: While many other financial reports simply show you transactions that have already occurred, one of the benefits of a balance sheet is that it gives you an idea of things that need to occur soon. If you’ve just made a huge sale, your profit and loss statement may show your “business health” as great, whereas your balance sheet would also show the huge bill you owe a vendor within the next 30 days. It is a more accurate picture of your business's status.
o Long term planning: A balance sheet is a great tool for categorising what obligations or receipts will be taking place soon or what is more long term focused (Loans etc). Having this long term provides a business with a different view and allows business owners to consider the long-term implication of decisions e.g. purchasing equipment to increase profit vs paying off debt that will fall due in 2 years.
o Business Ratios: A lot of SME’s stay clear of ratio analysis as it’s seen as a larger company issue. A small number of key rations (liquidity, DSO, Inventory holding etc) will provide a business with optimal targets to target and aim for
Cash Flow & Cash Management
All businesses, never mind SME’s, need to have a laser like focus on cash management. Every business needs to understand what their free cash flow is and how much cash they generate each month.
Without this understanding or available reports, it’s easy for profitable companies to lose control of cash flow. This will not necessarily be seen within a P&L, as certain items will only bear out within a cashflow statement (e.g. stock build up, overdue debtors, capital expenditure).
A good bookkeeping process will be able to identify these issues before they escalate further. This system will allow an SME to slow down payables, reduce capital expenditure or use excess free cash flow to invest back into the business. This insight will give a business massive advantages in terms of decision making.
Most business owners don’t want to focus their valuable time on dealing with compliance or tax requirements. However, if these aren’t managed it will create needless anxiety, worry and will have future financial implications.
A bookkeeping system can ensure that compliance and tax requirements are met, in turn allowing a business owner to focus on growing the business. Areas of compliance that a bookkeeper can manage includes the following;
- VAT Filings;
- PAYE Returns;
- RCT Returns;
A bookkeeper can also assist an accountant in filing annual financial statements. An SME that can focus on growth, opposed to compliance issue, is more likely to succeed in the long term.
- Strategy Development
All SME’s will have a strategy. This strategy may not be written down in a plan but will exist in the background of every business. For example, a plumbing business may target private customers with a high-end quality offering while other plumbing business may look for low margin, large scale construction clients.
A bookkeeping system can help validate the success of that strategy, or alternatively, show how a strategy is failing. As businesses evolve their strategy will evolve with them, and a well implemented bookkeeping system will allow SME’s to measure if they are developing in the right direction.
As well as tracking strategy changes, bookkeepers will know the financials better than most and can contribute to strategy development. They will know what is contributing to profitability and what areas are not growing. This insight, coupled with an SME’s entrepreneurial tendencies, are a powerful combination.
Bookkeeping will not be a core competency for start-ups or SME’s, and it doesn’t have to be. A lot of businesses use basic excel documents or pen and paper to record transactions.
However, bookkeeping can act as a differentiator or an internal strength within a competitive landscape.
That differentiator may be understanding what financially drives profit within a business, what the cashflow requirement is at any time throughout the year, understanding whether to invest more into the business or taking the steam out of growth, identifying excess spend or simply managing the compliance burden on that business.
This does not have to be a large financial investment and the pros and cons of managing bookkeeping yourself, hiring a bookkeeper or outsource the process is discussed in a later guide.