Understanding Cost of Goods Sold

The account on your income statement called Cost of Goods Sold can be confusing to non-accountants. In this article, we’ll attempt to de-mystify it and explain how it works.

Cost of Goods Sold is an account in your Chart of Accounts that is a very special type of expense. It is the amount of direct costs of items that were sold by the company. It is related to inventory, and it helps to see the flow of transactions to understand the big picture.

When you purchase an inventory item for sale, it’s considered an asset (not an expense yet) in your company. When you sell an inventory item, the asset is reduced and the Cost of Goods Sold account is increased, moving the item from an asset to an expense. It’s no longer an asset once it’s sold, and the cost of the item sold reduces your profit and is expensed into the Cost of Goods Sold account.

Some accountants will abbreviate the Cost of Goods Sold account to COGS, and you might hear them call it that.

In the case of wholesale and retail businesses, the cost of goods sold is the amount that was paid for the inventory items to be sold. In the case of a manufacturer, the costs can include the cost of raw materials, labor to produce the item, and sometimes additional allocations of other related costs. Construction businesses may have a Cost of Construction account or Contract Costs instead of COGS. Service businesses will typically not have a balance in the Cost of Goods Sold account. If they do have direct costs, the costs are often coded to a Supplies account under expenses.

At any point in time, the cost of items you purchase are in two different accounts:

    1. The unsold items are reflected in the asset account, Inventory, on your Balance Sheet report.
    2. The sold items are reflected in the Cost of Goods Sold account, on your Income Statement report.

It’s important that the Cost of Goods Sold balance is accurate, because there are many good things you can learn from it when you compare it with inventory. You can learn how fast your inventory is selling, and you can determine your gross profit margin.

If your inventory purchases have not been coded correctly, you can take inventory and arrive at the correct cost of unsold items. If your physical inventory does not match your books, your accountant can make a correcting entry between Cost of Goods Sold and the Inventory account so that both of them are accurate.

If you have further questions about the Cost of Goods Sold account, feel free to reach out any time.

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Mid-Year Review

Can you believe that half of 2019 is gone already? That means it’s a great time to take stock of how your business has done for the first half of 2019 so that you can meet your financial goals for the entire year. 

On Track for Sales

Are you on track to make your 2019 revenue number?  The first step is to check your 2019 budget numbers for total revenue. (Don’t have a budget? – Check with us; we’d be delighted to discuss that service with you.)

Next, get your Income Statement for June 2019 Year-to-Date and check the revenue figure. Are you on track with your budget, or are you halfway there revenue-wise, accounting for seasonality? If so, pat yourself on the back!  If not, what promotions will you put in place to boost your growth for the rest of 2019?

On Track for Profit

Looking at the same Income Statement, check your net income figure. Are you on track with what you planned?  If so, great!  If not, the reason is simple: it will be either lower sales than expected or higher expenses than expected. 

If your expenses are too high, you’ll need to drill down into each of your expense accounts, including cost of goods sold, to see which ones are higher than expected. Were there some unanticipated costs?  Does your pricing need adjusting? Do you need more volume to cover your costs?  This is where we can help you with an analysis of where your opportunities are to increase profit. 

On Track for Cash

One more place to look is your cash balance. It can be uncomfortable when you are running short of cash for your business. If your balance is lower than you’d like it to be, it could be because of some of the factors mentioned above.  It could also be because you just purchased an asset like a truck.  If you need help with improving your cash flow, that’s another thing we can help you with. 

Mid-Year Review

This mid-year review can help you head off any small problems before they grow into big ones throughout the rest of the year. And it can keep you on track so you can meet your 2019 business goals.

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Five Timeless Tips to Improve Customer Service

Having repeat customers is essential to many businesses, and the key to keep clients coming back is to provide them with great customer service. Here are five ideas to rate your business’s savvy when it comes to serving customers well.

  1. Make a great first impression.

When customers make a purchase from you, make them feel great about it by sending them a series of indoctrination emails. Congratulate them on the purchase, let them know how to get the most out of their new purchase, and encourage them to connect with you on social media and your mailing list. 

