Accounting

Why Liquidity Is Important for Your Business

What’s the liquidity of your business’s assets? All businesses have assets. Assets are items of monetary value. They can be tangible or intangible. Regardless, if your business owns something of value, it’s considered an asset. Assets with high liquidity, however, are typically more valuable than those with low liquidity. To learn more about liquidity and why it’s important for your business, keep reading.

What Is Liquidity?

The term “liquidity” refers to the ease at which you can convert a given asset into cash. Most assets can be sold. When you sell an asset, you’ll convert it into cash. Assets with low liquidity are harder to convert — and often take longer to convert — into cash than those with high liquidity.

Secure Loans

Liquidity is important because it can affect your ability to secure business loans. Most banks and other financial lenders will look at your business’s liquidity ratio during the application process. When you apply for a loan, the bank or lender will analyze your business’ liquidity ratio to determine its overall financial health. A high liquidity ratio indicates that your business is capable of paying back borrowed money. A low liquidity ratio, on the other hand, indicates that your business may struggle to pay back borrowed money. To secure loans, you should focus on improving your business’s liquidity ratio.

Cover Unexpected Expenses

As a business owner, you’ll probably encounter expenses that you didn’t originally plan for. Unexpected expenses come with the territory when operating a commercial enterprise. Maybe you need to purchase a new piece of equipment, or perhaps you need to take out a new loan to finance your business. Regardless, unexpected expenses can and do occur in the world of business. Fortunately, a high liquidity ratio can help your business cover these expenses. When an unexpected expense arises, you can easily and quickly convert assets into cash. Using this cash, you can then pay off the expense.

Increase Cash Flow

With a high liquidity ratio, you can increase your business’s cash flow on the fly. Converting an asset into cash will result in a higher cash flow. Your business will have more cash on hand to cover both expected and unexpected expenses. A low liquidity ratio, conversely, can harm your business’s cash flow. You may struggle to convert assets into cash, resulting in a lower cash flow.

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Write-Off vs Write-Down in Accounting: What’s the Difference?

The terms “write-off” and “write-down” are often interchangeably to describe the devaluation of an asset. Regardless of what type of business you own, chances are it has assets. Nearly all businesses have at least some assets. Assets are things of monetary value, such as cash, equipment, materials, real property and even patents or other forms of intellectual property.

While both write-offs and write-downs do, in fact, involve lowering the value of an asset, they aren’t necessarily the same. Write-offs and write-downs are intended for different purposes. When recording

What Is a Write-Off?

A write-off is the complete devaluation of an asset. When you write-off an asset, you are claiming that it no longer holds any value to your business. If a piece of equipment is broken or obsolete, for instance, you may want to declare it as a write-off. You can write-off the asset by lowering its value to $0 in your business’s books.

You can also claim write-offs such as this as a tax deduction. The Internal Revenue Service (IRS) allows businesses, as well as freelancers, to deduct the cost of write-offs from their taxes.

What Is a Write-Down?

A write-down, on the other hand, is the partial devaluation of an asset. Assets can depreciate in value. In some cases, they may lose all of their original value in a short period. In other cases, devaluation occurs more slowly. A write-down is an accounting process in which you record an asset’s value as being lowering than its original value. The asset still has some value, but it’s less than the original value from when you initially purchased or acquired the asset.

Differences Between Write-Offs and Write-Downs

The main difference between write-offs and write-downs is that the former is the complete devaluation of an asset, whereas the latter is the partial devaluation of an asset. With a write-off, you are claiming that one of your business’s assets is essentially worthless. With a write-down, you are claiming that an asset has lost some but not all of its original value.

There are also nuances regarding the tax implications of write-offs and write-downs. Write-offs offer the greatest tax benefits. When you write-off an asset, you’ll lower your business’s tax liabilities for the year in which you claim it. Write-downs can lower your business’s tax liabilities as well, but they don’t have the same positive impact because they still recognize the asset as having some value.

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Pros and Cons of the Double-Entry Bookkeeping Method

Double-entry is a bookkeeping method that involves the use of a credit and a debit for each financial transaction. It’s designed to track a business’s money more closely. When using the double-entry bookkeeping method, you’ll record a credit and a debit for each of your business’s financial transactions.

If your business sells a product, for example, its liquid cash account will increase, whereas your business’s inventory account will decrease. The liquid cash account will receive a credit, while the inventory account will receive a debit. If your business buys a piece of equipment, conversely, its cash account will receive a debit and its asset account will receive a credit. Considering that many businesses use the single-entry bookkeeping method, you might be wondering what pros and cons the double-entry bookkeeping method offers.

Pros of Double-Entry Bookkeeping

Using the double-entry bookkeeping method creates a more accurate view of your business’s financial health. It’s considered a complete form of bookkeeping in the sense that it takes into account both credits and debits when recording financial transactions.

