Tage C. Tracy

Article / Updated 09-15-2022

Financial statement fraud, commonly referred to as "cooking the books," involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs that indicate suspect business accounting practices. These red flags include the following: Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered Unusually high revenues and low expenses at period end that can't be attributed to seasonality Growth in inventory that doesn't match growth in sales Improper capitalization of expenses in excess of industry norms Reported earnings that are positive and growing but operating cash flow that's declining Growth in revenues that's far greater than growth in other companies in the same industry or peer group Gross margin or operating margins out of line with peer companies Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages Unusual increases in the book value of assets, such as inventory and receivables Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction Invoices that go unrecorded in the company's financial books Loans to executives or other related parties that are written off A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.

Cheat Sheet / Updated 04-05-2022

Managing the finances of a small business is a multi-layered task. You need to become familiar with standard financial documents, pay attention to profits, and make the most of the business’s assets. And you always have to be thinking and planning ahead. You have some work to do, get to it!

Article / Updated 06-01-2017

The Limited Liability Company or LLC is an alternative type of business entity. A Limited Liability Company or LLC is like a corporation regarding limited liability, and it’s like a partnership regarding the flexibility of dividing profit among the owners. An LLC can elect to be treated either as a partnership or as a corporation for federal income tax purposes. Consult a tax expert if you’re facing this choice. The key advantage of the Limited Liability Company (LLC) legal form is its flexibility, especially regarding how profit and management authority are determined. For example, an LLC permits the founders of the business to put up, say, only 10 or 20 percent of the money to start a business venture but to keep all management authority in their hands. The other investors share in profit but not necessarily in proportion to their invested capital. LLCs have a lot more flexibility than corporations, but this flexibility can have a downside. The owners must enter into a very detailed agreement that spells out the division of profit, the division of management authority and responsibility, their rights to withdraw capital, and their responsibilities to contribute new capital as needed. These schemes can get very complicated and difficult to understand, and they may end up requiring a lawyer to untangle them. If the legal structure of an LLC is too complicated and too far off the beaten path, the business may have difficulty explaining itself to a lender when applying for a loan, and it may have difficulty convincing new shareholders to put capital into the business.

Article / Updated 03-26-2016

When implementing a new business concept, only one definition captures the real essence of capital: "It takes money to make money." From the aspiring entrepreneur designing new software in a home office to the executive of a multinational corporation looking to expand foreign distribution channels, launching any new business concept requires capital, or money, as a basis to execute the business plan. One of the most common reasons businesses fail is a lack of or inappropriately structured capital resources. For the sake of simplicity, capital is the amount of financial resources needed to implement and execute a business plan. Before a business sells its first product or service, it needs financial resources for product development, sales, marketing, administrative support, the company's formation, and countless other critical business functions. Capital should not be perceived as just the amount of "cash on hand" but rather the amount of financial resources available to support the execution of a business plan. While financial resources come in countless forms, types, and structures, two basic types of financial resources are available to most businesses: debt and equity. Debt represents a liability or obligation of a business. Debt is generally governed by mutually agreed upon terms and conditions as provided by the party extending credit. For example, a bank lends $2 million to a company to purchase additional production equipment to support expansion. The bank establishes the terms and conditions of the debt agreement, including the interest rate, repayment term, collateral required, and other elements. These terms and conditions must be adhered to by the company, or it runs the risk of default. Equity represents an investment in the business, usually doesn't have set repayment terms, but the owners of the equity investments do have a right to future earnings — they may be paid dividends or distributions if profits and cash flows are available. For example, a software technology company requires $2 million in capital to develop and launch a new software solution. A venture capitalist group invests the required capital under the terms and conditions present in the equity offering, including what their percentage ownership in the company will be, rights to future earnings, representation on the board of directors, conversion rights, and so on. The company isn't required to remit any payments to the capital source per a set repayment agreement but has given up a partial right to ownership (which can be even more costly). Of course, many variations, alternatives, subtypes, and classifications are present for each type of capital. If it were as easy as debt versus equity, there wouldn't be much need for bankers, accountants, venture capitalists, and the like (which would be a welcomed change to most business owners). You may be wondering whether debt or equity capital is best suited for your company. This decision really depends on the company's stage in terms of its operating history, industry profile, profitability levels, asset structure, future growth prospects, and general capital requirements, as well as where the sources of capital lie.

Article / Updated 03-26-2016

Managing the finances of your small business can be a challenge. To survive and thrive, you must earn profit consistently, generate cash flow from profit, and control your financial condition. You need a separate financial statement to highlight each aspect: The P&L Statement (also called the Income, or Earnings Statement) summarizes revenue and expenses and reports your resulting profit or loss — that’s what the P and L stand for. The Statement of Cash Flows begins by reporting the net increase or decrease in cash from your revenue and expenses during the period (which is a different amount than your profit or loss for the period); this statement also summarizes other sources of cash you tapped during the period, and what you did with your available cash. The Balance Sheet (also called the Statement of Financial Condition) summarizes your assets and liabilities at the close of business on the last day of the profit period and reports the sources of your owners’ equity (assets less liabilities). Make sure that you know how to read and interpret your financial statements. Not understanding your own business’s financial statements puts you at a serious disadvantage in making good business decisions and in dealing with your lenders and owners. Of course, the information in your financial statements is no better than your accounting system. Hire a competent accountant to design and run your accounting system. Your accountant can be a valuable helpmate in managing your financial affairs. Don’t confuse your balance sheet with the market value of your business. True, your balance sheet reports your assets and liabilities, and the difference equals the book value of your owners’ equity. Keep in mind, however, that historical costs are the values for many assets, and the balance sheet does not report your profit performance over recent years. Yet, the market value of a business depends heavily on current replacement values of your assets and your recent profit performance.

