Have You Outgrown Cash Basis Accounting? Here’s How to Switch to Accrual Basis.
Your business is your baby. Like most long-time shop owners, you’ve poured hours of your time—blood, sweat, and tears—into growing your business. By now, you’re a pro at customer service and fixing cars, but you may still need a little help with accounting, especially if you currently use the cash basis method.
Cash basis accounting, or keeping track of your finances via checkbook and bank account, is the simplest method of accounting; money going into the bank counts as income, and money going out counts as an expense. And that’s all there is to it.
Or is it? As your business becomes more complex—you start growing your team, making larger parts orders, dealing with multiple vendors and suppliers, and taking on a higher volume of jobs—you’ll begin to notice that things don’t always align. There’s more money coming in, and there’s more money going out. It’s no longer as simple as, “I do a job, front the costs, get paid right then and there, and know exactly how much I made.”
One of the biggest problems with sticking to a cash basis method of accounting is that it becomes easy to forget about or ignore the expenses you haven’t paid yet. You might see that you have $30,000 in the bank and think, “Awesome! We’re doing great.” But a parts bill you forgot about is taken out of your account right when you’re about to process payroll, leaving you with far less profit than you thought. Now you’re not able to invest in that new bay you were going to buy this month.
If you’re not tracking your income and expenses as they happen, you really don’t know where you stand until everything hits your account, making it difficult to plan ahead.
The accrual basis method of accounting, or recording transactions instead of payments, will give you a clearer view of how much profit you're making at any given time. The goal is to have accurate numbers; you don’t want to be misled into believing that you have more or less money to work with than you actually have, or will have. With accrual basis accounting, your finances are balanced as soon as transactions take place.
So, how do you get there?
When you’re using cash basis accounting, and your numbers don’t add up, the question becomes, “What am I missing? Did I forget to count a payment? Was there theft?” These are the variables we want to minimize. You want to be confident that all major expenses are being accounted for, so if there is a big chunk of change missing, you’ll be able to quickly figure out what’s going on.
The way to minimize variables in accounting is to pay close attention to the income and expenses that make the biggest difference to your finances. Sure, you could dive into every single detail and penny spent, but for many shop owners, that’s overkill. It can take a lot of time out of your day to accrue every single expense, and a few bucks won’t overly affect your cash flow.
Accrual basis accounting is fairly easy to implement in the auto repair industry because there are only two major variables that we need to consider:
Invoices are the easiest place to start accruing your income. What matters most is when the job is done, complete, and set out. Whether it’s by day or by week, you want to make sure that invoices are all dated correctly. Instead of tracking when invoices are paid, you can now base your income outlook on when the transactions took place.
Next, you want to look at the cost of goods sold, which includes the price you pay for parts on each invoice. These figures make up your expenses. Instead of looking at your bank account and waiting for the money to be taken out, you now know how much you paid to complete each job as soon they are completed in your system.
Now, you may have terms with your parts supplier where you pay them at the end of every month. In this case, you may not need to date every single small parts order. Instead, you can keep an ongoing list of parts you’re buying from each major supplier so that you have a good idea of what your parts bill is going to look like before it comes time to pay.
You may notice that payroll is missing from the list above. Many shops don’t accrue payroll because it can get tricky. If you commission a large chunk of work, you may want to accrue that into your monthly finances so that you’re keeping track of it.
Eventually, you will probably want to accrue your payroll, too, so that you have the clearest idea possible of where your finances stand.
When you are confident about your cash flow and know approximately how much money you have on hand without guessing, you can do a lot more with your business: invest in new technology, give your team a nice bonus, open a new shop, or help your community.
If you start by accruing the major items—invoices and cost of goods sold—you can get things rolling fairly quickly. Remember to date all transactions, and keep those payment dates as close as possible to the transaction date. Move the parts bill back to the date where the transaction actually happened, and you’ll start to gain a realtime idea of your finances.
Once you get the hang of dating transactions, you can become more sophisticated with accruing and feel more comfortable with how you’re spending money on your business.
Tekmetric’s shop management system makes it easy to track transactions in realtime. As jobs are completed, Tekmetric inputs all transaction information, including the price paid by the customer, the cost of goods sold, and the date of that transaction, into a variety of metrics that you can analyze. From end-of-day sales and end-of-month sales to gross profit percentage and gross profit dollars, Tekmetric makes it easier than ever to visualize the financial story of your business—anytime, anywhere.
This article was written with the guidance of automotive repair industry CPA Hunt Demarest of Paar, Melis, & Associates, P.C.