Being on the receiving end of an audit is daunting because of the sheer volume of work required to prepare but, as the saying goes, prevention is better than cure. There are many ways that we can build sound financial systems so that audits are not so much of a trial. There is little difference, from what I have seen between New Zealand, Europe or the USA on what constitutes a good set of books and what is required by the respective tax departments.
A good set of financial accounts are not only important to keep the tax people in your country happy. Accurate financial accounts are also vital because:
- They give you information on the status of your cashflow
- They provide information necessary to make investment or future decisions on your business
- They tell the story of the financial health of the organization
- They reduce the risk of internal fraud
- They provide marketing information e.g. is there a particular time of year when the revenue flow is better or tighter? Is there a time of year when expenditure is particularly high and so risks cashflow?
- They can be a good tool to attract investors if needed, for credit applications or donors in the case of non-profits.
Here are some tips to generally keeping your financial records in order.
1. Prepare a detailed forecast budget
No matter what the size of your organization, prepare a forecast budget for at least one year ahead. Detailed budgets are the means to forecast not only the overall financial comings and goings but they are also useful for forecasting potential issues for cash flow, will provide a reminder when particular expenses need to be paid and will provide a measuring tool for how well things are going. Forecast budgets need to be done at the right time (i.e. before you spend the money!), should be regularly reviewed (at least monthly) and should be flexible enough to take into account shifts in the business. Where there are a number of departments in an organization with different staff having access to a budget, a detailed forecast budget will clearly outline expectations for maintaining expenditure within certain limits. In such an organization it is a sound idea to have all key management staff have some input at the planning and review stages to gain buy in and to ensure that the figures are realistic.
2. Get your financial records organized.
Money flows in and money flows out. Simple concept but with oh so many more potential complications. I have often witnessed receipts that have been misplaced, receipts impossible to find because of an illogical filing system or no filing system at all or organizations that have not seen the need to even keep receipts. We will save ourselves a lot of time down the road, particularly at tax time when we need to tally our expenses and income, if we develop a system for organizing our receipts. I have noted that many businesses organize their receipts according to the month that they were gathered (i.e. all January receipts, all February receipts etc). Given that our annual tax returns ask us to categorize receipts into the types of expenditure this means double handling at the end of the tax year. Think about organizing your receipts according to the tax categories that apply to your business right from the outset. Keep the process simple, whatever works, but organize them in such a way that if the IRS auditor asks to see your travel receipts or your telephone receipts for the year 2012 that you are able to go directly to them.
Having some physical evidence of all your income is also very important. I know that it is easy for cash to burn a hole in your pocket and to fritter it away before you know it. If you want to go the "no risk" way then have a system for banking all cash and keep receipts of every deposit. The bank statements will show all revenue deposited but it can't hurt to get into a habit of keeping receipts as well. Your bank statement will not have any explanations of which client the deposits came from and it will be difficult to remember all the details two to three years down the track. Put a little extra detail on your deposit slips for future reference.
Find somewhere to store your receipts safely. Some receipts fade very quickly to the point of being unreadable so getting them into some form of storage as soon as possible will save confusion later. At the top of each receipt label them with at least the category that applies and the date so that if the receipt fades that the auditor has something to go on and may be able to see additional evidence from bank or credit card statements.
2. Where possible, use a credit card or bank card for your purchases
It is true that cash is king but using cash to make purchases for your business also presents greater risk. Keep using cash where you can make significant savings doing so but make it a point to use a debit or credit card for your transactions in the main. This means that you have supporting evidence for your expenditure, you reduce the risk of internal misappropriation of funds and you will have an easier time in reconciling your overall accounts because you have at least two sets of information that corroborate each other. If the absolute worst happens and all your receipts are lost in something catastrophic like a fire or flood then the bank and credit card statements will also be a saving grace. (I live in New Jersey post Hurricane Sandy where people lost everything to the water so not so unheard of a scenario!)
3. Find a financial recording system that works for you
So your receipts are in place and stored safely away. You need to find a good software tool to record all of your transactions. I am not here to endorse any one particular accounting software package but here are some hints to tell if it is a good one for you. There are many who have done a great analysis of the software that is ideal so I am going to post a link to one such analysis here : http://www.comparebusinessproducts.com/briefs/10-essential-accounting-software-features
4. Build in sound financial controls
If you are a sole trader this may not be necessary but the minute that you have more staff who have access to the accounts then your business or organization needs to have inbuilt financial controls. Financial controls may include having more than one signature on checks, a process whereby no-one is able to authorize their own expense reimbursement, regular review of credit card expenditures or regularly checking expenditure against budgets. Financial controls should take into account relatively smooth access to funding and the ability to pay bills. In today's financial systems where so much is being done online, including bank statements and bank reconciliations, it can become more of a challenge to find controls that work. It places more emphasis on having some independent eyes to regularly review expenditure and to be prepared to ask questions where necessary.
5. Review or Reconcile your accounts regularly
You will get full use of your financial information if you review/reconcile your accounts regularly, at least once a month. Expenditure can get out of hand very quickly and you can avoid getting into serious debt by anaylzing your accounts frequently and making adjustments to your budget if needed. If you are a board member, do not accept anything less than monthly financial reports that not only give the overall state of financial wellbeing but also supply an exceptions report to explain significant variations from the budget. No board member should sign off on a financial report without giving it a good look and asking questions where they are not sure. In choosing boards of directors, having someone with good financial management skills is essential. This may not mean a chartered accountant but at least someone who is skilled in financial analysis.
6. Carry out a long term financial analysis prior to any significant or long term decisions for your business
On one occasion, an organization I was working with had significant reserves in the bank and a very expansive restructuring proposal. They had enough funds to handle the immediate restructure but they made a significant error by not calculating the long term effects of the restructure and associated costs. Very quickly the organization was in serious debt. When making structural or longer term changes then ensure that you have looked beyond just the immediate financial implications.
7. Continually improve on your personal financial management skills.
While a good accountant is an important asset, this should not be substituted for business owners and managers having a good understanding of managing their own accounts. Find ways to continually upgrade your financial skills and the skills of your key staff.
8. Build in your own internal audit process
Whether you are a one-man band or whether you have employees and various divisions, every business or organization would benefit from developing an internal audit system. It may be as simple as having a few minutes every few months going through and identifying receipts, matching them up with bank statements and
against the budget. However, at the end of each financial year is an excellent opportunity to do a thorough look at the accounts, confirming each category of expenditure, doing a random check to see that receipts are easily located aand where you think they are and that proper sign off procedures have been used.
9. My "you walked under a bus" rule
Finally, what do you have in place should something happen to you or to a key member of staff who is responsible for the finances? Do you have some instructions somewhere so that financial information can be accessed, staff where they exist can still be paid, insurances can be claimed etc. Just ask yourself the question, "If I were to go under a bus tomorrow, would someone other than me (or my key staff member) be able to find everything they need to either keep the business afloat or to wind it up without too much difficulty.
I can just hear many of you saying, "I just don't have the time for all these procedures!" What and how much you put into place is your choice. For a minimum, make sure that you are compliant with your respective tax department requirements for record keeping. The peace of mind that comes with a good set of accounts is priceless.
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