June 10, 2011
When it comes to being an entrepreneur, it’s probably reasonable to say that you have a talent or passion for something and that you have taken that and turned into a business. But it’s also safe to say that you, like most small business owners, aren’t exactly savvy when it comes to the principles of accounting. This, believe it or not, could lead to making some major entrepreneurial mistakes.
When it comes to accounting, there is one major mistake that most small businesses owners seem to make: applying sales transactions as revenue before it actually is.
Let me explain.
Let’s say you make a sale for $1,000 and the company sends you the check all at once. Great! But let’s go a step further to say that the amount was for work that will take place over the next 10 months during 10 consultative meetings, which actually would come to $100 of revenue per month. Do you log the whole $1,000 as immediate revenue even though you haven’t actually delivered the goods or services yet?
If you said yes, then you are guilty of committing the biggest accounting mistake.
When to apply
It’s important to remember that you should never apply a sale or check as income or revenue until you have actually delivered the goods. Once you deliver the goods or service, then it is revenue. If you apply it before that point, it will make your revenue reports incorrect, and you may end up making business decisions (such as growing your business) that your company isn’t ready for.
If you make a sale that will span over 10 months and you receive a check for it all once, you should apply the revenue in your accounting accordingly. If you bill the client today for $1,000 (and they don’t pay all at once), you will do 1/10th of the work each month. In this scenario, you would book the revenue in your accounting as $100 of income each month for 10 months. If the check comes early, during that period or even late, that is a cash issue (balance sheet and cash flow), but it does not affect the income statement.
As a general rule, you recognize income when you earn it.
Keeping it straight
Here’s the dealio, if you are handling your day-to-day accounting practices on your own (as most small businesses are), then it’s imperative that you take the time to get it right. If you don’t, it will lead to problems in misreporting the amount of revenue you are actually making, and when you make it—and that is bad for business management.
The key to this tip is that it is for the income statement management, not for the balance sheet or cash flow. Therefore, the collections don’t come into play. It may seem a little confusing at this point, but as an entrepreneur, it is important to work at getting it right—reach out to your accountant if you must.