{"id":153,"date":"2018-12-27T17:20:16","date_gmt":"2018-12-27T22:20:16","guid":{"rendered":"http:\/\/pressbooks.library.upei.ca\/smallbusinessmanagement\/chapter\/accounting-and-cash-flow\/"},"modified":"2020-01-06T09:58:29","modified_gmt":"2020-01-06T14:58:29","slug":"accounting-and-cash-flow","status":"publish","type":"chapter","link":"https:\/\/pressbooks.library.upei.ca\/smallbusinessmanagement\/chapter\/accounting-and-cash-flow\/","title":{"raw":"Chapter 10: Accounting and Cash Flow","rendered":"Chapter 10: Accounting and Cash Flow"},"content":{"raw":"
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Simione Consultants LLC<\/h3>\r\n[caption id=\"\" align=\"alignleft\" width=\"80\"]\"image\" Used with permission from Simione Consultants LLC.[\/caption]\r\n

Health care is the largest single industry in the US economy. Currently, health care represents nearly 17 percent of the gross domestic product, encompassing nearly 600,000 establishments and employing more than 14 million people. The health-care industry covers an extraordinary wide range of businesses and operations. It includes large hospitals, diagnostic laboratories, nursing care facilities, and the offices of doctors and dentists. Each establishment has individuals that possess considerable expertise in their respective disciplines. However, they may not possess the knowledge or the expertise that would enable them to manage their establishments in the most efficient manner. That is where firms like Simione Consultants LLC play a vital role.<\/p>\r\n

Simione Consultants LLC represents the evolution of consulting companies that have spun off from many accounting firms. Accountants are no longer merely reconciling accounts or preparing tax returns for their clients. They are now offering a broad range of consulting services. Simione Consultants LLC provides expert assistance to hospital-based and hospital-affiliated home health and hospice agencies, visiting nurse associations, small proprietary agencies, and large national chains. They provide services that one might expect from a firm whose origins were in a standard accounting practice\u2014such as assisting in accounts receivables and cash-flow management. Other accounting services that they provide include financial analysis reports and the preparation of cost reports for the federal government. They can conduct in-depth cost analyses at a detailed and a granular level so that clients can improve their operational efficiencies. The compliance division consulting services include working with health-care attorneys, corporate compliance and audit departments, and government agencies such as the Office of the Inspector General. Its clinical operations division works closely with financial consultants to improve the financial health of its clients.<\/p>\r\n

What makes Simione Consultants LLC distinct is its ability to go beyond these basic accounting tasks and provide vital ancillary support for its clients in this niche market. They are in a position to conduct the valuation of businesses or assist in mergers and acquisitions. They help clients with preparing a prospectus or assisting with negotiations. Their consulting services can advise on how a client can maximize its return on an information management system by identifying system requirements and specifying possible solutions. In addition, the company has developed a software product\u2014\u201cThe Financial Monitor\u201d\u2014that provides quarterly home health and hospice reports with multiple valuable benchmarks, including national, state, and profit-status norms, to help their clients and the industry make informed financial decisions.<\/p>\r\n

A measure of how firms such as Simione Consultants LLC have moved beyond balance accounts is the company\u2019s ability to support a client\u2019s marketing function. The firm can help build comprehensive marketing plans and assist clients in developing and improving sales materials and training.<\/p>\r\n

Simione Consultants LLC began its work in the home health-care industry more than forty years ago with an agency in Hamden, Connecticut. It was the vision of William J. Simione Jr., the founding member, who saw an opportunity. With his brother Robert J. Simione, the managing principal, and a dedicated team of principals, management, and staff, William Simione has helped Simione Consulting LLC become one of the leading home health and hospice consulting companies in the United States with over a thousand clients. Robert Simione says that a company is only as good as the people who work for it, and Simione Consultants LLC has the best home health and hospice consultants in the country.<\/p>\r\n\r\n<\/div>\r\n

Understanding the Need for Accounting Systems<\/h1>\r\n<\/div>\r\n<\/div>\r\n
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Learning Objectives<\/h3>\r\n
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  1. Understand why a basic knowledge of accounting is important for a small business.<\/li>\r\n \t
  2. Understand the importance of selecting an accountant to enhance the overall operation of a business.<\/li>\r\n \t
  3. Define the two major approaches to accounting systems: cash versus accruals.<\/li>\r\n<\/ol>\r\n<\/div>\r\n<\/div>\r\n
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    The older I get, the more interesting I find lawyers and accountants.<\/em>[footnote]Independent (London), April 21, 2010, quoted in \u201cAccounting Quotes,\u201d Qfinance, accessed February 14, 2012, www.qfinance.com\/finance-and-business-quotes\/accounting<\/a>.[\/footnote]\u00a0<\/span><\/p>\r\n