  1. Measure response time.

How fast do you answer prospect and customer questions? Social media has changed the game. Customers that reach out via social media platforms, their phones, chat, or messaging apps expect an immediate answer.  Facebook even gives a badge to businesses who respond quickly and consistently.   

Not only do businesses need to monitor messages coming in from a record number of places – email, phone, web forms, chat, social media, and more – they need to respond faster than ever. 

Without measuring your response time, it’s hard to know how you’re doing, so putting measures in place is the first step to improving this customer service metric. 

  1. Publish clear policies.

Good customer service starts with setting clear expectations. Before a customer buys from you, they should be able to know what your return policy is in case something goes wrong. Some of the policies that should clearly be published online as well as at all customer-facing business locations include:

  • Returns policy: If the product or service is not as expected, can the customer obtain a refund? Is there a re-stocking fee?  What about shipping?  Cash back vs. store credit?
  • Shipping policy: Most people expect free shipping these days. They will want to know what it costs and how long will it take to get the item.
  • Terms of service: Are there any limitations to the product? Or legal items that need to be communicated?
  • Privacy policy: All clients will be giving you private customer data. They will want to know if it’s secure, if you share it with anyone, and if you are compliant with laws like GDPR (Europe), the CAN-SPAM act (US), or CASL (Canada).
  1. Encourage feedback.

Your best ideas for new products and services can come from your customers. Ask for feedback by sending customer satisfaction surveys and requests for testimonials and reviews. Read what customers have to say about your service so that you can make improvements as needed. 

  1. Check your ego at the door.

As small business owners, sometimes we need to be humble, especially when things go wrong. Be generous with apologies to customers; it will go a long way toward improving customer relations. If you’re at fault, admit it and make it right with the customer.  Even if you’re “right,” find a way to explain to the customer so that they feel good about you and your business. 

Delivering great customer service can be a huge competitive advantage for your business. How does your business stack up against these five ideas?  Try them, and watch your revenue grow.

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Do You Know Who Your Top Customers Are?

Every business has customers, and while all customers are important, most entrepreneurs will agree that some customers are more important than others. This may be due to the amount of revenue the customer brings in, their ability to refer new clients to you, the interesting challenges of the customer, or another factor. It makes sense to identify these clients so you can spend more time with them or at least acknowledge them in some way.

How do you find out which clients have generated the most revenue with you? If you store customer data in your accounting system, you can run a report to generate the data you need.  In QuickBooks, the report is called the Income by Customer Summary Report.  In Xero, it’s called Income by Contact. If you do not store customer data in your accounting system, you may be able to generate a report from your billing system, shopping cart, or point-of-sale system.

The reports look like this: each row holds the customer name and the Income column holds total revenue by the customer. If your system allows you to sort the revenue field, do this in descending order. If not, you can export the data to Excel and sort it in Excel. 

Once you’ve sorted the data, the answer is right in front of you.  Your top customers based on revenue will show in order. These are the customers you may want to consider spending more time with. Schedule periodic lunches with them, give them a call on a regular basis, and send them a gift or thank you note once in a while.  The report helps you organize your connection points with your top clients so you don’t miss an opportunity or forget to reach out to an important customer. 

Run this report on a regular basis so that you’re focused on nurturing the most important relationships in your business. You can also look at trends to see if you’re losing revenue over time or gaining revenue with new clients. You can reach out to clients that are spending less with you to try to save the relationship before it’s too late.  And you can get to know new clients that are growing with you so that you can grab even more business. 

Make this report a regular activity in your business to stay close to what your customers are doing with you.

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Accounting-Related Policies

Setting customer expectations in your business is essential to gain the trust of your customers, avoid conflicts, and maintain a high level of customer service. One way to set customer expectations is to clearly state policies that are customer-facing. Many of these are accounting policies that we can help you with. The following policies are ones that every business should clearly publish. 

Refund Policy

When customers purchase your products or service and don’t get what they expect, what is their recourse? Your refund policy should clearly state which products and services are refundable. Do customers need to physically return the product in-store or via shipping? What if it’s a service? Are they refunded in cash or credit card? Or is it a store credit? Is there a deadline for refunds?

