FINANCIAL ACCOUNTING AND CASH FLOWS
Regardless of the size of a business and the sector that you want to venture into, you will need the services of an accountant or you can just learn the basic accounting procedures that will aid you in maintaining a positive cash flow in your bank account. Before starting your business, you will need to follow some procedures that will aid you in maintaining a positive cash flow. You can either gain the knowledge yourself or hire an accounting staff that will ensure that proper measures in place
- Gain the knowledge yourself
Before going into a business you will to gain at least the basic accounting procedures that will be useful to your business in the long run. You can acquire this knowledge from online courses or by going to a school physically. This may also include the use of accounting software programs such as Quick book, Sage etc. in order to support your business.
You will need financial tools that will aid you in the proper management of your business organization. Without this understanding and without a dedicated commitment to using financial tools, you reduce your chances of success of managing a positive cash flow in your business because financial matters will rise in your business and the financial solutions or measures you can provide are the:
- Balance sheet which shows the worth of your business organization
- The profit and loss account which shows if your business organization made profits or loss for a particular period or year ended
- The cash flow system that predicts the cash balances of your business organization into the future.
When formulating these financial statements, you will need to be comfortable on the value that each measures will depict. Understanding these measurements will make you strategize properly, make better decisions and make the best use of funds as a business owner.
Making entries into a software program does not require a trained bookkeeper but it is important that you, the business owner, have a full understanding of double entry accounting. There is one aspect of bookkeeping that you could consider delegating: payroll and payroll reporting, which can be handled by Payroll Service Providers at a low cost.
If you are in a partnership, it is especially important that you have knowledge of the accounting as well as what is happening in the other areas of the business.
- Hire an Accountant
If you feel that as a business owner you are busy and you will not have the time to learn the basic accounting procedures, you can decide to hire a chartered accountant who is experienced and is certified by the Institute of Chartered Accountants in Nigeria (ICAN) or any other accounting body.
The accountant will be in charge of preparing the annual financial statements of the organization, preparing payroll accounts and summarizing the financial activities of your business organization for the preparation of tax returns. You can hire an accountant through referrals or outsourcing the hiring to a reliable organization. The accountant or you as the owner of the business will also determine the accounting software that needs to be adopted.
Ways in which your accountant can aid in dealing with your bank
- Preparation of cash flow statements that will predict the amount of cash that the business organization will need
- Preparation of the relevant financial statements that include the balance sheet which will show the assets and liabilities of the business organization and profit or loss statement that shows the expenses and the income generated
- Preparation of a well detailed or comprehensive business plan that will give access to loans for the business
- The accountant will also organize information and present it in a neat and tidy fashion
TAKE NOTE OF THE FOLLOWING:
THE TAX LIABILITY OF YOUR BUSINESS ORGANIZATION
Depending on the structure of your business, here are tax liability matters that your accountant will also deal with in order to avoid being penalized or resort to paying fines. You will need to acquire a Tax Identification Number (TIN) and pay taxes such as the Personal Income Tax (PIT), Capital Gains Tax (CGT), Withholding Tax (WHT), Company Income Tax (CIT) and also the Value Added Tax (VAT).
Company Income Tax (CIT)
All businesses whether small or large is liable to pay tax on the income generated. The payment of tax is dependent on the form of business and it is respective to their taxable income. Company income tax is only payable to the federal government annually. The finance bill 2020 which was signed in October exempts small business owners from payment of taxation with an annual turnover of less than N25 million from Company income tax. Although before the finance bill all businesses are liable to a taxable rate of 30% in the country
Personal income tax (PIT)
Personal Income Tax (PIT) can be defined as a direct tax that is charged on the income of an individual or a sole proprietor. The Personal Income Tax Act (PITA) as amended in 2011 divided individuals into two groups which are the employees (PAYE) and the self-employed. The study deals with the latter which is the self-employment tax. The self-employment tax is a tax that is paid by either a sole proprietor or a partner based on the amount of profit earned. This is for unincorporated businesses like the sole proprietorship
Value Added Tax (VAT)
Value Added Tax (VAT) can be defined as a type of indirect tax that is imposed on the supply of goods and services in a given state. VAT is governed by the Value Added Tax Act Cap V1, LFN 2004 as amended. It is mostly eventually borne by the final consumer of the goods and services. VAT in Nigeria was calculated at a flat rate of 5% before the Finance Bill 2020 that was signed in October 2019 by the President amended the rate to 7.5%. Section 7 of the VAT act grants the power of administration of VAT on the Federal Inland Revenue Service (FIRS) in Nigeria.
Capital gains tax
When a sole proprietor or partnership business sells an asset and make gain on the sale of the asset, the business must pay 10% of the chargeable gains made from the sale of the asset. The capital gains is the difference between the sales proceeds from the sale of an asset.
ASSETS CHARGEABLE UNDER CAPITAL GAINS TAX
- Options, debts, and incorporeal property
- Any currency other than the Nigerian currency
- Any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired
- Assets situated outside Nigeria
EXPENDITURES ALLOWABLE FOR DEDUCTION FROM THE SALES CONSIDERATION
- Expenditure wholly, exclusively and necessarily incurred for the acquisition of the asset
- Incidental cost on the acquisition of the assets
- Expenditure wholly, exclusively and necessarily incurred in enhancing the values for the assets of the disposal
- Expenditure incurred on asset for the purpose of establishing, preserving or defending the title or right over an asset
- Incidental cost of making the disposal
GAINS NOT CHARGEABLE
Section 26 of the Capital Gains Tax Act in Nigeria exempt some capital gains from taxation. They are:
- Gains of ecclesiastical, charitable or educational institutions, statutory and diplomatic bodies are exempt from such taxation
- Where trustees or nominees transfer assets to beneficiaries they are not considered to be disposing the asset, hence the transaction does not attract Capital gain tax (CGT)
- Gains made upon a disposal of business assets where the proceeds are now spent in acquiring new business assets
Withholding tax (WHT)
Withholding tax (WHT) can be defined as an advance and indirect source of taxation deducted at source from the invoices of the tax payer. The main purpose of the withholding tax is to capture as tax payers might have evaded. Withholding tax rate are usually 10% or 15% depending on the type of transaction carried out. Withholding tax can also be said to be an advance payment of income tax. The WHT tax must be remitted to the relevant tax authorities on or before the 21st day of the month following the month in which the deductions were made.
