The equity section of the balance sheet looks different depending on the legal structure of your business. The most common entity types are corporations, partnerships, and sole proprietors. In this article, we’ll take a look at what the equity section of the balance sheet looks like for sole proprietors.
The Equity Section
As a reminder, the balance sheet has three major sections: assets, liabilities, and equity. The equation Assets = Liabilities + Equity is true for all entities. For a sole proprietor, equity is called Owner’s Equity. There are typically two accounts listed: the Owner’s Capital Account and Owner’s Draw Account.
Owner’s Capital Account. This balance represents how much money the owner has put into the business. Also included are cumulative business income or loss amounts from prior years.
Owner’s Draw Account. This balance represents how much money the owner has taken out of the business. Since a sole proprietor does not get a paycheck, taking money out of the business via a draw is how they get their money.
A third account will show up if you run a balance sheet report in your accounting system on any date during the year: Current Year Earnings.
Current Year Earnings. This balance is the same as the net income on the year-to-date income statement. It represents the profit in the business.
On a formal balance sheet for external purposes, only one account will show and that’s the Owner’s Capital Account. The draw and the current year earnings will roll into that account.
Salary vs. Draw
It’s important to distinguish between the idea of a salary and a draw. In corporations, owners receive salaries in the form of paychecks, where payroll taxes are taken out and W-2s are issued at year-end. The salary and taxes are deducted as expenses in the corporation’s income statement. For a sole proprietor, this is not at all how it works.
A sole proprietor has no salary. There is no payroll expense or payroll taxes on the income statement for the owner. The owner could have employees, and those payroll expenses would be shown on the income statement, but there is nothing for the owner.
The owner takes draws, which is not an expense. Draws are a reduction in equity. They do not affect profits. They do not change taxes owed. An owner can take a lot of money out of the business, and there is no impact on profits. There is definitely an impact on cash flow though!
A sole proprietor does pay payroll taxes in the form of self-employment taxes. They simply do it on their IRS Form 1040 as opposed to payroll tax forms that a corporation would use.
The equity section can be the most difficult section to understand on the balance sheet. Hopefully, the explanation above will provide a bit more clarity so you can better understand how to read your business’s financial statements.
Sometimes we just need to slow down. It could be our body telling us it needs a break. It could be our mind experiencing the first signs of burnout. Even if you own your own business, you are subject to burnout, especially if you are a people pleaser or say “yes” to everyone!
But how do we do that? It might have been so long since we’ve changed our pace, we don’t know where to begin. Here are some tips on the best ways to slow down in business.
1. Eliminate wasted time.
Take a deep look at your to-do list. Identify one task that you’ve always done that adds nothing to your business. Does it really need to be done? Try to find tasks that don’t make any sense to do any more that you’re still doing just because you’ve always done it.
You should be able to free up a lot of time! For now, use it to slow down. Take a nap, call a friend, visit your employees with no agenda and really listen, take a walk and smell the roses, or simply hug your child.
2. Get off electronics.
A friend recently suffered from a concussion and her doctor told her to stay off electronics to help her brain heal faster. She limited herself to one hour a day for two months. What would you do if you had to stay off electronics? My friend read all the paperbacks she had that she hadn’t gotten to (for 15 years), cooked more, went shopping for things she had wanted for years, took walks, and learned a new language.
If you spend any time on social media, eliminating it even partially can be a huge pickup in time. Getting off electronics and using that time to get back into nature is healing for everyone.
3. Get enough sleep.
If you are sleep-deprived, everything takes longer. Slowing down and getting enough sleep each night can make you more productive, reducing your work hours. Plus, you just feel more refreshed.
4. Gain a new perspective.
Slowing down your normal routine can help you gain perspective. You might have been fighting fires in the trenches for so long, you’ve forgotten why you’re in business to begin with. Take time to re-connect with your mission, vision, and purpose. Make sure your employees understand their grander goals as well.
5. Avoid multi-tasking.
Almost everyone thinks they are good at multi-tasking, but it turns out science says only a minority percentage of people can really multi-task effectively. Become self-aware of your own habits related to multi-tasking. Do things take longer when you multi-task? Do you make mistakes you have to go back and correct when you multi-task? If so, you may be in the majority of people who simply shouldn’t do it.
