One of the more frequent questions asked by small business owners and entrepreneurs, is how they can compete with the big players. There is a healthy debate on what they perceive as their disadvantage in having to comply with rules “meant for the whales or the conglomerates and multi-nationals,” particularly in the areas of accounting and internal control.
Admittedly, with all the complex and specialized accounting standards and interpretations, compliance has become a daunting exercise, especially for the smaller players. This is not to downplay the ability of small and medium-sized businesses to align themselves with the big players, but the cost of compliance and the amount of effort are, in some cases, no longer commensurate to the expected benefits.
As an example, let’s take the case of JP and Kat, college sweethearts turned business partners. They believe that as entrepreneurs, their energy should be dedicated in growing their home and office supplies business and not worrying whether their sales are accurate or their expenses completely accounted for. “We keep it easy and straightforward” is how they describe their accounting process. They count as sales only those cash collected. Purchases from suppliers and payroll payments to employees are considered expenses. They require their store managers to send SMS of their “sales” for the day and their warehouse supervisor for all inventory issuances. Once a month they invite a childhood friend, who has some accounting background, to put together their income statement over a bottle or two of Bordeaux. For them, the complex accounting standards and interpretations are rules intended for “whales” and not for “planktons” like them given their current level of operations.
Their clamor for a scaled approach to compliance with accounting rules is understandable, but at the same time, we need to realize that compliance need not mean being overly sophisticated and financially impossible. In JP and Kat’s case, here is some guidance in simplifying their compliance:
Right on the money
Whether you find yourself operating in an open sea or a small pond, the standards for financial reporting remain the same – prudence, fairness and reliability of information. Let us take a look at the major components of JP and Kat’s income statement—their revenues and expenses.
JP and Kat follow the cash basis of accounting for convenience. Considering their business model, however, a good chunk of their sales are transacted on credit and the absence of any actual cash exchange should not stop them from recording revenues in their books. Philippine Accounting Standard (PAS) No. 18 provides a number of revenue recognition criteria, but in a straightforward sales transaction, business owners and entrepreneurs just need to determine when “delivery” has happened. This normally coincides with the transfer of risk and rewards associated to the goods being sold. Does delivery occur upon loading of the truck, by mere handshake with customers or upon issuance of invoice? This should be clearly defined and more importantly, consistently applied.
On expenses, the cardinal rule is to recognize once incurred. Similar to the concept on revenues, recording does not necessarily coincide with the timing of actual cash payout or receipt of invoice. Reckoning point is when a related benefit has already been enjoyed by the entity, which may be upon receipt or consumption of goods, actual use of services or transfer of title.
There is also the challenge of segregating personal and business expenses. So when does personal become too personal? Here are some of the more common observations:
Owner expenses. Can JP and Kat buy that latest luxury brand of couple shirts, for example, and charge the purchase to the company? This certainly fits as a clothing item, but justifying the expense as uniform incurred in the normal course of operations may be difficult to prove. If the funds used to buy the item came from the company, then this should be recorded in the books as cash advances to the owners rather than as a business expense.
Own use. For JP and Kat’s type of businesses, there is also the issue of personal consumption. Goods originally intended for sale to customers are sometimes being used for personal consumption. As this practice becomes recurring, the transaction should be accounted for as deemed sale with a corresponding cost of sales, decrease in inventories and setup of accounts receivable. If there is no intention to repay, then these are treated as a form of dividend, resulting in a decrease in owner’s equity.
Conjugal properties. Just like many business owners, JP and Kat allow their own properties, such as a condo unit as office space, laptops, delivery van and cars to be used in the business at no cost. For compliance’s sake, such generosity should find its way into the books. If these personal properties are intended to be kept in the business, then these should be accounted for as a non-cash capital contribution. Otherwise, if JP and Kat’s intention is to keep ownership and intermittently allow the business to use these assets, then in substance there is a lease arrangement that should be reflected in the company’s records.
In one of the rare instances, tablets and phones may not be the smart choice for JP and Kat’s sole accounting records. At a minimum, their business should maintain separate registers for cash receipts, cash disbursements, sales and purchases, general and subsidiary ledgers and a general journal as an almanac of their business. Being both tech savvy, a fully automated system may be the most efficient way to go for the couple. Efficient, but in their case and at this stage, is costly and not really mandatory.
My trusted lieutenant and childhood friend
Loyalty is definitely invaluable and understandably, most small and medium-sized businesses prefer familiarity to competence. Finance and Accounting are more often than not left to the care of a family member, or in the case of JP and Kat, their childhood friend. With the ever changing accounting landscape and complex regulatory environment, at a minimum, JP and Kat must ensure that there is at least one competent individual who will handle or head both accounting and financial reporting. Business decisions are often based on numbers. And if their numbers are wrong, business owners are bound to make the wrong decisions.
While it is true that several accounting rules have grown increasingly complex and difficult, I still believe that smaller players can comply and compete. Small and medium-sized businesses can still be compliant, by keeping things simple. Simple, but not too simple.
Small business owners and entrepreneurs like JP and Kat might consider themselves as planktons, but their role in nation-building has never been bigger. They may not be able to swim against the current, but they certainly can rise with the tide. Planktons they may be, but even the biggest of whales depend on them for survival. And so do us as a country.
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Aldi e P. Garcia is a Partner from Assurance, Markets Lead for Priority Targets and the PwC Experience Leader of Isla Lipana & Co./PwC Philippines. Email your comments and questions to firstname.lastname@example.org. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.