    \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0- Alex James<\/p>\r\n<\/blockquote>\r\n<\/div>\r\n

    Imagine that you invite a friend from China, who is visiting the United States for the first time, to a baseball game. Your friend has never been to a baseball game before and knows nothing of the game\u2019s rules. He might notice on the scoreboard listings for runs, hits, and errors. Your friend might also see notations on the number of strikes and balls. He does not know exactly what any of those terms mean, but he notices that some people in the stands applaud when the number of runs increases. Your friend might be amused by seeing individuals periodically running from one base to another; however, without knowing the basic rules of baseball, he cannot possibly understand what is actually occurring. He certainly could not comment on how well the game is going or provide suggestions about what one of the teams should do next. Most Americans would be in the same position if they were watching a cricket match. In both cases, you and your friend are in the same position of someone who wishes to run a business without having a fundamental understanding of accounting systems.<\/p>\r\n

    Warren Buffett has said that accounting is, to put it simply, the language of business. Without a fundamental understanding of this language of accounting and its set of rules, you are in the same position as your Chinese friend\u2014you really do not know what is going on with a business. If someone is considering starting a business, he or she should possess some degree of fluency in this language. One does not expect this businessperson to be as knowledgeable as a certified public accountant (CPA) or an expert in tax issues. However, such businesspeople should have a clear expectation that they will be able to look at the key elements of an accounting system and interpret how well their businesses are doing. They should be able to track some of the key tasks and elements associated with a comprehensive accounting system.<\/p>\r\n

    [pb_glossary id=\"876\"]Accounting[\/pb_glossary]<\/strong><\/em><\/a>\u00a0is defined by the American Institute of Certified Public Accountants (AICPA) as \u201cthe art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.\u201d[footnote]Ramnik Singh Wahla, Accounting Terminology Bulletin No. 1: Review and R\u00e9sum\u00e9, 1953, accessed February 14, 2012, c0403731.cdn.cloudfiles.rackspacecloud.com\/collection\/papers\/1950\/1953_0101_AccountingReview.pdf<\/a>.[\/footnote]<\/span> Put more simply, it is essentially an information system. Accounting provides critical information to potential investors and businesses managers. Accounting may, in fact, be one of the oldest information systems known to humans. Some have argued that accounting systems were the impetus for the development of writing systems in Mesopotamia.[footnote]Denise Schmandt-Besseart, \u201cAn Ancient Token System: The Precursor to Numerals and Writing,\u201d Archaeology 39 (1986): 32\u201339[\/footnote][footnote]Richard Mattessich, \u201cPrehistoric Accounting and the Problem of Representation: On Recent Archeological Evidence of Middle East from 8000 B.C. to 3000 B.C.,\u201d Accounting Historians Journal 14, no. 2 (1987): 71\u201391[\/footnote]<\/span> Archaeologists have discovered clay tokens, dating back 10,000 years ago, which functioned as part of the inventory system measuring agricultural goods, such as grains and domesticated animals. By 3500 BC, these tokens were being stored in containers\u2014known as bullae. Notations on the surface of these containers indicated the type and quantity of the tokens held within; for many, this system was the basis of an abstract system of written communication.[footnote]Salvador Carmona and Mahmoud Ezzamel, \u201cAccounting and Forms of Accountability in Major Civilizations: Mesopotamia and Ancient Egypt\u201d (working paper, Instituto de Empresa Business School, Madrid, Spain, and Cardiff University, Cardiff, UK, 2005), accessed December 2, 2011, latienda.ie.edu\/working_papers_economia\/WP05-21.pdf<\/a>.[\/footnote]<\/span><\/p>\r\n

    Other ancient societies recognized the importance of carefully monitoring and recording economic transactions. The Roman Empire needed to finance its operations and employed the familiar concept of an annual budget to coordinate expenditures and taxation. It had treasury managers, known as questors, who were subject to periodic audits.[footnote]John R. Alexander, History of Accounting (Princeville, HI: Association of Chartered Accountants in the United States, 2002), 4[\/footnote]<\/span> The most famous monograph on accounting dates to Renaissance Italy. Luca Pacioli, a Franciscan friar and polymath, wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita in 1494. Essentially this was a math textbook, but it included a section on double-entry bookkeeping. This approach to accounting had been covered by Beredetto Cotrugli a century earlier.<\/span>[footnote]John R. Alexander, History of Accounting (Princeville, HI: Association of Chartered Accountants in the United States, 2002), 9.<\/span>[\/footnote] The text was immediately recognized as an important contribution and was one of the first books produced by Gutenberg. On a first reading, Pacioli\u2019s coverage appears to be remarkably \u201cmodern.\u201d It described how merchants should identify their assets and liabilities, note transitions as they occur, and identify them as either debits or credits. He pointed out that the total of debits and credits must be equal, thus his model became the basis of the balance sheet. In the intervening five hundred years, business has essentially adapted Pacioli\u2019s approach. Obvious, over the last five centuries, businesses have grown both in size and in complexity, and accounting systems have grown with them. Therefore, it is important for any business regardless of size to be able to \u201ccount\u201d on solid accounting information.<\/p>\r\n