6. Stop worrying about billable hours (for service businesses) – at least for a while.
If you are really fixated on billable hours, you may need to just let them go for a while until you can get your perspective back. There is more to life and business than billable hours.
7. Re-connect with your business community.
If there has been no time to connect with your co-owners, customers, and employees, slowing down can provide that time. The most important thing is to simply show up and listen. You will learn a lot!
8. Make time for strategy.
If your business is headed in the wrong direction, that is the ultimate time-waster! Slowing down allows you to re-visit your strategy, making sure you are working on the right projects, that you have the right company culture, and that your business goals are in alignment with your big-picture purpose.
9. Do nothing.
It’s really okay to do nothing when you’re the business owner. You need time to come up with ideas, think about the hard issues, and even daydream. You have to stop working in the business so you can work on the business.
10. Get better at managing distractions.
If you get interrupted every five minutes, you will be drained of energy at the end of your work day. Get smart about managing interruptions so you can be more productive. This will free up more time for you to take breaks and slow your pace during your workday.
Try at least a few of these ideas to slow down before your mind or your body insist on it.
Prioritizing Capital Expenditures
Most small businesses own fixed assets, which include items like land, buildings, equipment, and automobiles. The investments of adding, replacing, or improving upon fixed assets is called capital expenditures (capex).
It seems like there is never enough money for all the capital expenditures that need to be done in a business. To make the best spending decisions, the business owner needs to put processes in place for capex activities.
The first step is to make a list of all the capital projects you want to do. Here are some examples:
- Buy an additional truck for deliveries.
- Expand the warehouse space.
- Purchase a piece of equipment for the manufacturing line.
- Redo the dock area to improve loading efficiency.
Once you’ve made your list, you can begin to formalize your capital expenditure process. Each project should be detailed and estimated, with bids from vendors so that you have a very good idea of the cost.
The next step is the most important. What are the estimated savings for each project? In other words, what will your return on investment be? In capital expenditure spending, this answer is crucial. For each project, estimate the expected savings in time, money, and intangible benefits, and what the breakeven time will be.
This step can be extremely difficult because the savings might not be concrete. It could be that the benefit is improved customer service, which should result in future sales. In this case, you still need to estimate future sales. In most cases, it can take years for a capital expenditure to start paying off from a cash flow standpoint.
Now, make a summary table of your results.
|Truck||$40,000||Increases sales by $1,000 per week.
Marketing spending (non-capex) increases by $3,000/year.
Assume cash sale – if loan, figure interest expense.
|First year: $9,000 savings.
Second year savings: $49,000. Breakeven comes in second year.
|Increases sales capacity and reduces delivery times.|
|Redo the dock area||$20,000||Time saved – payroll costs decrease by 1/2 headcount. Savings of $27,000. If attrition used, defer savings.||First year savings: -$7,000. Second year savings: $27,000. Breakeven comes at end of second year.||Employee happiness, reduced turnover are intangibles.|
When deciding which project to do, return on investment is only one factor to consider. You must also consider employee satisfaction and turnover issues, customer service, capacity management, tax breaks, breakeven time, cash flow, lending limits and financial ratios, and other factors that might be specific to your industry.
The key is to have a process. If you don’t, you might off the top of your head say “let’s do the cheapest project first.” But it might not be the one with the highest return, which can cause cash flow and profitability issues down the road.
Taxes need to be considered, which have been left off of the above example. Especially if it’s just before year-end and you have high profits, December could be the best timing for a higher return on investment.
Another consideration is if you will need a loan to make these improvements. Interest rates have been rising, and these costs, plus your cash flow impact, need to be evaluated. As your debt increases, your financial ratios also need to be evaluated. You have to be careful not to go into too much debt overall.
Once you have documented all of these considerations, you can make a much better-informed decision on your capex spending and which project to do first. You might consider creating a capex committee to help you make a decision. Be sure to include your accounting advisor on the committee!
Three Processes for Capital Expenditures
You need three processes to properly evaluate capital projects:
- Initiation, estimating, and evaluating return on investment for each capex project.
- Prioritization – what gets done first?
- Managing and monitoring the projects once they have started.
We’ve talked about the first two; let’s talk about managing the project. You’ll want to appoint a project manager that can oversee the project’s progress and make any course corrections needed. Once the project is complete, set milestones so that you can see how accurate the estimates were of both costs and benefits. You might need to set milestones every year for several years in order to accurately measure actual return. Doing this will make you a better estimator in the future.
