Creating and Managing a Budget

Why do I Need Budget?

A budget can help to plan and control your future income and expenses, it is an itemization of likely income and expenses for a given period of time. It can be used as a strategic plan of a business. Whether you are creating a budget for personal use or for your business.  Without preparing a budget a business may not be able to assess its resource to buy capital assets or know whether its revenue, or if its will exceed expenses or expenses will exceed revenue. To create a budget, whether for personal use or for your business, incorporate the following steps:

  • Set Goals – Make a list of your financial goals and when you wish to accomplish them.  You can set both short-term and long-term goals.  Short-term goals are those you wish to reach within twelve months.  An example of a short term goal may be to save enough money in six months for a vacation.  A long-term goal is usually five years or longer, you may wish to save 20% of the value of purchasing a new home in the next five years.  When setting a goal for the long-term remember to consider inflation over the passage of time.
  • Evaluate Your Income – How much disposal income do you take home each pay-period.  Do you have savings in a bank such as cash, or a money market account?   If you are creating a budget for your business, consider whether you have a net income or net loss after paying all expenses for the company, do you have a positive cash flow?
  • Identify Your Spending – Determine what are you recurring and/ or fixed monthly expenses each month.  How much is your rent or mortgage, car note, utilities etc.  What are some of your variable expenses that you can cut back on? You may decide to mostly prepare your meals at home and cut back on restaurant dining.  Make a decision on those optional expenses that you can eliminate.
  • Create Your Budget – Create an excel spreadsheet, or purchase a budget software and identify your goal at the top of the sheet, example, “Save $5,000 in 10 months for My Dream Vacation”, this would mean you have to save $500 per month for the next 10 months in order to meet your budget.  Next list your monthly income and all your expenses, both fixed and variable, if your total savings after listing all your income and expenses is not equal to or more than $500, you will have to either reduce your monthly expenses, more likely those variable expenses such as groceries, utilities, etc. or find additional income to meet your budget.

If you stick with your budget and keep your goal in mind you will reach that goal. Of course, there may be circumstances that requires an adjustment to the budget, if your financial conditions change, adjust the budget to a realistic amount and stick with it.We hope this blog provided useful and valuable insight on Creating and Managing a Budget.

For more information and insight email us at info@rtmcpa.com or contact us at (301) 797-8259

Accrual Versus Cash Basis Accounting

The most commonly used basis by small businesses is the cash basis method of accounting.  Most small businesses (with sales of less than $5 million per year) are free to adopt either the cash or accrual accounting method.  The Internal Revenue Service (IRS), in the first year of business, gives a choice of reporting income, expense, and profit on a cash or accrual basis. 

So what is the main difference between the accrual and cash basis of accounting and which is more acceptable?

    

The main difference is the timing of when revenue and expenses are recognized.  Under the cash basis of accounting, revenue is recognized when received and expenses are recorded when paid.  Whereas, under the accrual basis of accounting, revenue is recognized when earned and expenses when incurred.

Businesses are required to use the accrual method of accounting if:

  • Sales of the business is more than $5 million per year
  • The Business has inventory sold the public with gross receipts of over $1 million per year.

It is important to note that whichever method a business choose to use, either one gives only a partial picture of the financial status of your business.

Advantages and Disadvantages

Accrual method – Cash flows may not be positive as the financials will show a high sales amount, but not cash in bank, as payments have not been received by customers. However, under this method, the ‘full picture’ of the transactions are recorded.

Cash method – Cash in the business is readily recognized under this method. However, revenue could fluctuate from one month to the other, and having a large amount of cash in bank could just be a result have getting paid by credit customers in that month and the following month, could have slow sales and significant decreased in revenue and cash.

Regardless of which method a business uses, management must garner a thorough understanding of its business operation and financial health. There are many variables that contributes to a successful and profitable business, including the financial capabilities.

Converting from Accrual to Cash Basis

There are times, for example in the preparation of a tax return when a business may report its books on the accrual basis of accounting, but want to report its results under the cash basis of accounting. It is pertinent that the changes to convert from accrual to cash for tax preparation purposes should not be entered into the accounting records of the business, unless the business is changing the basis of accounting to the cash basis permanently. 

Main Accounts for Converting:

Accounts Receivable – Exclude current receivables from Income for cash not received in the period. Include receivables from the prior period where cash has been received in the current period for prior period sales.      

Accounts payable – Exclude expenses for any payable that were not actually paid in cash during the period.  Include payables from the prior period where cash has been paid in the current period for prior period expenses.

 Your conversion should be done external to the accounting system, for example in an excel spreadsheet. Additionally, while the IRS allows for the use of the cash basis method for tax reporting purposes, it is limited to smaller organizations that do not report any inventory at the end of their calendar or fiscal years.

 We hope this blog provided useful and valuable insight on the difference between the cash and accrual basis of accounting. For more information and insight email us at info@rtmcpa.com or contact us at (301) 797-8259

 

Understanding The New Lease Standard

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) (collectively, the Boards) have completed deliberations on new standards that significantly change the accounting for leases.  The plan requires lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets.

