Business Financial Records Chapter PDF

# Chapter 15: Financial Records "Profit is not the legitimate purpose of business. The legitimate purpose of business is to provide a product or service that people need and do it so well that it's profitable." - James Rouse - ## Importance of Financial Records Simple records are important to the...

# Chapter 15: Financial Records "Profit is not the legitimate purpose of business. The legitimate purpose of business is to provide a product or service that people need and do it so well that it's profitable." - James Rouse - ## Importance of Financial Records Simple records are important to the small business owner as a way of keeping track of finances. Keeping accurate records, and understanding the relevance of source documents, is useful to be able to enter accounting information correctly. To establish whether the business is profitable the owner needs to calculate the profit or loss. In addition, the operations of business should always include planning for the expected income and expenses. In this regard, the ability to perform a break even analysis is very important. ## Records for Small Business A small to medium business enterprise will need to keep careful records and to develop useful documentation. Most small businesses are run on a cash basis, and money is recognized as being earnt or spent at the time cash is paid or received. Accurate financial record keeping is vital, as it ensures that the owners and managers can be fully informed of the current state of profitability and liquidity. Good financial records show how efficient the business is, assist when approaching external organisations such as financial institutions and the taxation department, and allow planning for the future to occur. Basic record keeping requires the business to keep a particular set of information and data. These can be written manually or through the use of computerized management and accounting packages which is more common. Following is an explanation of the basic records that would need to be kept by any small business. ## Documents and Records This section will focus on external business communication using standard forms to communicate information to other businesses. Standard forms might include common business documents such as order forms, invoices, credit notes, statements, receipts, deposit slips and reconciliation statements. ### Common Business Documents | Document | Description | |---|---| | Invoice | When a sale or purchase has been made, this shows the amount owing. It also includes the date, quantity, price, any GST, discounts, address and terms of sale. It must state that it's a Tax Invoice. | | Receipt | A record that the amount owing on an invoice has been paid. This should include the date, details and amount. These can be paper, electronic, or EFTPOS. | | Order form | Used to request a sale or purchase. Contains details such as the date, quantity, price, any discounts and address information. Can be paper or electronic.| | Bank deposit slip | Shows a sum of money that has been banked. | | Credit note | If a product is returned for any reason, a credit note records the credit the customer or supplier has been given for the return. | | Statement | Used to provide a summary of the customer's or supplier's account. Includes amounts outstanding, amount that have been paid and all other details such as dates, address and products. | | Bank reconciliation | Used to compare the cash payments and receipts of the business with the records held by the bank. | ### 1. Invoice An invoice is issued when products are sold to a customer on credit. It contains details of the business name and Australian Business Number (ABN), the date of issue, the invoice number, details of the customer purchasing the product and a unit description of each good or service supplied, plus a breakdown of the GST applied to each part. The Australian Taxation Office (ATO) requires tax invoices to include: * The business name and Australian Business Number (ABN) of the supplier or seller * The date of issue and the words 'Tax Invoice' at the top, on the right hand side * An invoice number next to 'Tax Invoice' * The purchaser's name, address and ABN for goods or services costing $1000 or more * A unit description of each good or service supplied, including quantities * An indication of which goods or services do not include Goods and Services Tax (GST) by showing a zero in the GST amount column and an indication of which goods or services include GST by showing the GST amount * The GST exclusive price, the GST amount and the GST inclusive price for each item, together with the totals. ### 2. Receipts The ATO requires cash register receipts to include: * The business name and the ABN of the supplier * The date of issue and the words 'Tax Invoice' at the top, on the right hand side * An indication of which goods or services are taxable by showing an asterisk * with a note at the bottom advising what the * indicates * The final amount payable, GST inclusive * The amount of GST which is payable stated as follows: 'Total includes GST of $.....' ### 3. Order Form An order form can look very different depending on the business that is using it. Every business has different products or services that they will sell and so they will record orders differently. For example, the difference between the order form used in a restaurant, a furniture shop and an abseiling adventure business will be massive. The basic sections of any order form would be the businesses information, customer information, a description of each item being ordered and their cost. ### 4. Bank Deposit Slip This is a receipt issued by the bank when the business sends a staff member to the bank to bank the cash collected in the business. It contains details such as the account that the money is to be paid into, the date and the amount. The business then uses this basic information to enter more detail. ### 5. Petty Cash A petty cash system is established because it is too difficult to have all payments being made from the business using a cheque. If small items of expenditure are needed, cash, a business credit card or direct transfer can be used. This section discusses how the use of cash for business payments can occur using a petty cash system. Ensuring the business has good internal control processes means that instead of just taking