Is my business optimized for TAX?
The CPA and Analytical Accountancy
A lot of small business owners will seek a CPA to get their taxes done but getting their taxes done becomes problematic because their books are not set up and managed in a way to enable the right information to be delivered to the CPA. The goal being that their tax return is done right or optimized to enable the business to pay the least tax possible.
The CPA can only work with the information they are given. They are typically not going to spend time going into the client’s books, figuring out exactly what the business is doing and whether they are doing it the right way and the smart way.
The business owner thinks they just need a CPA but what they really need is a solid financial structure within their accounting systems and software so that they have good financial data to give the CPA.
Example – No Accounting Software, Just Spreadsheets
In one example we had recently with a $2m+ Columbus-based small business that did not have any accounting software in place at all. The numbers they were submitting to the CPA were all over the place and way off. You’d be surprised how often we find people running businesses without any real accounting software or specific accounting processes in place.
Example – Multiple Incompatible Accounting Software Applications
In another example, a $6m annual revenue small business in Orange County California their accounting was in two different incompatible accounting software applications. As a consequence, they had no way to hand off to a CPA what they had done for the year or any consistent and comprehensive financial data.
In both of these cases, their revenue numbers were adrift by hundreds of thousands of dollars. Consequently, they had overpaid their taxes, the second case by over $200,000.
While these may appear to be extreme examples, they are not unusual. Most times when we take on a new client, we find all kinds of issues associated with inaccurate and inconsistent financial data going to their CPA.
CPA’s Rarely Question or Analyze The data They Are Given
It’s sad to say that rarely if never, do we find that their CPA is doing anything to question the data or help the company to better organize or structure their financial processes.
CPAs Taking a Business’s Numbers at Face Value
Business owners that we talk to typically assume that if they give their CPA access to their books they will analyze them and extract accurate information and then his job is to make sure that they pay the minimum tax legally. That’s their job, to analyze the books and figure out how to pay the least tax.
To really minimax the amount of TAX your small business pays a CPA on their own rarely is enough. The challenge is that the majority of CPAs just take your data and use it to complete your TAX return.
Time and again we find that the CPA draft a company’s tax return at the last minute, allowing no time to review the numbers, question the result, and make smart adjustments.
What we usually see is that the CPA just takes the numbers at face value, completes the return and they are done. Whether you are doing things correctly, and accurately or accounting for outgoings or income in the smartest way is rarely something they spend any time analyzing.
What Are Bookkeepers Typically Doing?
Their bookkeepers (when they have one) also only have a rudimentary understanding of accounting. They understand the basics of using QuickBooks. However, they are not thinking analytically to offer suggestions for how to set up QuickBooks to maximize tax strategies.
As the average bookkeeper goes about their daily process of entering transactions, they don’t understand the ramifications of what they are entering and how they are entering it. How that information is going to be used for the owner’s tax return.
The bookkeeper, therefore, goes ahead and sends the numbers to the CPA. The CPA then goes ahead and completes the company’s TAX return. However, nobody is actually steering. It’s all done on a kind of autopilot. In these cases it’s like you have the two services, bookkeeping entering transactions and a CPA completing a tax filing, both doing the admin but no one is actually managing the financial data and process.
In larger companies, there is often a financial controller or CFO providing this function. In smaller companies that oftentimes just does not get done. No one is there to steer the ship. This results in companies overpaying tens of thousands of dollars in taxes. Also, sometimes even worse the business encounters problematic cash flow issues because decisions are made based on an incorrect understanding of their cash flow and profitability.
Example – What the Bookkeeper Did
In this recent example, we worked for a small business based in Worthington Ohio. The bookkeeper was entering things in the way they think they should however we noticed that the numbers were skewed on the income side.
As we researched why these numbers were skewed, we saw the problem. Every time they applied an “early pay discount” to a vendor bill, it was going into the “gross” sales numbers. These was not sales numbers, they were income, but they were not sales. These discounts should have been entered into a different type of account, an ‘other income’ account.
The result, in this case, was that the company’s sales numbers were inflated to the tune of $89,000 and therefore their “general liability” insurance premium was calculated using Gross Sales and resulted in a much higher premium.
Insurance companies determine a business’s potential liability and therefore premium, based on gross sales. Other income should not be in the calculation.
