Revenue is NOT cash. For some people this may be obvious, but for others it may come as a surprise. This sets the foundation for how you understand income, how you recognize it and how you record it.
You need to understand that sending an invoice is not the same as receiving cash, you need to track it properly to make decisions based on revenue earned, while also keeping an eye on your bank. Let's dig deeper and talk about how improper bookkeeping can lead to inaccurate cash planning.
We often talk about financial goals for entrepreneurs in terms of money earned. But earned money is not necessarily real. The amount that you asked for on an invoice may not always be paid for a variety of reasons. The project might fall through, scope of work might change, or worst case, the client just outright refuses to pay. This can impact business owners who have been making future plans based on unexpected income that won't be received. But let's put all that to the side and assume that you are getting paid, the work is done, and now the money's in the bank.
How are you making sure that those payments are properly applied in your books? Let's say you're a coach and you're invoicing clients individually for their first session with you. When invoicing a client for $2,500, you don’t follow the proper steps and mis-categorize the transaction. This can lead to a number of problems, but these are the 3 main ones.
1. If you misrecord a payment as a sale, your accounting system will show that you’re waiting to be paid and you have double counted your income. In the realm of taxes, you have increased your liability on what you should owe, because it looks like you owe money on twice as much money as you should have.
2. You have created a headache for your client because they may be receiving automatic reminders asking for money they have already sent you. This could lead to lack of trust that they will not be double charged in the future.
3. It shows that you have money on the way, but when you correct the issue you’re going to have to find another source of funds to cover these costs. That unexpected shortfall could leave you in the dust.
How can I avoid this?
First, use a consistent method to invoice clients and receive payments. Ideally, this is going to get processed directly through your accounting system or some third party software that integrates with your accounting. This way invoices are electronically accounted for and payments can be easily or in the best case automatically applied.
When received, if clients pay outside your normal system, say by cash or check, you're going to want to make sure to mark that amount as a payment for the invoice, instead of directly as a sale, the invoice will then be marked as close. Then the sale will only be recorded at one time. No one wants to be surprised when managing cash flow. Setting the right foundation for how sales are recorded helps to ensure that you're looking at accurate revenue information.
Cash flow is the top reason for small business shutdowns, and it's hard to plan to pay business expenses when you don't have a clear understanding of what's coming. Properly managing payments and matching them to open invoices really gives you a true reflection of what to do to you.
And what's already been paid, which is also going to be important for you at tax time. Take the time to categorize sales properly. That's going to inform the strategic and operational decisions that you're making for the future of your current company. So, if you're looking for best practices and tips to set the financial foundation, you need to keep your business standing.
If you are earning significant revenue, but need help with cash flow, Virtual CFO is for you. We will take care of all invoicing, including tracking and following up on payment, categorizing expenses, and managing payroll and taxes.
We'll take you through a 60 day onboarding process to learn your systems and guide you through best practices. And then we'll take over your bookkeeping financial statements, and then we'll review metrics on a monthly call. Plus, you've got a CPA team in your pocket for questions that come up for you throughout the period. Click HERE for more info and sign up today.