Spending at the right time on capex projects is surely still more art than science. Putting formal processes in place will improve your chances for a better return, smoother cash flow, and improved profits. And, since this is an incredibly complicated area, we are happy to step in and help with any of these capex processes, so feel free to give us a call.
Five Ways to Welcome in a New Year: 2023
A new year is a perfect time for a fresh start for you and your business. Here are five ways to welcome 2023 and make it your best year ever.
- Decide on a theme for 2023
Setting a theme for the year can help you remember what you want to focus on. Some examples of themes might be:
- Growth and improvements to your business. You can be specific, such as making your theme the year of mastering technology, the year of profitability where you focus on cutting costs or increasing sales, or the year of diversity where you focus on creating a diverse team.
- Downsizing, cleansing or simplifying. Perhaps your business has grown so quickly that you need to sit back, de-clutter, re-design, or simply clean your office.
- Is it time to launch a new service?
- Giving back. If everything is humming along, it could be time to start giving back to your profession or community.
From here, you can create a plan of tasks and timelines that are aligned with the theme you’ve chosen.
- Go on a retreat
If you need to regroup and rejuvenate from a stressful holiday season, then a retreat can do the trick. A retreat is a time to set goals for your business and make a plan. You could discover that you are on track or that you need a course correction in your business.
A retreat can be made alone or with certain team members. Typically, the events of a retreat include a combination of planning and brainstorming sessions, education, team-building, and social activities.
If a retreat sounds like too much work, then a quick vacation might be in order, just so you can enter the new year with a relaxed mind.
- Learn from 2022
If 2022 was a bumpy time for your business, it might be a good idea to perform a detailed review. This will help you learn what went wrong and explore why. You can then brainstorm ideas on how to avoid the pitfalls of 2022 as you move into 2023. You can make it as informal as you want, or structured as an after-action review.
- Select a word for 2023
If setting a theme is too complicated, how about selecting one simple word for 2023? Here are some ideas:
- Abundance (think big, go after large contracts and big projects)
- Powerful relationships (OK, that’s two words!)
- Forgiveness (especially good if you are in customer service or have difficult clients)
I’m sure you can think of one that will be perfect for you. Once you do, write the word on several sticky notes and paste it everywhere you work and maybe even at home. Your postings will serve as a reminder of what your intention is throughout 2023.
- Make a profit plan (AKA budget)
Making a profit plan for the new year will help you hone in on the profit amounts that you want to achieve. Understanding how much volume you need to reach and what you can spend will avoid surprises at year-end. At mid-year, it’s a good idea to see if you are on track for the rest of the year.
Whether you do one or all of the ideas above, we hope you have an awesome 2023 and that it’s your best year ever.
Are Your Employees “Quiet Quitting?”
“Quiet quitting” is a very new term in 2022 that refers to one or more employees who remain working, but only do the minimum job during regular work hours. They are done going the extra mile, they are done working overtime, they are likely done caring all that much, and they may also be quite burned out.
The last three years have been anything but easy. Shortly after the closings occurred due to the pandemic, many people lost their jobs. While recovery was taking place, millions more people decided that they would either retire or take a rest for a few years. This made up what was called the Great Resignation. It took a few years for employment to come back to pre-pandemic levels.
A huge movement to work remotely simultaneously occurred, and many people have been reluctant to return to the office. Many more people suffered financial hardship, in spite of government help, and are still recovering.
All of these conditions and more have stressed employees and led to mental health challenges for millions. Thus, “quiet quitting” should not be too much of a surprise.
What Can an Employer Do?
There is quite a bit an employer can do about quiet quitting. For the entire staff, here are some tips to try:
- Ensure that employees’ health plans include a robust mental health component.
- Partner with a child-care and/or senior-care agency to reduce the stress of finding support for families who need it. This will help women re-enter the workforce, as they have been the most impacted.
- Implement employee wellness programs designed specifically to reduce stress as well as to take care of physical and mental well-being.
- Add some perks, such as employing a yoga instructor or a teacher certified in mindfulness-based stress reduction methods for an hour a week.
- Encourage employees to take vacation time to reduce burnout.
