One of my early mentors taught me the value of a accrual accounts. When you own or run a small business the last thing that you want is for a surprise to destroy your earnings for a month or quarter. The more for which you accrue, the less your earnings volatility. Banks especially like to see steady, not volatile. earnings.
I suggest you set up accrual accounts for most, if not all of the below:
- Bad debt reserve. This is very standard. Put a portion of your profits each month into a bad debt reserve and then when you have a bad debt, charge the bad debt off against the reserve instead of against monthly earnings. This way you will have a small earnings hit each month for bad debts instead of a big bad debt expense in the month of the bad debt expense.
- Inventory reserve. If you also take a portion of earnings each month and put it into an inventory reserve then you won’t have a big charge against earnings in the month when you take your annual inventory, should you have an inventory shortfall. Also, if you do cycle counting then you take any shrinkage from cycle counts and write it off against the reserve, not earnings. This is another very standard reserve account
- Legal reserve. Most businesses don’t have a regular amount of legal expenses each month. They tend to have the occasional legal bill for a lawsuit or something else. Again, to avoid “lumpy earnings”, set up a legal reserve, add to it each month, and write off your legal bills against the reserve, not earnings.
- Sales tax reserve. It’s never fun to have a state sales tax auditor come in and find out that you did something wrong and owe a large payment, and perhaps penalties, for improperly remitting sales tax. If you set up a reserve, and fund it each month, then you write off these payments against the reserve.
- Expense account reserve. If you have associates who travel and get reimbursed for their travel expenses, set up an expense account reserve. Then if you have a lot of people all traveling in one month, say for example, to a convention, your earnings don’t get a big hit in that month. You simply write off the large travel bill against your reserve.
- Insurance reserve. Sometimes your insurance bills increase dramatically, such as with health insurance. Or you have a deductible to pay for a large claim. If you have an insurance reserve set up you charge these expenses against the reserve.
- Accounting reserve. Most businesses pay their accounting expenses on a regular schedule, but sometimes your outside accounting firm sends you a large bill for doing a special project. Again, instead of your earnings being negatively impacted by this surprise large bill, you write it off against the reserve.
Also, if, you have an earnings shortfall at the end of an accounting period, you can review your accrual accounts, and if you are over accrued, you can add the excess amounts back to earnings. You may get a little grief from your auditors about this but I have always stood my ground and pointed out that these over accrued amounts came out of earnings, now they aren’t needed to the extent that we thought they would be, so we are adding them back to earnings. I haven’t lost that argument yet.
Did I miss any accrual accounts? If so, let me know and I will share the information.
© Copyright 2011 by Jim Sobeck. All rights reserved. This information may be reproduced as long as full credit is given to the author.