All of these questions should clearly be outlined in your refund policy.  Your website is a great place to publish it. 

Customer Complaints

If your customer has a complaint, how should they submit it? Is there a hotline to call, a suggestion box, or a form to fill out? If your business and employees are licensed, is there a government agency to write? A notice should be posted on your website and in your physical location describing where to submit complaints.

Shipping Policy

Not all businesses need a shipping policy, but you do if you ship physical goods to a customer location. What is the cost of shipping? What is the expected delivery time? A shipping policy explains this as well as what can go wrong: If the item was never received, what should one do? Must you sign for a shipment? If you return a shipment, who pays the shipping? If an item is received damaged, how do you file a claim?

Payment Methods

While not a policy this customer communication needs to be clearly posted. What forms of payment will you take? If you take a check, what ID does the customer need to show? Do you take some of the newer forms of payment such as Apple Pay or cryptocurrencies? How do gift cards work?

Past-Due Accounts

If a customer doesn’t pay their bills on time, they should know what to expect. Will interest be charged? Will the account be sent for collections? Will someone break the customers’ legs? Will future purchases be cancelled or require a C.O.D. (cash on delivery) payment? 

You might not think of your accountant when it comes to writing these policies, but you should; we can help. A good accountant can help you craft these customer service policies so that your communications and expectations with customers are better than ever. 

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How AI Is Changing Accounting

Artificial intelligence (AI) has arrived in the accounting profession in a big way. The good news is it’s streamlining accounting tasks, finding patterns in data you can take action on, and generally making things better. Here are just a few places we’re seeing AI and machine learning impact accounting.

Transaction Coding

Most systems have incorporated some form of machine learning into transaction coding. When bank feeds are imported, each transaction needs to be coded to add the account code in the chart of accounts.  Class, tracking codes, and other custom data may need to be added as well. Rules can be set so that the accounting application can pre-code the transactions; in this case the accountant simply approves or corrects the entry.

Invoice Fetching

It starts with a picture of a receipt. Invoice fetching applications can turn pixels into data using sophisticated OCR (optical character recognition). The data is then turned into a business transaction that can be imported into an accounting system.

Auditing

The books of many government agencies, nonprofits, and large businesses need to be audited on a regular basis. Auditing is an expensive process. Smart programs can review a company’s data and assess where the risks and anomalies are so that the audit program can be modified to focus on the more important parts. This reduces risk and cost for everyone involved. 

Accounts Payable

Artificial intelligence can help to speed up the matching of purchase orders, packing slips, and invoices so that accounts payable tasks are streamlined.  It can also automate approvals and look for duplicate invoices to avoid overpayments. 

Accounting Tasks That Are Clerical

Robotic Process Automation (RPA) is a platform that allows users to create automation without involving the IT department. Think Excel macros or Zapier on steroids. Any workflow with a mind-numbing set of clerical steps is a candidate for RPA. 

AI allows accountants to spend less time on routine tasks and more time on higher-level analysis work. As AI becomes more affordable for small businesses, everyone will benefit from this long-term trend.

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Buying a Car or Truck for Your Business?

When you purchase a new vehicle, you get the fun of riding around in a new car with the new car smell! Our job has just begun – to get your new asset recorded properly on your books. We thought it’d be fun to give you a behind-the-scenes sneak peek at our part. 

Sales Contract

The first thing we’ll ask you for is the sales contract.  It will give us the payment price of your car, and we’ll use that number to record your new asset on your balance sheet.  If you paid cash with no trade-in, the journal entry we’ll make is:

Debit: 2019 Toyota RAV4

$25,500

Credit: Cash

$25,500

Then we’ll decide on a depreciation method and book depreciation monthly or at year-end.

Debit: Depreciation Expense

$5,100

Credit: Accumulated Depreciation

$5,100

Trade-in

If you traded in a vehicle that is on your books, we’ll need to make an adjustment to your books. Effectively, your old car will be eliminated from your balance sheet. If this asset had a book value and it was not fully depreciated, the net value would be compared to the trade-in value and a gain or loss on the asset sale would be recorded on your income statement. 