All financial transactions have a credit and a debit. Unless you record both of them, you won’t have a complete and accurate depiction of your business’s financial health. Using the same example from above, if you sell a product but only record it as a credit, your business’s inventory account won’t be correct. Selling a product will reduce your business’s inventory account, so you need to record a debit for it as well. The double-entry bookkeeping method requires the use of both a credit and a debit for each financial transaction, including product sales.

Cons of Double-Entry Bookkeeping

On the other hand, the double-entry bookkeeping method requires more work than its single-entry counterpart. It’s essentially twice the work of the single-entry bookkeeping method. For every financial transaction, you’ll have to record both a credit and a debit. That’s the basis on which the double-entry bookkeeping method works. If you run a small business, such as a sole proprietorship, you may discover that it’s not worth the additional time and energy.

Because it requires more work, the double-entry bookkeeping method is prone to more errors than its single-entry counterpart. If a transaction doesn’t have both a credit and a debit, the trial balance won’t be correct. As a result, you’ll have to go back and add the missing credit or debit.

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What Is the Realization Principle in Accounting?

Have you heard of the realization principle? It’s a common concept used in accounting. Many businesses use it to determine when revenue has been earned. To learn more about the realization principle and how it’s used in accounting, keep reading.

Overview of the Realization Principle

The realization principle is an accounting concept that involves the recognition — or the realization — of revenue when purchased products are delivered or when purchased services are completed. In other words, businesses don’t consider revenue to be earned until one of these actions has occurred.

A customer may pay for a product or service. Until the product has been delivered or the service has been completed, though, the business doesn’t consider the revenue to be earned. With the realization principle, revenue is only earned after the delivery of a product or the completion of a service.

Benefits of Using the Realization Principle

Using the realization principle offers several benefits. The main benefit is healthier financial records. It offers a clearer and more accurate representation of your business’s finances.

Just because a customer pays you for a product or a service, your business may not generate from it. The product could get lost or damaged during shipping. Alternatively, the customer may cancel the service before you have a chance to complete it. Regardless, there are instances in which your business may not generate revenue from a purchased product or service. If you recognize revenue as earned prematurely, it will throw off your business’s financial records. The realization principle offers a solution. This concept ensures that your business doesn’t recognize revenue as earned until the delivery of a product or the completion of a service.

Tips on How to Use the Realization Principle

There are a few things you should know when using the realization principle. For starters, you must track the dates when products are delivered and services are completed. After all, this is the basis on which the realization principle works. You’ll have to track the dates when products are delivered and services are completed to effectively use the realization principle in your business’s accounting strategy.

The realization principle works on a simple concept: revenue isn’t considered earned until the purchased product has been delivered or the purchased service has been completed. It’s designed to provide a better overall picture of your business’s finances by showing the true amount of revenue your business has earned.

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Why You Should Be Creating Profit and Loss Statements

As a business owner, you’ll need to create financial documents on a regular basis. Among the most important financial documents at your disposal is a profit and loss statement. Available in Quickbooks, it offers an overview of your business’s financial health. Why should you be creating profit and loss statements exactly?

What Is a Profit and Loss Statement?

Also known as an income statement, a profit and loss statement is a financial document consisting of your business’s revenue and expenses for a given period. Most businesses create them on a monthly basis. At the beginning of a new month, they’ll create a profit and loss statement for the previous month. This financial document shows how much money a business generated during this period as well as how much money a business spent during this same period.

Identify Unnecessary Expenses

With a profit and loss statement, you can identify unnecessary expenses incurred by your business. Maybe you subscribed to a second landline telephone that your business doesn’t use, or perhaps you’re overpaying for an office cleaning service. Regardless, a profit and loss report will show these and all other expenses incurred by your business. You can then review your business’s expenses to determine whether or not they are necessary. If you find an unnecessary expense, you can cancel it so that it doesn’t hurt your business’s profits.

Win Over Investors

If you’re trying to secure financing from investors, you’ll need to create profit and loss statements. Investors will look closely at your business’s expenses and revenue. After all, they want to know that your business is capable of growing and increasing its profits. With a profit and loss statement, you can show investors exactly how much your business earns in revenue as well as how much it pays in expenses. Investors will then feel more confident financing your business.

It’s Easy

Creating profit and loss statements is easier than you may think. You don’t need any formal training in accounting, nor do you need to hire a professional accountant. As long as you have Quickbooks, you can run a profit and loss statement. In Quickbooks, there’s an option to run a profit and loss statement. Using Quickbooks, you can quickly create a profit and loss statement for any period. As a result, you don’t have to manually calculate your business’s income and expenses.

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What Are Accrued Expenses in Accounting?