Standard Bookkeeping Skills – Go as Far As…
As we work with various bookkeepers in small businesses, more often than not, they just have the standard bookkeeping skills. They understand to create an invoice and when the customer pays you receive that payment. They know the process inside QuickBooks. They know how to use their accounting software to follow those stepped procedures.
What they don’t understand is what happens when they do that. If they receive a payment, where does that go? If they create an invoice for an item and receive the money where did that go?
They don’t understand what’s happening behind the scenes, where all this information is going on the financial reports. They just understand the day-to-day processes.
They understand how to report certain types of income or costs, but they don’t understand the implications associated with it if it’s reported one way or another way. In terms of the impact on the business. They understand accounting steps that you need to follow for just general accounting. However, they don’t understand how specific steps land on the financial reports.
Example – Making Business Appear Non-profitable
In this example, an in-house bookkeeper was entering new items in the accounting software. These were two-sided items, meaning that they purchase and sell these items goods for resale. When you do that, as part of the process you decide what cost of goods account to use for the purchase, and what income account to use when it’s sold.
In this case, they created these items as a one-sided item which means they only sell it, they don’t ever purchase it. They then had it pointed to a cost of goods account. The result was that on every invoice and payment received with those items on them, all income went into a cost of goods account instead of income. As a result, the company showed inflated cost of goods and much less net profit than they really had.
In analyzing that business’s financials, we saw jobs in the range of $20,000 with cost of goods of $50,000. That did not make any sense.
With that happening the owner tried to look at how they are doing in the current month, they just observed that their profits are down and consequently were making bad decisions. Bad decisions such as letting people go unnecessarily.
The owner was looking at that financial report to determine the health of the business, i.e. “am I doing well?” Their incorrect impression was, “Wow I’m doing really poorly, I need to cut back”.
That’s a classic example of where the general population of bookkeepers don’t think about the implications of what they are doing, and the effect that can have on the business’s profit and loss statement.
Q: What’s the difference between small business Bookkeepers, Accountants, and CPAs?
- Records the business’s day-to-day transactions
- Business Accountants
- Analyses and optimizes the business’s financials (Understand the Business)
- Profit and loss, Cash flow, Accuracy of the bookkeeping
- CPAs (Certified Public Accountants)
- Advises on strategy and business set-up to pay the correct tax (Understand TAX law)
Filling The Gap – The Smart Accountant / Financial Controller
What’s needed is an analytical bookkeeper, a smart ‘accountant’ to be constantly analyzing the business and making sure the numbers are accurate and impacting the business’s TAX liability in the smartest way possible.
More often than not when we are involved with the accounting of a small business we see multiple inaccuracies and inappropriate accounting of revenue. These issues at best skew the owner’s perception of how profitable they are, and at worst they are paying significantly more tax than they have to.
These kinds of issues only come to light when we are involved with the day-to-day financial operations of the business.
Is It Realistic?
Is it realistic for a small business owner to go to a CPA and say that they want them to understand their business, to make sure their books are accurate and optimized to pay the least tax possible?
Is it realistic to go to a CPA and get that level of service from them?
If theory, it should be but, in most cases, we see, CPAs do not provide that kind of service.
CPAs Don’t Understand
The CPA and the bookkeeper are two completely different worlds. The CPA does not have a clue regarding day-to-day transactions. A CPA will know how to make a journal entry to take something from this account and put it in that account due to it being in the wrong account.
However, to tell you how to set up QuickBooks to do that, they really don’t know. What they’ll tell you is what needs to be done for a given business. You should be doing things ‘this’ way, or ‘this’ should be in a cost of goods, it shouldn’t be in expense, but they expect the bookkeeper that manages the accounting software to go set that up.
Example – Migrating to ‘Completed Contract” Accounting
A good example of this is with a current local builder/contractor client based in California we are helping. They are now going to a completely different accounting method called ‘completed contract’.
However, in order to do that we have to figure out how to set up that entire new accounting method in QuickBooks. The CPA is not going to do it, they do not even know specifically how to set that up in QuickBooks.
What Needs to Be Done Not How
The CPA can advise what needs to be done, but they are not going to tell a bookkeeper how to do it.
What we see is that the CPA does not take any responsibility for the business’s financial data being accurate.