Let’s say the balance sheet value of the three-year-old car you traded in was $10,000 and you got $8,000 on the trade-in. Here’s what we would record:

Debit: 2019 Toyota RAV4

$25,500

Debit: Accumulated Depreciation

$15,000

Debit: Loss on Sale of 2016 Car

$ 2,000

Credit: Old 2016 Toyota RAV4

$25,000

Credit: Cash

$17,500 ($25,500 – $8,000 trade-in)

We’d also start the depreciation for the new car.

New Car Loan 

Most often, a new car purchase will be financed, so we have a new liability to record too.  We’ll need to get a copy of the loan documents from you and an amortization schedule of the payments. Let’s say you made a ten percent down payment with no trade-in.  Here’s how that would look:

Debit: 2019 Toyota RAV4

$25,500

Credit: Cash

$2,550

Credit: Toyota Loan

$22,950

Then, each time you make a monthly payment, the amount will need to be split between principal and interest and those amounts will need to change each month.

Debit: Interest Expense

$390

Debit: Toyota Loan

$60

Credit: Cash

$450

We left out a few trade secrets just to keep it intriguing. There are a lot of other numbers on a car purchase: taxes, licenses, warranties, add-ons, fees, and more. Some of these can be directly expensed, while others need to be included in the value of the asset. So if you’re happy that we’ll take care of this for you, we’re happy to do so. 

Let us know if you purchase an asset this summer so we can get it booked right for you. 

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Your New Hire Checklist

Hiring a new employee is a big accomplishment in any small business, and there are a lot of steps involved, too. Here’s a handy checklist to help you stay organized when you bring that new hire on board. 

First things first, the legal and accounting items:

  • Signed employment agreement, typically an offer letter. There may also be a supplemental agreement outlining employee policies.
  • Payroll documents include:
    • IRS form W-4
    • Form I-9
    • Copy of employee’s government-issued ID
  • Most states require a new hire report to be filed; sometimes your payroll system vendor will automatically file this for you.
  • Notify your workers comp insurance carrier.

Next, it’s time for employee benefits enrollment:

  • Health insurance
  • 401K
  • Any other benefits you provide
  • Provide the employee with the holiday schedule
  • Explain their PTO and vacation if not already explained in the offer letter

Set your new employee up for success with the right equipment:

  • Desk, chair, lamp, other furniture
  • Uniform
  • Tools
  • Coffee mug, refrigerator shelf
  • Phone
  • Truck, keys
  • Computer, monitor, mouse, keyboard, power strip, floor mat
  • Office keys, card entry, gate remote, parking assignment
  • Filing cabinet, keys
  • Tablet
  • Forms
  • Office supplies
  • Cooler, other supplies

Your new employee may need access to your computer software systems:

  • Employee email address
  • Any new user IDs and password for all the systems they will need to access
  • Document access

How will your new employee learn the ropes?

  • Set up training
  • Assign a buddy

Hopefully, this list will give you a start toward making your employee onboarding process a little smoother.

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Beyond the Books: The World of Accounting

In small business, accounting refers to a set of tasks that revolve around maintaining a general ledger – your books — and preparing financial statements. Beyond small business accounting, there are many more aspects to accounting. In this article, we’ve prepared a glossary of accounting terms so you can discover the larger world of accounting.

Cost accounting. This type of accounting looks at the cost of items for sale. It’s especially useful in manufacturing, construction, or even restaurants where dozens or even hundreds of components are purchased and assembled to make the items that are for sale. Cost accountants account for and evaluate these costs to determine when they are too high or low and need to be repriced or purchased in a different way. 

Cost accounting can be applied to small businesses to help them with pricing, determining breakeven points, controlling costs, and budgeting.

Government accounting. Government accounting is simply accounting that’s done for government entities. Government accountants are concerned with maintaining government regulations as well as learning a different way of keeping books.

Nonprofit accounting. Nonprofit accounting is unique to nonprofit organizations in that they often need to track and mark specific donations, manage grants and meet reporting requirements, fulfill public disclosures and reporting, and maintain a fund accounting process.