Accrued expenses are common when running a business. Whether your business operates in the B2B or B2C sector, it will probably face accrued expenses. As you buy products or services that are essential to your business’s operations, these expenses will generally increase. What are accrued expenses in accounting exactly, and how do they differ from other expenses?

Overview of Accrued Expenses

Also known as accrued liabilities, accrued expenses are costs incurred by your business that have been recorded but not satisfied. Not all business-related purchases require upfront payment. If you’re buying a wholesale shipment of products to resell, for instance, the vendor may simply send you an invoice. Vendors often have strong relationships with their clients. As a result, many of them allow their clients to buy products or services on credit. When you make a purchase for your business, an accrued expense is created until you pay for it.

Accrued expenses are considered liabilities because they haven’t been satisfied. Using the same example from above, an accrued expense is created if you buy products from a vendor. You must wait for the vendor to send you an invoice, after which you must pay the total amount denoted on the invoice.

Accrued Expenses vs Accounts Payable: What’s the Difference?

While they are both considered liabilities, accrued expenses and accounts payable aren’t the same. Basically, accounts payable are short-term liabilities that require payment in the near future. Accrued expenses, on the other hand, are usually long-term liabilities that haven’t been recorded. Payment dates can vary, but most accrued expenses are considered long-term liabilities.

Don’t Forget to Record Accrued Expenses

Some business owners neglect to record accrued expenses. They assume that an expense shouldn’t be recorded until it is paid. Of course, this is a bad habit that can adversely affect your business’s financial records. If you don’t record an accrued expense, you won’t be able to fully realize your business’s true liabilities and, therefore, its cash flow.

When your business generates an accrued expense, its liabilities will increase. An accrued expense is a liability, and like all liabilities, you must pay them at a later date. As a result, it’s important to record your business’s accrued expenses. Regardless of its total cost, accrued expenses can affect your business’s cash flow. By recording them, you’ll have a clearer and more accurate representation of your business’s financial health.

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The 4 Steps of the Accounting Cycle

Accounting is essential to running a successful business. If you don’t know how much money your business spends, as well as how much money it generates in sales revenue, you’ll struggle to create a profitable business. While there are different ways to approach accounting, one of the popular methods involves the four-step accounting cycle. In just four simple steps, you can keep track of your business’s financial information.

#1) Analyze Transactions

The first step of the accounting cycle is to analyze transactions. Transactions may consist of receipts and invoices. Receipts, of course, denote an expense, whereas invoices denote revenue generated. To begin with the accounting cycle, you must identify all of your business’s transactions for the given financial period.

#2) Record Transactions

After analyzing your business’s transactions, you’ll need to record them in the form of journal entries. Journal entries are a form of structured data about transactions. They typically include the date of a transaction, the dollar amount of a transaction, the account number associated with the transaction and a brief description. If you use Quickbooks, you can create journal entries for your business’s transactions using the accounting software.

#3) Add Journal Entries to General Ledger

The third step of the accounting cycle is to add the newly created journal entries to your business’s general ledger. The general ledger is a document that contains journal entries for transactions. Also known as the nominal ledger, it serves as the central hub for accounting processes. You can review your business’s general ledger to gain a better understanding of its financial health. Once you’ve identified your business’s transactions and recorded them in the form of journal entries, you should add those journal entries to your business’s general ledger.

#4) Run an Unadjusted Trial Balance Report

The fourth and final step of the accounting cycle is to run an unadjusted trial balance report. What is an unadjusted trial balance report exactly? It’s a summary of all the balances in your business’s general ledger. With an unadjusted trial balance report, you’ll see an overview of your business’s transactions displayed neatly in a single report.

The accounting cycle may seem confusing, but it’s actually rather simple. It consists of four basic steps: analyze transactions, record transactions, add journal entries to the general ledger and run an unadjusted trial balance report.

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What Is Liquidity in Business Accounting?

Have you come across the term “liquidity” when researching accounting activities? If so, you might be wondering what it means. No matter what type of business you operate, it probably has at least some liquidity. All businesses, including business-to-consumer (B2C) and business-to-business (B2B), have liquidity. With that, some have greater liquidity than others. So, what is liquidity, and how does it related to your business’s activities?

Overview of Liquidity

Liquidity is a measurement of how fast your business can convert its assets into cash. Whether you realize it or not, your business probably has assets that can be converted into cash. Examples of common assets owned by businesses include stocks, real estate, inventory, equipment and patents. Not all assets can be converted into cash immediately, though. You’ll typically need to sell them to generate cash. The time it takes to convert assets into cash is described as liquidity.