- Add training programs so that employees can have a chance to develop new skills.
- Add an education reimbursement program where employees can go back to school and earn a degree or certificate related to their job.
- Bring back the company Christmas party, picnic, or movie night so employees can socialize with each other again.
Anything that can help to refresh and rejuvenate your employees will help reduce quiet quitting in your company. While many of these can cost quite a bit, a few of them are very affordable.
On the individual level, and especially for individuals you suspect may be quiet quitting, it’s a good idea to conduct a formal process of setting goals. While this is normally done during employee performance review time, it doesn’t have to be. It can be very effective to sit down with an employee and simply ask what they want to get out of this job and what they want their future to look like.
Goal-setting encourages well-being and can give an employee something to strive for. Refreshing goals quarterly can help an employee re-engage with their job. It can also help a supervisor identify an employee who might be happy doing another job, so that a re-assignment can take place that is advantageous for both parties.
Increasing Employee Engagement
Whether your employees are quiet quitting or not, it’s always a good idea to offer programs and benefits that help employees re-engage, rejuvenate, and refresh their work on the job.
What Is an Audit?
The word “audit” can be thrown around a lot in casual conversation. When an accounting professional uses it, it means something very specific. We’ll discuss this and other uses of the term “audit” in this article.
A financial audit is an official service designed to inspect the accounting records, technology, and processes of an organization. An audit can only be conducted by a licensed CPA that is independent of the organization.
Independence is a special term as well, meaning the CPA who audits the organization must have no relationship with the organization or its owners and employees. For example, if the organization’s owner is the sister of the auditor, that won’t work!
To conduct an audit, the CPA performs an audit program, which is a set of tasks that review the company transactions, balances, and accounting processes. The audit program is custom-designed to the company based on the risks perceived by the audit team, the type of organization being audited and other factors. Once the audit has been completed, the auditor will issue a formal report stating the findings of the audit. The report typically includes a letter, financial statements, and footnotes.
The auditor’s report can be utilized by the company’s management as well as third parties, such as lenders and stockholders.
While there are mandatory audit requirements for large public companies, government institutions, schools, and some larger nonprofit organizations, small businesses are not typically audited because of the expense. That’s when additional assurance services come in handy.
Other Assurance Services
An audit falls under assurance services in accounting, and it’s the most stringent of all. Other types of assurance services include:
Compilations. In this engagement, the CPA performs basic checks on your financial statements and puts them together with a cover letter. It basically tells a third party that you have a CPA, but it provides the least amount of assurance service.
Reviews. In a review, there are a few more checks and tests that a CPA will perform before issuing financial statements. This service provides more assurance than a compilation, but less than an audit.
Agreed-upon procedures. An engagement with agreed-upon procedures is a very specific engagement where one aspect of the business is reviewed in accordance with a specific goal.
For small businesses who are asked for documents from your accountant by a bank or lender, you can often provide one of these lower-level assurance reports and it will not only suffice, but save your money.
Auditing a Class
Auditing a class has nothing to do with accounting! It simply means you’re sitting in on a college course, but not getting any kind of credit or grade.
The Dreaded IRS Audit
The term audit can also be used informally to define an inspection that is narrower in scope, such as an IRS audit or a state agency audit. There is no assurance provided in this type of audit. The purpose of this audit is to produce whatever records you are asked for in order to verify the numbers you sent to the agency.
An audit may be somewhat of a stressful and unpleasant, but necessary, experience. Having your accountant support you along the way can be reassuring (pun intended).
The Accounts Payable Process
All businesses, no matter their size, have bills to pay. The larger the business, the more formal the accounts payable process tends to be. That doesn’t mean small business owners can’t benefit from a formal accounts payable process. Too many “fake” bills are being sent, and all businesses should have safeguards in place. Let’s take a look at the workflow of accounts payable to see where we can put some controls in place to protect your hard-earned money.
A good first step is to initiate a purchase ordering process. All spending over a certain amount, such as $500, should require pre-approval from a manager or officer of your company. This can take the form of a purchase order.
A purchase order (PO) is simply a pledge on the part of your company to purchase an item or group of items from a particular vendor. It should include the vendor’s information, the item(s) and quantities, the price that the vendor has agreed to, and who initiated and approved the proposed purchase. It will look similar to an invoice, but it’s not an invoice and should be appropriately marked.