The new standard could affect companies’ decisions about whether to lease or buy assets

Under the current accounting model, a company applies a classification test to determine the accounting for the lease arrangement: Some leases are classified as capital leases (e.g. equipment lease) whereby the lessee would recognize lease assets and liabilities on the balance sheet.  Other leases are classified as operating leases (e.g. Office lease) whereby the lessee would not recognize lease assets or liabilities on the balance sheet.

The existing operating lease model has been criticized for failing to meet the needs of users of financial statements because it does not always provide a faithful representation of leasing transactions.

Core Principles of New Standards

The new standard will require companies that lease assets; referred to as “lessees”, to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.

Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than twelve (12) months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease.

 Unlike current GAAP which requires only capital leases to be recognized on the balance sheet the new ASU will require both types of leases to be recognized on the balance sheet.

 Who is Affected by the New Guidance

 Leasing is an important activity for many companies, whether a public or private company, or a not-for-profit organization.

 The new ASU affects all companies that lease assets such as real estate, airplanes, ships, and construction and manufacturing equipment.

 Effective Date for New Lease Standard 

  • For public companies, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Thus, for a calendar year company, it would be effective January 1, 2019. 
  • For all other organizations, the ASU is effective for fiscal years beginning after December 15, 2019 and for interim periods within fiscal years beginning after December 15, 2020. 

Early application will be permitted for all organizations.

 

We hope this blog provided useful and valuable insight on the new lease standard. For more information and insight email us at info@rtmcpa.com or contact us at (301) 797-8259

New FASB Standard – Revenue Recognition

There are some keys changes that will be implement in the very near future for Revenue Recognition.  These new pronouncements will change how we recognize revenue.  The main reason for the changes to the standards is because revenue recognition guidance differs in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)—and many believe both standards are in need of improvement.

 Below is a summarized version of the changes that are forthcoming.

 ASU 2014-09 Revenue from Contracts with Customers (Issued May 28, 2014)

 Applies to all contracts with customers except:

  • Leases 
  • Insurance contracts
  • Financial instruments
  • Guarantees
  • Nonmonetary exchanges between entities in same line of business to facilitate sales to customers

 Effective Date – Public Entities:

  •  Annual reporting periods beginning after December 15, 2017 (delayed effective date)
  • Early adoption allowed for years beginning after December 15, 2016 (original effective date)

 Effective Date – Non-Public Entities:

  • Annual reporting periods beginning after December 15, 2018 (delayed effective date)
  • Early adoption allowed for years beginning after December 15, 2016 (original early adoption date)

 Core Principal of the New Standard:

 “An entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” 

 Companies should start putting policies and procedures in place to implement the new standards. 

We hope this blog provided useful and valuable insight on the new revenue recognition standards. For more information and insight email us at info@rtmcpa.com or contact us at (301) 797-8259

 

 

 

How Important is Cash Flows to a Business?

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In order for a business to survive, the business must be able to generate and sustain a positive cash flow.  Understanding the basic concepts of cash flows will result in good cash management. In preparing the financial statements for a business, a balance sheet, income statement and statement of cash flow are usually presented.  The balance sheet shows the Company’s assets, liabilities, and retained earnings at a point in time and the income statement shows the income, expense, and net income or loss.  The statement of cash flows provides information about the cash receipts and disbursements of the Company during a given period as well as the investing and financing activities.

The cash flow statement is normally used to assess the following:

  • The Company’s ability to generate future cash flows that is positive.
  • The Company’s ability to meet its obligation, i.e. pays its debts.
  • The cash and non-cash elements of the Company’s investing and financing activities.

The cash flow statement is comprised of three categories, 1) Operating, 2) Investing, and 3) Financing. 

1) The operating category represents sources and uses of funds from the operation of the Company.  The funds relate primarily to revenue and expense items presented in the income statement. Some examples of operating cash inflows are receipts from sales, interest income, and rental income.  Examples of operating cash outflows are salary expense, administrative expense, and rent expense.  Non-cash operating items includes gain or loss on disposal of assets and depreciation expense.

2) The investing category represents assets and investments of the Company.  Examples of investing cash inflows are proceeds from the sale of investments, collection on loans made to others and sales of assets.  Examples of investing cash outflows includes purchase of fixed assets, Loans made to others, and capitalized interest.

3) The financing category deals with financing of the Company.  Examples of financing cash inflows are proceeds from loans, capital contributions, and advances made to the company by a related party.  Examples of financing cash outflows includes distributions, principal payment on debts, and repayment of advances.

In laymen terms, if you take in more cash than you spend, then you will have a ‘Positive’ cash flows, which is what you want in order to meet the Company’s debt and grow the Company.  In contrast, if you spend more cash than you take in, then you will have a ‘Negative’ cash flow and will have difficulty in meeting your debts.  A positive cash flow allows the Company flexibility in making purchases and investments, and more importantly, make the Company more desirable for banks to do business with.  Start your business by practicing good cash management, this includes knowing your cash needs, identifying the best source of financing, and always being prepared to meet the Company’s cash flow needs when they occur.

We hope this blog provided useful and valuable insight on practicing good cash management. For more information and insight contact us at (301) 797-8259