The Importance of Liquidity

Liquidity is important because it can help your business cover liabilities. Your business will inevitably incur debt when executing its respective operations. According to Fundera, in fact, seven in 10 small businesses have outstanding debt that haven’t paid back. Allowing debt to go unchecked, of course, can cut into your business’s profit margins. Lenders and vendors often charge interest on outstanding debt. The longer a debt goes unpaid, the more interest you’ll have to pay on it. If your business has excellent liquidity, you can use the cash generated from the sale of assets to pay off some or all of your business’s debt.

How to Improve Your Business’s Liquidity

Even if your business has poor liquidity, there are steps you can take to improve it. Reducing overhead, for example, will naturally have a positive impact on your business’s liquidity. Overhead consists of ongoing expenses that aren’t directly related to your business’s money-making activities. While you can’t always eliminate all overhead expenses, you can often reduce them. Canceling unnecessary services and changing utility companies can reduce your business’s overhead and, therefore, improve its liquidity.

If your business uses invoices, you can improve its liquidity by collecting from delinquent customers or clients. Customers and clients don’t always pay invoices on time. They may allow invoices to go unpaid longer after the due date. By collecting payments from these customers or clients, your business’s liquidity will increase.

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Positive vs Negative Cash Flow: What’s the Difference?

Cash flow offers an accurate representation of your business’s profitability. Regardless of what products or services your business sells, you can use this metric to determine whether your business is succeeding or failing at generating profits. Cash flow, however, can have a positive or negative value. For effective cash flow management that helps your business succeed, you must understand the differences between positive and negative cash flow.

What Is Positive Cash Flow?

Positive cash flow means your business received more cash — or other assets for than matters — during a given period than what it spent or incurred during the same period. All businesses have incoming and outgoing cash. Incoming cash refers to payments from customers or clients as well as money generated from other business-related activities, such as investing. Assuming your business’s incoming cash is greater than its outgoing cash, the value of its cash flow will be positive.

What Is Negative Cash Flow?

Negative cash flow, on the other hand, means your business spent or incurred more money during a given period than what it generated or otherwise received. A negative cash flow is concerning because it indicates your business is spending more money than it’s making. If your business has some cash reserves, it may be able to weather a short period of negative cash flow. Eventually, though, it will need to change its practices to achieve positive cash flow. Allowing negative cash flow to go unchecked for an extended period will quickly drain your business’s finances. Negative cash flow, in fact, is a common reason why small businesses fail.

Tips to Improve Your Business’s Cash Flow

Even if your business’s cash flow is negative, there are ways to turn it around. For example, you may be able to improve your business’s cash flow by switching utility companies. If your business operates out of an office or building, shop around for different utility providers. With a little luck, you may find a new utility provider that offers a lower price than your business’s current provider.

Another way to improve your business’s cash flow is to lease equipment rather than buying it. When you lease equipment, you’ll essentially pay to use it. Therefore, it’s almost always cheaper in the short term to lease rather than buy equipment. The only downside is that you won’t own the equipment when you lease it. You can also send invoices to customers and clients more quickly. The sooner a customer or client pays, the better.

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How Does Accounts Receivable Financing Work?

A bank loan isn’t the only way you can finance your business’s operations. There are alternative financing options available, one of which is accounts receivable financing. If your business uses invoices to collect payments from its customers or clients, you can use accounts receivable financing. With that said, you might be wondering how this alternative financing method works exactly.

The Basics of Accounts Receivable Financing

Accounts receivable financing involves tapping into your business’s unpaid invoices for financing. There are private financing companies that specialize in accounts receivable financing. They will either buy your business’s unpaid invoices — typically at a slightly lower rate than their face value — or they will loan you money using your business’s unpaid invoices as collateral.

Under the former option, you’ll obtain money by selling unpaid invoices to a private financing company. The financing company will essentially buy your business’s unpaid invoices. Under the latter option, you’ll obtain money in the form of a loan by using your business’s unpaid invoices as collateral. You’ll still have to pay back the loan, but you’ll get immediate cash that you can use to finance your business’s operations. There are the two basic methods used for accounts receivable financing.

Advantages of Accounts Receivable Financing

Many businesses struggle to collect payments from their customers or clients. With accounts receivable financing, you don’t have to waste time or resources trying to collect payments. You can simply sell the unpaid invoices to a private financing company.

Accounts receivable financing is also faster than traditional financing methods, such as bank loans. It can take well over a month for a bank to approve your business for a traditional loan. In comparison, private financing companies may approve your application for accounts receivable financing in just a few weeks. If your business is in dire need of immediate cash, accounts receivable financing can be an attractive choice for this reason.

Disadvantages of Accounts Receivable Financing

Accounts receivable financing, of course, is only an option if your business uses invoices. If customers or clients pay upfront, you won’t be able to use this alternative financing method.

If you intend to sell your business’s unpaid invoices, it’s important to note that you won’t get the full value for them. Private financing companies make money by buying unpaid invoices at a lower value.

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