People in business usually fall into one of two categories – those who are fascinated with numbers, and those who are frightened by them. Take heart. Numbers are neither magical, mysterious, nor menacing. They merely reflect decisions you have already made in your business. Every decision leads to a number, but numbers themselves are not decisions.
If you want to sustainably succeed in business, you must learn how to identify and diagnose the activities which are sabotaging your financial results and then know how to correct those mistakes so that the results you desire can be achieved. Said another way, it’s not how much you make, it’s how much you keep that counts. Realistically, it all comes down to measuring. Never forget this: Measure Results, Change Activities.
Why Keep Records?
Everyone in business must keep records. Good records will help you do the following.
Monitor the progress of your business.
You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success but only if you know how to use them. It doesn’t do any good to get the numbers and not know what they mean or which numbers are important or worse, not knowing which levers to pull to improve your results.
Prepare your financial statements.
You need good records to prepare accurate financial statements. These include income (profit and loss) statements, balance sheet and cash flow statement. These statements can help you in dealing with your bank or creditors and help you manage your business.
An income statement shows the income and expenses of the business for a given period of time. A balance sheet shows the assets, liabilities, and your equity in the business on a given date. The cash flow statement shows you how much cash you started with at the beginning of a period and the amount of cash you added or used during the current period from operating, investing, and financing activities.
The key is having your financial information laid out in a way that you can do something with the information ie. Financial Analysis. If you’re like most, you get an income statement that gives you one column of numbers which means nothing. A column of numbers does you no good unless you have a point of comparison. With no frame of reference, what good is it to know if your profits were $1,050 or that your sales were $183,030.
Business and financial intelligence starts with multiple points of comparison over several time periods. These comparisons MUST be on a single piece of paper or spreadsheet to be useful. Comparing this month’s income statement to last month’s is a good start, but an even better comparison would be this month’s income statement to last month’s to the month before (or comparing each of the six months before that). This gives you the ability to spot trends, to see if you’re doing better or worse and to start zeroing in on where specific issues and problems are hiding.
The ultimate security is your understanding of reality.
Identify source of receipts.
You will receive money or property from many sources. Your records can identify the
source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
Keep track of deductible expenses.
Deductible expenses are those expenses that are allowed by the IRS when you are computing the net profit (loss) or taxable income at the end of your business tax year. In order to pay the least amount of income tax and maximize your own profits, you need to become familiar with those expenses that you’re allowed by law to deduct. It’s easy to forget expenses when you prepare your tax return unless you record them when they actually occur.
Prepare your tax returns.
You need good records to prepare your tax returns. These records must support the
income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements. By no means am I suggesting that you do it all yourself. As a matter of fact, I strongly suggest that you hire a CPA or Enrolled Agent to do the final preparation and aid you in maximizing your tax benefits. However, if you have done all the preliminary work you will benefit in two ways: (1) You will save on accounting fees, and (2) you will learn a lot about your business by working on your taxes.
Support items reported on tax returns.
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported.
The supporting documents the IRS reviews include bank statements, cancelled or substitute checks, payroll records, invoices, and the like. You should also retain documents supporting deposits which do not reflect income, such as loan documents. What happens if your records are inadequate? If you fail to retain adequate records to support the items claimed on your returns, the IRS has authority to reconstruct your income using one of several methods, including estimating increased net worth, looking at bank records, or estimating the raw materials used in manufacture. Whatever method the IRS uses, you have the burden of proof if you dispute their estimate. Without adequate records, proving the IRS estimates wrong is difficult, at best. You could end up with an assessment for additional taxes, plus penalties and interest. A complete set of records will speed up the examination.
Just how long you should keep records is partly a matter of judgment and a combination of state and federal statutes of limitations. Federal returns can be audited for up to three years after filing (six years if underreported income is involved), so all records substantiating tax deductions should be kept at least that long.
Here are recommended retention periods for various records:
- Cancelled or substitute checks 7 years
- Credit card receipts 7 years
- Paid invoices 7 years
- Bank deposit slips 7 years
- Bank statements 7 years
- Tax returns (generally) 7 year
- Employment tax returns 7 years
- Expense records 7 years
- Financial statements Permanent
- Contracts Permanent
- Minutes of meetings Life of company plus 7 years
- Corporate stock records Permanent
- Employee records Period of employment plus 7 years
- Depreciation schedules Life of assets plus 7 years
- Real estate records Ownership period plus 7 years
- Journal & general ledger Life of business plus 7 years
- Inventory records 7 years
- Investment records Ownership period plus 7 years
- Home purchase and improvement records Ownership period plus 7 years