Brush your teeth!
We all know that this is a principle to live by. And yet, everyone does it a bit differently.
Fannie Mae brushes her teeth using the American Dental Association’s guideline: for 2 minutes, twice a day, with a soft bristle toothbrush. She uses an electric pink toothbrush.
Sally Mae brushes her teeth using a slightly modified guideline: until she gets bored of brushing, once a day before going to bed. She uses a plain ol’ green plastic toothbrush.
Does Fannie Mae brush her teeth? Yes. Does Sally Mae brush her teeth? Yes. And guess what? Neither of them ever get cavities.
Brushing your teeth is a general guideline that has a lot of wiggle room for how you execute it: time of day, type of toothbrush, brand of toothpaste, frequency, etc. Kids grow up abiding by the “house rules” their parents set and carry those into adulthood. As long as you are brushing your teeth, you are (generally) OK.
The same can be said of the Generally Accepted Accounting Principles, or GAAP. (You were wondering if I was ever going to get to the financial part of the story, right?) As long as businesses are not veering too far off course from GAAP, they are (generally) OK. (But remember, if your business will have an audit or review completed, you must follow everything in GAAP!)
As a business owner, how do you know what principles you should use, which ones you don’t need to use, and when and how to use them?
What is GAAP?
GAAP is a comprehensive set of detailed rules on how to keep your accounting books. These principles were originally created to ensure publicly traded companies have similar financial reports, allowing investors to easily compare and make sound investing decisions. (For example, how do the finances look between Apple and IBM?) Publicly traded companies are required to follow all the rules in GAAP and have to be audited every year and obtain a “clean” opinion on their audit report.
Just like everyone has their own “brush your teeth” guidelines, it’s OK for companies that are not audited or reviewed to veer from GAAP. However, these were set because they point a company towards healthy bookkeeping habits. You don’t want to get too crazy squirting your tube of toothpaste or start brushing with a bar of soap!
To help your business avoid veering too far off course, or sticking too strictly to guidelines you don’t need to follow, I can help you set your own financial guidelines, or “house rules.” What do you need to follow, or not? How do you apply GAAP? What does each principle mean for your business in the day-to-day operation? Each company is unique, has different financial goals, and operates under different circumstances.
Are you unsure if your financial practices are best for your business? Contact me today for a financial “house rules” consultation.
3 GAAP Concepts for Small-Medium Businesses
When I work with my clients, I guide them towards following GAAP. But it’s important to keep in mind that some rules don’t make sense for small businesses if they are not being audited. For example, Do you record a 5-year bank loan as a short term or long term liability, or some of both?
Here are three GAAP basic concepts that every business owner should consider implementing as part of their financial best practices:
Revenue Recognition (accrual basis). This concept dictates when to record revenue. Businesses should record revenue when it has been earned – when your products have been delivered or services have been rendered – regardless of when cash is received.
In terms of “house rules,” here is a helpful way to remember this principle: You can’t have your dessert (revenue) until you’ve eaten your dinner (delivering the product).
If you’d like more detail on accrual basis vs cash basis accounting, you can refer to Is Cash Basis Accounting Driving You Towards A Collision? Accrual Basis Can Save You.
Matching. The Matching principle dictates that you record revenue, and the expenses associated with receiving that revenue, in the same time period (month/year).
For example, if you provide a service to a client in January, you want to record the wage expense for paying your employees to provide that service in the same month you record the revenue.
The best way to achieve matching is by using accrual basis accounting, mentioned above. It can be difficult to match using any other method. After all, you can’t control when your clients pay you. If they are late in payment, and you record it when it was received instead of when it was earned, your expenses and revenue will not match, making it difficult to see the true picture of financial health.
Proper Cut-off. This concept dictates that businesses record items in the proper month and year so there is a clean cut-off of activity from one month to the next. This is especially important at year-end.
For example, if you ship your product to a customer on December 31, then you should record that revenue in December, not January. If you don’t ship the product out until Jan 2, revenue needs to be recorded in January. If the client pays before you ship, you haven’t earned the revenue until it is shipped. Alternatively, if you provide the product in December, but the client doesn’t pay until February, revenue should still be recorded in December, which is when you held up your end of the bargain.
Want more GAAP in your life? I thought so! Next month, I’ll be diving into more GAAP concepts: cost, materiality, consistency, and conservatism. You don’t want to miss these important topics.
Get Expert Guidance On GAAP “House Rules”
I can help you set up GAAP “House Rules” for your business, ensuring your books and financial reports are all in order. I partner with business owners and leaders to determine which principles to follow and which are not critical to invest their time and energy.
For the success and financial health of your business, it’s important to know the big picture, and I can help you apply these principles in the reality of your business. Contact me today for an initial conversation about setting up your GAAP “House Rules.”