Sometimes your business just doesn’t perform as well as you need it to. Spending 15-hour days at trade shows, pulling all-nighters to revamp your market strategy and tweaking your website all weekend don’t always guarantee a profit or cash flow boost.
If you happen to be applying for a loan or line of credit or are in the process of selling your business, a few bad months could mean the difference between loan approval and rejection. When faced with this kind of pressure, some small-business owners look for alternative ways to hit their numbers. Unfortunately, this can lead to trouble.
That's because "aggressive" accounting is a risky proposition. Unlike sales and marketing—where being aggressive is often rewarded—cooking the books (or even just warming them up a bit) can ruin your business reputation and potentially lead to legal problems.
The sticky part is, while some accounting moves are blatantly wrong, others may not be so obvious to business owners without an accounting or finance degree. In fact, during a due diligence process, many small-business owners are surprised to learn that some of their long-standing “common sense” accounting practices are just plain wrong.
Here are five accounting techniques you may be using that can get you in a mess of trouble:
1. Stretching Out Your Accounts Payable
Accounts payable are liabilities—money that your business owes to suppliers and other companies. As accounts payable balances go up, the net worth of your business goes down.
Let’s say you expect to owe $100,000 to suppliers this month—your balance sheet should reflect that. But if you're applying for a loan, that additional debt might hurt your chances of being approved. So you call up your suppliers and ask them to hold off on sending invoices for 60 days in exchange for future business. This provides a temporary boost to your balance sheet and fools the bank into thinking your business is worth more than it really is, but that’s not right.
2. Financing Expenses
Now let’s say you're more worried about your earnings than your balance sheet. You could choose to take out a loan for $100,000 to immediately pay off the money due to your suppliers. But instead of recording the $100,000 in expenses for the period, you add it to your balance sheet as a loan and only record the interest expenses for the month. Showing a few thousand dollars in interest expenses—instead of $100,000 in payable expenses—will do wonders for your profit margin, but that’s not right.
3. Channel Stuffing
A business that sells physical goods to retailers that needs to boost its sales this month could very easily do so using channel stuffing. This is how it works: You offer your buyers a “no questions asked” return policy. Then you tell them they don’t have to pay you for six months but the only way for them to lock in this deal is if they agree to buy twice as much as they usually do. They take the deal; your business ships out the inventory and records the sale as revenue. On the surface, it might look like a legitimate deal, but it’s not, because you've basically told them they can send it back if they don’t sell it, and that’s not right.
4. Premature Revenue Recognition
The revenue recognition principle is one of the foundations of modern accounting. Basically a business should record revenues in the period when the work related to the revenue was performed. But if you need a quick boost to your earnings, you could offer a discounted price to a customer today for work that won’t be performed until next year. Even if you sign the contract today—and collect a down payment today—the revenue shouldn’t be recorded until you actually do the work. Recording it now would boost this month’s earnings, but that’s not right.
5. Pretending All Customers Always Pay
If any part of your business’ sales takes place on credit terms (anything other than cash upfront), then proper accounting practices require you to assume that a percentage of those customers won’t pay. This allowance for uncollectable accounts, which turns into a bad debt expense, hurts your earnings. Pretending that 0 percent of your customers will default can provide a quick and easy boost to earnings, but that’s not right.
The principle of conservatism—where you recognize expenses and liabilities as soon as possible but only recognize revenues and assets when you're certain they'll be received—should always drive your accounting policy. When in doubt about how to record something on your books, choose the way that's less beneficial to your business. It may hurt you in the short run, but you’ll sleep better at night.
Read more articles on financial management.