Financial accounting. Financial accounting is the preparation of financial reports for external use and includes providing financial statements. 

Attest. Attest accounting is where a CPA goes through a process of verifying financial reports of a business to interested third-parties, such as banks and the public. The three main services in this area include compilations, reviews, and audits. Only a CPA can perform these services.

Fraud or forensic accounting. A specialty role in accounting, forensic accountants can help a company that has been the victim of fraud. There are also services available to help reduce the possibility of fraud. 

Tax accounting. Tax accounting can be many things: the preparation of federal and state income tax returns for businesses, individuals, and other entities like estates and trusts; state and local tax assistance with collection, filing, remittance, and compliance; franchise tax support; and payroll tax collection, filing, and payment. There are more, but these are the big ones.

Budgeting. Making a revenue and spending plan is an important accounting function.

Internal auditing. Large companies have internal audit departments that maintain checks and balances for the company. In small companies, having someone in charge of monitoring internal controls would be the equivalent function.

Accounting systems. Some accountants are technology-savvy, and this type of accountant can help solve technology issues, integrate accounting system modules, and streamline workflow.

Fiduciary accounting. A fiduciary is someone legally responsible for financial responsibilities in an organization. Fiduciary accounting typically refers to accounting for trusts, but can have a much broader meaning.

Public accounting. Public accounting is practiced by employees in a public accounting firm, which is one that serves many businesses with varying accounting needs.  This is opposed to private or industry accounting where an accountant goes to work for one company in their accounting department. Public vs. industry accounting is really referring to an accountant’s career experience. 

Managerial accounting. This type of accounting focuses on internal numbers and how the organization can reach its goals. It’s broader than cost accounting, but there is an overlap. Accountants who serve in an advisory capacity to businesses will focus on this area. 

Did we get all of the terms you might be wondering about? If not, ask us, and we’ll add it here.

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5 Ways to Speed Up Your Cash Flow

One of the biggest challenges for small businesses is managing cash flow. There never seems to be enough cash to meet all of the obligations, so it makes sense to speed up cash flow when you can. Here are five tips you can use to get your cash faster or slow down the outflow.

1. Stay on top of cash account balances.

If you’re collecting money in more than one account, be sure to move your money on a regular basis when your balances get high. One example is your PayPal account.  If money is coming in faster than you’re spending it, transfer the money to your main operating account so the money is not just sitting there. 

2. Invoice faster or more frequently.

The best way to smooth cash flow is to make sure outflows are in sync with inflows. If you make payroll weekly but only invoice monthly, your cash flow is likely to dip more often than it rises. When possible, invoice more frequently or stagger your invoice due dates to smooth your cash balances. 

Take a look at how long it takes you to invoice for your work after it’s been completed.  If it’s longer than a few weeks, consider changing your invoicing process by shortening the time it takes to send out invoices. That way, you’ll get paid sooner.  

3. Collect faster.  

Got clients who drag their heels when it comes to paying you? Try to get a credit card on file or an ACH authorization so you’re in control of their payment.

Put a process in place the day the invoice becomes late. Perhaps the client has a question or misplaced the bill. Be aggressive about following up when the bill is 45, 60, and 90 days past due. Turn it over to collections quickly; the older the bill is, the less likely it is to get paid. 

4. Pay off debt.

As your cash flow gets healthier, make a plan to pay off any business loans or credit cards that you have. The sooner you can do this, the less interest expense you’ll incur and the more profit you’ll have. 

Interest expense can really add up. If you have loans at higher interest rates, you might try to get them refinanced at a lower rate, so you won’t have to pay as much interest expense.    

5. Reduce spending.

You don’t always have to give up things to reduce spending. Look at your expenses from last year and ask yourself:

  • What did you spend that was a really great investment for your business?
  • What did you spend that was a colossal mistake?
  • What do you take for granted that you can cut?
  • Where could you re-negotiate contracts to save a little?
  • Where could you tighten up if you need to?

Managing cash flow is always a challenge, and these tips will help give you a little cushion to make it easier. 

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