    The exact nature of accounting support will be greatly determined by the type and size of the small business. The level of accounting support required by the nonemployer business will obviously differ significantly from the level required by a business generating tens of millions of dollars of revenue and employing hundreds of workers. The level of support will also be influenced by the business owner\u2019s familiarity with accounting and the type of accounting information systems that have been determined as appropriate. Regardless of size or type, small businesses should plan on eventually acquiring the talents of an accountant. Preferably, the decision to use an accountant should occur with the creation of the business.<\/p>\r\n

    Hiring an accountant or an accounting firm is an important decision for a small business. Employing an accountant does not translate into this individual being a full-time employee of the business. At the start, most small businesses will use the accountant as a consultant or a contract employee. As they grow, some small businesses might benefit from acquiring the services of full-service accounting firm. Although some start-ups, particularly those that might be cash-strapped, use the services of the bookkeeper only, but this is ill-advised. Most small businesses will need the services of a CPA. Another type of accountant a small business might employ is known as an enrolled agent. These are accountants who have passed a tax test from the Internal Revenue Service (IRS).<\/p>\r\n

    When looking for an accountant, there are some issues that you should consider. Try to find an accountant who has some working familiarity with a particular type of business or industry. Hopefully, you will be able to find an accountant with whom you have some rapport. This is important because a good accountant is more than simply someone who balances the books. You should consult an accountant before determining what type of accounting system you intend to employ\u2014cash versus accrual (see Section 10.1 \"Understanding the Need for Accounting Systems\"<\/a>). Remember that an accountant will play an important role in assisting you in the creation, purchase, and development of an accounting information system for the business. This system is important in providing the appropriate information to the external community (for this audience the term [pb_glossary id=\"1396\"]financial accounting[\/pb_glossary]<\/strong><\/em><\/a> is often used)\u2014bankers, angel investors, venture capitalists, and\/or the government. The same accounting information system will also be an important component of internal controls (in this case the term [pb_glossary id=\"1397\"]managerial accounting<\/strong>[\/pb_glossary]<\/a> is used)\u2014the systems and policies by which you make a firm more efficient. In this role, an accountant can help develop appropriate policies with respect to cash control and inventory control. An accountant can play a critical role in developing business plans, particularly with respect to budgets and financial statements. As highlighted in Section 10.3 \"Financial Ratio Analysis\"<\/a>, you should consult an accountant before selecting an accounting software package. Quite often, an accountant can be extremely useful in training people to use such a software package.[footnote]Jean Murray, \u201cFinding Help with Bookkeeping and Accounting Tasks,\u201d About.com, accessed December 2, 2011, biztaxlaw.about.com\/od\/businessaccountingrecords\/a\/findacpa.htm<\/a>.[\/footnote]<\/span><\/p>\r\n\r\n

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    Video Clip 10.1\u00a0Why Warren Buffett Said Accounting Is the Language of Business<\/h3>\r\nThis video introduces the importance of accounting.\r\n\r\nhttp:\/\/www.youtube.com\/v\/Z6YEsyO0eOo\r\n\r\n<\/div>\r\n
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    Video Clip 10.2 Why You Need an Accountant<\/h3>\r\nThis video explains why a small business needs the services of a professional accountant.\r\n\r\nhttps:\/\/www.youtube.com\/watch?v=EKxmpALHn80\r\n\r\n<\/div>\r\n
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    Video Clip 10.3 What CPAs Wish Every Small Business Knew<\/h3>\r\nThis video approaches small business\u2019s need for accounting from the accountant\u2019s perspective.\r\n\r\nhttp:\/\/www.youtube.com\/v\/R_FcOu2_SoA\r\n\r\n<\/div>\r\n
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    Alternative Approaches to Accounting Systems<\/h1>\r\n
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    The system of double-entry bookkeeping is, perhaps, the most beautiful one in the wide domain of literature or science. If it were less known, it would be the admiration of the learned world.[footnote]\u201cEdwin T. Freedley,\u201d Cyber Nation<\/em>, accessed February 14, 2012, www.cybernation.com\/victory\/quotations\/authors\/quotes_freedley_edwint.html<\/a>.[\/footnote]<\/span><\/p>\r\n