If the price is not standard or the items are custom, there may be an estimate from the vendor that documents the price on the purchase order. The estimate document is written by the vendor, while the purchase order is originated by your company.
While the purchase order is important, it does not create any entry on your accounting records, as no transaction has taken place yet.
The invoice is the documentation of the purchase with a request for payment and is created by the vendor you are obtaining goods or services from. It should be recorded on your accounting books once it is received from the vendor.
The invoice should be matched with the purchase order, checking to see if each item, quantity and price match the same on the purchase order. Any discrepancies should be explained.
The timing of the invoice can vary. It may be received before or after you actually receive the goods or services that it covers.
The invoice should not be paid yet (unless prepayment is required). We’ll cover that in a minute.
If the goods you have ordered are physical and are to be shipped to you, then there will usually be a packing slip or shipping document included in the shipment. The shipping document will have quantities, but may not have prices. The document should be matched with the actual items received and any shortages or overages should be noted.
A process to stock the items into your inventory should then occur. A transaction should be entered into your system to increase inventory for the goods you receive.
The (corrected) packing slip should be matched with the invoice to make sure everything on the invoice was received. If there is a discrepancy, it should be noted.
Items may come in a later shipment if they have been back-ordered. You’ll need to set up a process for that, noting it on the appropriate documents.
As you can see, a couple of processes need to be put into place. There should be a process for each document listed above. There should also be a process for matching the documents, and there should be a process for when there are discrepancies. Last, there should be approval processes all along the way.
Your workflow may vary from the one listed above, depending on the order the documents are received and when payment is required. You may even have a different workflow for different vendors.
Once the purchase order, shipping document, and invoice have been matched and corrected, it’s time to get them approved for payment by the appropriate level of management that you desire. This is something you’ll want to set up in advance: which of your employees can spend and approve what amounts.
Once your invoice is approved, it is time to look at the payment terms, noting when payment is due. It can then be set up to be paid. This can be done inside a system, using a company credit card, sending a bank transfer or wire, or writing, signing, and mailing a manual check.
Payment affects your books as well, so an entry should be made when payment is issued.
A great accounts payable workflow will protect your company from unauthorized payments, missing items, and even hasty purchasing decisions. There are also many accounts payable systems to support the automation of many of the steps, but don’t forget you still need to set up the processes so they work for your company and the vendors you use.
As always, if you need our recommendations, we’d be happy to help.
The equity section of a business’s balance sheet is the most difficult part to understand. The accounts that make up that section vary depending on the type of entity in which the business is structured. In this article, let’s take a look at what the equity section looks like for companies that are organized as partnerships.
The Equity Section
As a reminder, the balance sheet has three major sections: assets, liabilities, and equity. The equity section focuses on the investments that the owners have in the business. For partners, it consists of their capital accounts. The section could look like this:
Partner A Capital $25,000
Partner B Capital $25,000
Partner C Capital $50,000
Each partner has their own Capital account within the equity section of the balance sheet. A partnership with 100 partners will have 100 capital accounts in the equity section. Computing the balance for each partner is where the work comes in.
A partner’s capital account balance is affected by numerous transactions throughout the year as well as current earnings, which are distributed to the partners based on their ownership percentages. Ownership rules and percentages are spelled out in the partnership agreement.
Items Affecting Partners’ Capital
To compute a partner’s capital account balance, here is the basic formula:
Balance at beginning of period
+/- Partner’s share of net income/loss
= Balance at end of period
Contributions to capital includes money that the partner has given the partnership out of their personal assets. Withdrawals are the opposite: this is money that the partner has taken out of the partnership and used for their personal use.
Net income is a bit more involved, with two more steps. First, the sum of the entire partnership’s income and expense accounts must be calculated. This number should be the same number as net profit or loss on the partnership’s income statement, from the beginning of the year to your balance sheet date. Second, the net income must be divided up to calculate each partner’s share based on their ownership percentages. These amounts are then rolled into each partner’s capital accounts.
To make sure the partnership equity section is accurate, good recordkeeping is a must for the partnership as well as each of the individual partners. If we can help you understand more about your partnership, please reach out any time.
How do you arrive at a price for the products and services you sell? While it depends on what industry your business is in, there are only a handful of foundational pricing methods that are useful to know. Here are several of them.