They just say, “these are the numbers we have been given”. And submit those in a tax return. Even worse, in larger CPA firms, the CPA does not even prepare the tax return, they have an ‘assistant’ do it, take a quick look at it, and sign off on it.
In An Ideal World
In an ideal world, a CPA will provide some direction, and specific tax strategies, they will work with the accountant/bookkeeper to make sure that the bookkeeping is being done in a way so that everything is good and accurate at the end of the year so the file is clean, perfect the way it’s supposed to be and then they prepare a tax return from it.
However, that’s not at all what we see happening in reality. Not even close.
Making matters worse a lot of the errors we see, the things that have not been done in QuickBooks in a correct and optimal way, would not be noticed or seen at all in a one-off tax strategy meeting with a CPA. The only way these errors come to light is when you are deeply involved with the day-to-day financial operations of the business.
What does it take to optimize for tax and make a business’s books accurately reflect the business?
In a fairly short period (as in an hour or two) a good accountant can potentially find some problems and provide some direction to correct some issues. However, to really be on top of it and to make sure the business is optimized financially it’s an ongoing deeply involved activity.
Answer: “While a CPA can help, you also need a good accountant to analyze your books and business processes. A good accountant will make sure your CPA’s suggestions are implemented correctly. They will also present the right information to your CPA.”
What a Business Really Needs Is…
What a small business really needs is someone who can provide accountancy services that can make sure that the information that goes to the CPA is both accurate and optimized.
Mind The Gap
That gap, the people doing the books in the company not really understanding accountancy or analyzing and optimizing, not making sure that the business’s numbers are reported accurately and optimized for minimum tax liability is where things go wrong.
Time and again we find that companies just have a bookkeeper who enters day-to-day transactions and that’s it. They just hand off their file to the CPA at the end of the year.
The net result is that the business does not have an accurate picture of how profitable they are and also overpays its taxes to the tune of hundreds of thousands of dollars.
CPAs Are Not Always Right
It’s not unusual for us to go to three different CPAs with the same question and get three different answers. The company’s accountant or bookkeeper (who is deeply involved with the business) needs to have the competency to challenge the CPA if their answers appear incorrect.
The accountant needs to be able to independently research a situation if the advice from the CPA does not sound right. They need to be able to challenge their CPA and not just assume that everything that comes out of their mouths is gospel.
I’ve Been to My Doctor, But I Want a Second Opinion
Just like when you go to a doctor, if the advice is to take a certain treatment that does not sound right to you, most people will not hesitate to get a second opinion. CPAs should be treated the same. If they make a recommendation that may significantly affect the business, it is perfectly reasonable to get a second opinion and or do your own research.
A primary role of the accountant / financial controller can also be helping to discern if the company’s current CPA is good at what they do. If they are not, then they are the person who is most likely to be able to find a CPA that is good at what they do.
Late Again, And Again, And Again
Another issue that we see come up time and again is that the CPA completes the draft tax return at the last minute. The problem with this is that if there are any issues, questions, anomalies or indeed anything that needs to be changed there is no time to do it.
Tax returns are always driven by deadlines, tax returns must be submitted by a certain date. CPAs find themselves rushed during these times and are often running behind. A late tax return will typically generate costly penalties. Also, because the return is running late things that should be challenged and worked through go unaddressed.
A good financial controller will make sure that the CPA has the correct information in plenty of time and will hold the CPA accountable for getting the draft return done in plenty of time to allow issues to be resolved, without generating penalties for late submissions.
The Bottom Line
A lot of small business owners make the mistake of assuming all they need is a CPA and their CPA is going to look after them from a tax liability point of view. And optimize their books to pay the least taxes possible. In reality, the CPA just fills in a form based on the numbers they are given.
Often times the numbers they are given are wrong and they end up overpaying their tax. Their CPA is simply not involved enough to really optimize the business, financially speaking.
Data Entry Bookkeeping – Is the Norm
Most bookkeepers just enter the data and move on. If your bookkeeper just enters day-to-day transactions but does not take time to interpret and analyze the company’s financial data, the company’s profit and loss suffers. If something does not look right, go research, dig into it and see what’s wrong about it.
Before It Goes to Your CPA
What business owners really need to do is make sure they have an accountant who not only understands how to do basic bookkeeping but also understands how to analyze your business to make sure your revenue is reported correctly and that you are optimized to pay the minimum tax BEFORE IT GOES TO A CPA.