    Edwin T. Freedley<\/p>\r\n\r\n<\/div>\r\n

    The evolution of accounting has led to two major systems: the cash basis model and the accrual basis model. Before describing the two systems, we must identify a very important term\u2014accounting transactions. When in business, we either receive money from a sale or spend money, such as in buying a piece of equipment. We can define these as transactions. The manner in which we record transactions defines the difference between a cash basis accounting system or an accrual accounting system.<\/p>\r\n

    In most cases, either system can be used by a business (there are situations under which a cash-based accounting system cannot be used, the details of which are discussed later), but regardless of the system used, a business must clearly specify which method is being employed.<\/p>\r\n

    In the [pb_glossary id=\"878\"]cash-based accounting[\/pb_glossary]<\/strong><\/em><\/a><\/span>\u00a0system, a transaction is recorded when money is either received or spent. As an example, a business has three sales on June 29 of a particular year. The first sale is for $500, the second is for $1,000, and the third is for $300. However, the three customers use different methods of payment. The first customer pays for the product in cash, the second customer writes a personal check, and the third customer pays by credit card. The second customer\u2019s personal check clears on July 5, while the credit card company transfers the $300 into the business\u2019s account on July 3. Under the cash basis accounting system, the business would list the first sale of $500 as a June transaction, but it would list the second and third sales (totaling $1,300) as July transactions. The same logic is used with respect to expenditures. If the same firm purchased a laptop computer in July but did not have to pay for two months, then the transaction would be recorded in September.<\/p>\r\n

    Under the [pb_glossary id=\"879\"]accrual accounting[\/pb_glossary]<\/strong><\/em><\/a> <\/span><\/span>system, transactions are recorded when they occur. If the aforementioned business was functioning under the accrual basis accounting system, then all three sales (totaling $1,800) would be recorded as June transactions, and the purchase of the laptop would be designated as a July transaction.<\/p>\r\n

    Generally, though, with some few exceptions, businesses must use the accrual basis accounting method if they have inventory of any component of items that they sell to the public and if the sales are more than $5 million per year. Other conditions under which the cash basis accounting system may not be used include C corporations, partnerships with at least one C corporation partner, and tax shelters.[footnote]\u201cComparison of Cash and Accrual Methods of Accounting,\u201d Wikipedia<\/em>, accessed December 2, 2011, en.wikipedia.org\/wiki\/comparison_of_cash_method _and_accrual method of accounting<\/a>.[\/footnote]<\/span> The major benefit of cash basis accounting is its simplicity. It greatly reduces the demand on bookkeeping. The cash basis system also provides a much more accurate indication of a company\u2019s current cash position. This approach may be used to affect taxable income, which can be done by deferring billing so that payments are received in the next year.[footnote]Melissa Bushman, \u201cCash Basis versus Accrual Accounting,\u201d Yahoo! Voices<\/em>, accessed December 2, 2011, voices.yahoo.com\/cash-basis-versus-accrual-basis -accounting-147864.html?cat=3<\/a>.[\/footnote]<\/span> However, there are drawbacks to the cash basis approach\u2014the most serious being that it may provide a distorted or an inaccurate indication of profitability. The reality is that cash basis accounting systems are really only appropriate for businesses with sales under $1 million and that function basically on a cash basis.<\/p>\r\n

    Accrual basis accounting is in conformance with IRS and generally accepted accounting principles (GAAP) regulations. Although more complex and generally requiring greater bookkeeping with a more sophisticated approach to accounting, the accrual basis provides a more accurate indication of the profitability of a business. The major drawback of the accrual basis system comes with respect to understanding the business\u2019s cash position. A firm may look profitable under this system, but if customers have not paid for the goods and services, the cash position might be dire.[footnote]\u201cCash vs. Accrual Accounting,\u201d Nolo.com<\/em>, accessed December 2, 2011, www.nolo.com\/legal-encyclopedia\/cash-vs-accrual-accounting-29513.html<\/a>.[\/footnote]<\/span> A summary of the pros and cons of the two systems is provided in Figure 10.1 \"Comparative Accounting Systems\"<\/a>.<\/p>\r\n\r\n

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    Figure 10.1<\/span> Comparative Accounting Systems<\/h3>\r\n\"image\"\r\n\r\n<\/div>\r\n
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    Video Clip 10.4\u00a0Accrual versus Cash-Basis Accounting Video Presentation<\/h3>\r\nA lecture on the two accounting systems.\r\n\r\nhttp:\/\/www.youtube.com\/v\/mAEscMr5IMA\r\n\r\n<\/div>\r\n
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    Video Clip 10.5 Accrual Basis versus Cash Basis Accounting Power<\/h3>\r\nA video with voice-over of a PowerPoint presentation.\r\n\r\nhttp:\/\/www.youtube.com\/v\/3RxJFyUPu_o\r\n
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    Key Takeaways<\/h3>\r\n