Keeping the Books: Have-to and Ought-to

John Vinturella
 


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Many feel that once an entrepreneur has gotten a business up and going, they are bored by operating the business and ready to move on to their next startup challenge. In fact, the proof of the entrepreneur's mettle is in demonstrating that the plan for the business was sound, and that the strategy was executable.

This often requires that they stay with a business for several years to prove the concept, before selling or going public, and possibly bringing in longer-term professional management. In any case, the quality of the records kept by a business can be a significant factor in taking the business to such a “liquidity event, " that is valuing the business in a way to convert equity to cash. Some generally accepted principles for this record keeping include:

  • A business should have financial reports prepared at the end of each calendar or fiscal year, with interim reports during the year. Use of the “natural" business year as the formal accounting period has been increasing. The natural year is the 12-month period ending at the lowest point of business activity for the period.

  • Since many business transactions will be incomplete at the end of any accounting period, some estimates will be necessary. Such estimates are an acceptable part of financial reports as long as they are made according to procedures that have proved reliable in the past.

  • Each business is considered a separate accounting unit, with the affairs of the business kept entirely separate from the owner's personal affairs. All records and reports should be prepared on this basis.

  • Financial statements are prepared on the assumption that the business unit will continue to function in its usual manner.

  • For some accounting objectives, two or more methods are possible. For example, there are several methods of computing depreciation and also of valuing inventory. They are all valid, but once a method has been selected for use in the records of a business, it should be used consistently.

  • Accounting must be practical. Strict adherence to a principle is not required when the increase in accuracy is too small to justify the increased cost of compliance. A uniform policy should be adopted to guide such exceptions, however.

  • All assets and services required by a business should be recorded on the date they are acquired at their cost to the business. This cost includes costs incurred to procure the asset or service and to place it in position or condition for business use. Donated assets are recorded at their cash equivalent value as of the date of donation.

  • A major objective of accounting is to determine income by matching costs against revenue. The net income of a business is the increase in that company's net assets brought about through profitable exchanges of product and services or through sale of assets other than stock in trade.

    Most businesses will have at least two basic financial statements prepared at the end of the annual accounting period-a statement of income and a balance sheet. There may also be other statements containing important information. These might include a reconciliation of retained earnings in the business, a statement of source and application of funds, and listings of such items as inventories, accounts receivable, and accounts payable. However, the statement of income and the balance sheet are the basic financial statements.

    Higher standards are generally required for a stock offering, or purchase by a public company. Such transactions frequently require audited financial statements, where an accountant will want to make a “purchase investigation. " A purchase investigation is a normal audit with intensified examination of certain items critical in a valuation situation. The accountant may go to greater lengths, for example, to make sure that the physical plant and all equipment are present and in serviceable condition.

    If financial records are inadequate or suspect, the accountant qualify the certification, or state an inability to render an opinion regarding the statements. This might happen if the accounting records were not prepared in conformity with generally accepted accounting principles.

    Often the inability to get the company's statements audited can kill a deal. At best, it will cause intensive inspection by the buyer or investor, and probably lower the proceeds for the business owner.

    John B.Vinturella, Ph.D. has almost 40 years experience as a management and strategic consultant, entrepreneur, author, and college professor. For 20 of those years, Dr. Vinturella was owner/president of a distribution company that he founded. He is a principal in business opportunity sites jbv.com and muddledconcept.com , and maintains business and political blogs.

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