METHODS OF ACCOUNTING
There are 2 main categories of method of accounting which are the
- Cash basis method
This method has to do with the recognition of cash (income) when you receive income and the recognition of expenses when you make payment. A high number of business operates on the cash basis because it is simple to understand and implement
- Accrual method
This method has to do with matching revenue with expenses not regarding whether cash is received or paid. Take for example if as a business owner you sold your product to a customer who decided to pay later, if you are adopting this method you will need to recognise it and record it.
KEEPING SEPARATE BUSINESS RECORDS
This is not common especially among small businesses who don’t segregate their personal money from their business money. Before you start your business, you must ensure that you create a separate business account that will enable you to keep your business records separate from your personal records.
Internal controls are actions or procedures put in place in an organization in order to ensure that the business receives all of its income without it being diverted for personal gains of dishonest employees or fraud or through carelessness.
If you are a manufacturer you will need to put in place inventory policies that will ensure that the inventory of your organization do not just disappear. You need to have safeguards implemented in places very early on in the process by setting up controls as to who can sign for goods and services and who controls the release of goods and services out the door after the processing has been completed.
BANK ACCOUNT RECONCILIATION
Bank reconciliation has to do with reconciling the differences or disagreements that occur between the bank statement and the cash book of the business organization. The bank account needs to be reconciled at least once a month when you receive your bank statement. Your accountant could be in charge of this function. When the two match, we say the account has been reconciled.
EMPLOYEE BENEFITS POLICY
When hiring Employees for your organization you will need to make decisions on the following
- The number of hours people will work.
- What holidays they are entitled to.
- What your vacation policy might be.
- Health insurance coverage for your employees
- Pension payment for your employees
- What sick leave policy to offer. Will you pay employees when they are sick or will, this time, be considered unpaid time off.
THE THREE MAJOR FINANCIAL STATEMENTS
The three major financial statements are the:
- Balance sheet
This is also known as the statement of financial position. It provides information on the worth of a business organization from a book value perspective. The statement of financial position is broken into 3 sections which summarizes the assets owned by the company, the liabilities and the shareholder’s equity. You will also notice “depreciation” on a balance sheet prepared by an accountant. Depreciation is a non-cash expense and is nothing more or less than an attempt to record that these assets go down in value over time. Some ratios like asset turnover, the quick ratio, receivables turnover, days to sales, debt to assets, and debt to equity are used to gauge the efficiency of a balance sheet.
When banks look at a financial statement, they are interested in various financial ratios. Ratios help indicate the financial strength of a business and how the business can handle payback of loans. Various industries will have different levels of ratios. You can track your ratios with others in your industry to see how your business compares.
- Income statement
This is also known as the profit and loss accounts and it shows the income received and the expenses borne for a particular period of time. It may be monthly, quarterly or yearly. Offering a great deal of transparency on the company’s operating activities, the income statement and the balance sheet are tied together your earnings or net profit will show in the balance sheet or statement of financial position. The use of accounting software programs in the modern age has added in producing financial statements with less time and stress. On the income statement, analysts will typically be looking at a company’s operating efficiency. Therefore, key ratios used for analysing the income statement include gross margin, operating margin, and net margin as well as tax ratio efficiency and interest coverage.
- Cash flow statement
The cash flow statement of a business organization provides detailed information on how liquid it is by showing the cash transaction activities. It shows all the cash inflows and outflows. A standard cash flow statement consists of the operating, investing and financing part. The operating portion is closely tied with the income statement, showing cash generated from net earnings on the top line. The operating cash activities also include depreciation and amortization, and any operating write-offs such as uncollected accounts receivable.
The other two portions of the cash flow statement, investing and financing, are closely tied with the capital planning for the firm which is interconnected with the liabilities and equity on the balance sheet. Investing cash activities primarily focus on assets and show asset purchases and gains from invested assets. The financing cash activities focus on capital structure financing, showing proceeds from debt and stock issuance as well as cash payments for obligations such as interest and dividends.
Tips for your accounting and cash flow measures
- Prepare frequent financial statements, at least, monthly or even weekly.
- Keep track of key income statement percentages. If you’re in manufacturing, your cost of goods sold percentage should be relatively the same as competitors in your industry.
- Compare your income statement with prior periods.
- Maintain good internal controls. Learn from the practices used in your industry to prevent dishonesty and shrinkage.
- Do not delegate the authority to sign checks or purchase orders.
- Don’t use money that you have withheld for payroll taxes or Value Added taxes for other purposes.
- Keep in mind that liquidity is not the same as making money. You can be making a profit and still go broke by running out of cash. Learn and practice cash flow control.
- Look ahead and write out your list of projected financial requirements including premises, equipment, staff and working capital
- Arrange for financing well before the need arises
It is important for you as a business owner to gain the knowledge or accounting or hire accountants in order to evaluate your current status against your competitors or even the business that you might want to acquire. The accounting system that your organization adopts will put it in order and it will also ensure that positive cash flow is generated
About the author
Onamakinde Dare Daniel is a highly motivated accountant with knowledge in Accounting, Taxation, Management, Audit, Costing and Research. He is keen on tax matters due to its ever dynamic nature.