Time and Materials Pricing
Many service-based businesses price based on the time spent performing the service. An attorney usually has an hourly rate. A massage-therapist will charge based on a 50- or 80-minute service. Plumbers charge a minimum fee for the first hour and another rate for subsequent hours. A moving company charges by the hour (they may also charge by truck or have a fuel charge these days).
In some cases, time-based pricing may be loosely tied to the salary level of the person performing the service, but there must be a substantial markup to cover payroll taxes, health insurance, overhead, training, and any materials or tools that are included.
Cost-plus pricing is used in the retail industry where goods purchased from a manufacturer or wholesaler and made available for sale. This method is based on the cost of the item. A common example is keystone pricing, where an item is marked up to twice the purchase price plus one dollar.
Other industries that use cost-plus include groceries and auto dealers.
Market pricing is pricing that is dependent on fluctuating market conditions. Commodities are the best example. Crops, oil and gas, and metals are a few items that are priced by market.
Target pricing is where you start with a price that you feel customers will be willing to pay, then design a service or product around it. It’s most commonly used in the software industry. As an example, let’s say you come up with an idea for a software application that you feel people will pay $49 per month for. You then build a software development and support team around a budget that supports that price.
Value pricing is based on what the client values and will pay for. For projects, it can be based on the client’s expected return on investment. Value pricing is used in internet marketing and for some services and products.
There is a fine line between premium pricing and value pricing. Some luxury brands may be premium-priced with some value pricing thrown in.
Pricing in Real Life
In business, determining a product or service’s price is part math and part art. It can be a combination of two or more of the methods listed above, or a method not listed above. Many factors and considerations should go into your pricing decisions.
One thing we can help with is to determine if your pricing is adequate for the profit margins you want. We can also help with what-ifs. For example, if you raised your price by ten dollars, but demand went down five percent, what would your numbers look like?
Pricing is a skill to pick up, just like selling, running a business, and customer service are skills you need. If we can help you with your pricing process, please reach out any time.
For small business owners, it seems like there is never enough time to get everything accomplished. One tool that will help you get the most out of your time is time batching, also called time blocking. If you haven’t heard of this before, it can revolutionize the way you approach work.
What Is Time Batching?
Time batching is where you group like tasks together on your calendar to gain economies of scale. Almost everything can be batched: answering emails, running errands, customer calls or appointments, employees’ questions, and even meetings.
Here are a couple of examples. Instead of running to the office supply on Tuesday, going to the printer on Thursday, and visiting the warehouse on Friday, why not do it all on Wednesday in one trip? Instead of answering emails throughout the day, plan to answer them for 30 minutes at 8AM, 1PM, and 4:30PM. Instead of having appointments scattered throughout the week, make them back-to-back on Monday.
The beauty to time batching is that your brain will be less exhausted at the end of the day. The reason is interruptions are minimized, as are switching costs. Switching cost is the time it takes your brain to switch from one task to the next. Too much switching strains the brain by making it change gears frequently. Time batching helps your brain get into and stay in “flow,” with more work accomplished in less overall time.
Business and Personal
You don’t have to restrict time batching to your work life. It’s likely you are already practicing time batching at home and don’t know it. When you prepare the week’s meals on Sunday or wash several loads of laundry in a row, you are practicing a form of time batching.
While some things can’t be batched, like walking the dog, many more can. You just need to be open to the possibilities.
The Highest Payoff
The highest payoff with time batching comes when you can reduce the interruptions that happen to you the most. For example, when an employee has a question, could they write them down during the day and approach you at the end of the day with all of them at once?
Emails and texts are constant interruptions for many. The first thing to do is turn off your email and text notifications so that you’re not interrupted every time one comes in. Then, decide how often during the day you want to check for new items. Aim for three or fewer times if your job allows it.
Phone calls can be another interruption. When possible, encourage callers to schedule a time to call you or let them know how much more efficient email is.
Getting It All Done
Time batching is something that you can practice for years and still get better at. Try implementing one piece of time batching at a time to avoid overwhelming yourself with change. Look intentionally for more items to batch every few months, no matter how long you’ve been practicing.
Time batching will not only help you get home sooner to your personal life; you’ll also be less drained and more energized at the end of the day. Try it and see what you think.