some cash from the cash register, the business has a separate amount of cash allocated for small cash payments by employees of the business. The business sets up this system by writing out a cheque for cash, and then keeping this amount of sets safely in the business, with an employee in charge as the petty cashier. If a staff member needs to pay for a taxi fare, postage, morning tea or other small amount, they fill out a voucher requesting the cash, then use this for the purchase and give the petty cashier their receipt as evidence of the transaction. On regular occasions, the business writes out another cheque for cash to bring the balance of the petty cash fund back up to the initial amount. ## Documentation for Internal Control ### Control of Cash Cash control requires keeping clear records of transactions using source documents, correct petty cash and banking procedures, and control procedures within the business to ensure that cash is not misplaced, stolen or unaccounted for. * Bank cash on a regular basis and do not keep large amounts of cash on the premises. * Have cheques signed by two people when the cheque amount is over a certain limit. * Count the cash in a secure location away from customers. * Regularly empty the cash register so that there is never a large amount of cash contained in a register. * Ensure a receipt is written out or printed for every transaction, including petty cash. * Investigate any cash shortages or irregularities with cash register totals. * Do not borrow money from cash registers but use a petty cash system. * Complete regular bank reconciliations. A bank reconciliation is a check that the payments and receipts of cash and cheques for the business have been processed through the bank account. Every month, the business will receive or download a bank statement which is a summary of all payments and receipts that have gone through the businesses bank account. The business should tick off every item by checking it against the records that are kept in the accounting system. There will be some unpresented cheques and some deposits not recognised yet and these should be further investigated or reconciled. There may also be direct debits that the business has not yet entered into the accounts and these can also be reconciled. ## Calculation of Profit ### Income and Expenses Income and expenses are most relevant to the budgeting function of resource allocation. A business will show income and expenses in the form of an Income Statement, also called a Profit and Loss Statement or a Statement of Financial Performance. This statement gives important information about the profit or loss that the business has earned, and shows the financial performance over a period of time. An Income Statement is composed of two main elements: income and expenses. A simplified definition of each is given here. | Element | Description | |---|---| | Income | Money received by the business, e.g. sales, fees, interest. | | Expenses | Payments or costs incurred by the business, e.g. cost of sales, rent, wages, internet, water. | The Income Statement is used to calculate whether the business has made a profit or a loss for a period of time. If total income is greater than total expenses, then the business has made a profit. If expenses are greater, then the business will record a loss. ### Examples: Simple calculation of profit or loss Clara runs a lawn mowing business. In the last financial year, she took in $26,000 in fees. Her costs for the year were as follows: Advertising $2,000; Repairs $3,000; Petrol $4,000; Fertiliser $3,500. #### Clara's Lawn Mowing Income Statement | Element | Amount | |---|---| | Fees | $26,000 | | Less: Expenses | | Advertising | $2,000 | | Repairs | $3,000 | | Petrol | $4,000 | | Fertiliser | $3,500 | | **Profit** | **$13,500** | An example of the Income Statement for a service business such as Clara's is shown here. Clara has made a profit of $13,500 for this financial year. ## Break Even Analysis Business owners must make decisions about the setting of prices in order to obtain a profit. Cost-volume-profit analysis, or break even analysis, is used to determine how costs and profits are affected by changes in the volume of production. A business will calculate the volume of a product that must be sold at a specific price to 'break even', or in other words to completely cover costs of the product. Percentage mark up is the difference between the cost of a product and its selling price. A business may be a retailer who purchases items from a wholesaler, or a manufacturer who purchases raw materials and prepares a product for sale. For both types of business there is a similar process to be undergone in order to decide on the percentage mark up. The business owner must decide how much each item costs and add the percentage mark up on to decide the sale price of the item. ### Break even point Selling price can depend on the number of items that can be manufactured or sold. To work out the number of items required in order to cover costs, or in order to make a particular profit, a business can calculate the break even point. * **Mark up = Cost price + Percentage** Break even point is the number of sales, or the dollar amount of income, where all expenses are covered and neither a profit or a loss will be made. #### Example: Break even analysis Meg runs a fruit juice store. The cost of making one fruit juice is $3, which she plans to sell for $6 each, giving a contribution margin of $3 per juice. Her weekly costs are $400 rent, $600 wages and $50 electricity and phone. * **Breakeven point = $1050 / $ (6-3) = 350 fruit juices a week.** This means that if her shop is open 5 days a week, she needs to sell 70 juices a day, just to break even. Meg can rerun her break even analysis for different selling prices, or see if she can adjust the fixed and variable costs. To calculate break even mathematically, a business owner must try several different selling prices. If Meg conducts a market survey and decides that she can only sell 50 juices a day, then she will need to reconsider her selling price or see if she can adjust the fixed and variable costs. * **Selling price = $1050 / (Selling price - $3) = 250 juices a week.** At the lower expected sales, Meg needs to sell her juices for $7.20 in order to break even. If customers will not pay this price Meg will definitely reconsider costs.