Article / Updated 03-26-2016

As the owner or manager of a small business, of course you’re very busy, but it pays to step back and plan for your financial future. Take the time to forecast, plan, and budget. Have your Controller (chief accountant) prepare the following pro forma (according to plan) financial statements: Budgeted P&L statement for the coming year. Even if this budgeted P&L is abbreviated and condensed, it plays an invaluable role. Provide your Controller your best estimates and forecasts for sales prices, costs, and sales volume during the coming year. From this information your accountant can prepare a P&L that serves as your performance benchmark as you go through the year. Don’t be afraid to change the budgeted P&L in midstream. Sometimes totally unpredictable events make your original P&L budget out of date. Budgeted Balance Sheet at end of coming year. You don’t necessarily need a detailed listing of every asset and liability one year off. But you definitely should look ahead to your general, overall financial condition one year later. It’s better to spot problems earlier than later. Looking down the road at where your financial condition is heading can help you avoid major problems. Budgeted Statement of Cash Flows. Preparing this budgeted financial statement is an excellent way to keep close tabs on your cash flow from profit (operating activities) and how you plan to use this cash flow. If you are planning major capital expenditures (new investments to replace, modernize, and expand your long-term operating asserts) a budgeted statement of cash flows is essential for making strategic decisions regarding how you will secure the cash for these expenditures.

Article / Updated 03-26-2016

Your small business is designed to make a profit — even if you’re not making one yet. Managing the financial aspects of profit requires special skills and powers of recognition. The following list offers tips on what to pay attention to: Cash flow accounting doesn’t tell you profit for the period, and accrual-basis profit accounting doesn’t tell you cash flow for the period. Credit sales are recorded as revenue before cash is received. Some expenses are recorded before cash is paid, and some are recorded after cash is spent. Depreciation expense is not a cash outlay in the period. Never confuse profit and cash flow. You need to look at your P&L report for your profit, and you need to look at your Statement of Cash Flows for your cash flow. Read the preceding tip again! Deep down in your psyche you probably believe that profit equals cash flow. You may want to believe this, but it ain’t so. Make certain that you have a firm grip on what cash flow is — and isn’t. Use a compact profit model for decision-making analysis. The P&L report is indispensable for controlling profit performance, but this profit performance report is too bulky for decision-making analysis. A compact profit model is better. The P&L statement is like a high-end digital SLR camera; a profit model is like a pocket-size digital camera that you carry around with you and is good enough for most uses. Seemingly small changes in profit factors can cause staggering differences. A small slippage in the ratio of margin on sales revenue can have a devastating impact on profit. A slight boost in sales price or a relatively modest increase in sales volume can yield a remarkable gain in profit. Small changes mean a lot.

Article / Updated 03-26-2016

The assets of your small business drive your financial picture to a large extent, so you need to know how to manage those assets to maximize their use to you. Use the tips in the following list to help put your assets to work for your business: Determine the sizes of assets you need to support the level of your annual sales revenue. The amount of your total assets determines the amount of capital you have to raise, and capital has a cost. The more assets you have, the more capital you need. Downsize your assets as long as you don’t hurt sales. Don’t rush into securing debt and equity capital without doing due diligence. Many small businesses are desperate for capital. Carefully examine the true, total cost of the capital and scrutinize the potential for interference from capital sources in running your business. Businesses that make profit generate taxable income. Small business (“S”) corporations, partnerships, and LLCs (limited liability companies) don’t have to pay income tax. They are pass-through tax entities; so, their owners include their respective shares of the business’s taxable income in their individual income tax returns. The profit of a pass-through business is taxed only once — in the hands of its owners. Cash dividends paid to stockholders by regular (“C”) corporations from their after-tax profits are included in the individual income tax returns of their stockholders and are thus subject to a second tax in the hands of the stockholders. To keep your assets working for your business, trust, but protect. Business is done on the basis of mutual trust, but not everyone is trustworthy, even a longtime employee and a close relative. Enforce effective controls to minimize threats of theft and fraud against your business. An ounce of prevention is worth a pound of cure.

Article / Updated 03-26-2016

Making profit generates cash flow — any business owner knows that. What may not be known, however, is that the actual increase in cash during a given period is invariably lower or higher than the profit number. Understanding how cash flow relates to profit is critical for business owners and accountants. The following points illustrate how cash flow relates to profit: The amounts of cash flows during the period rarely are equal to the revenue and expense numbers in the P&L (profit and loss) report for the period. Actions that lower cash flow: Increasing accounts receivable and inventory; decreasing accounts payable and accrued expenses payable. Actions that raise cash flow: Decreasing accounts receivable and inventory; increasing accounts payable and accrued expenses payable. Depreciation expense isn't a cash outlay; neither is amortization expense. Unusual losses recorded in the period may not involve cash outlay but rather be write-downs of assets or write-ups of liabilities.

Article / Updated 03-26-2016

Transactions are day-to-day accounting events that happen within a company. For example, the company receives a bill from the telephone company and posts it to accounts payable — that's a transaction. When the company pays the bill, that's another transaction. The term classes of transactions refers to the fact that the company's various transactions are divided into categories in its financial statements; like transactions are grouped together. Six management assertions are related to classes of transactions. Four of them closely mirror the assertions represented in the financial statement presentation and disclosure (in the prior section). However, the way the assertions relate to transactions differs slightly from the way they relate to presentations and disclosure, as delineated in the following list: Occurrence: This means that all the transactions in the accounting records actually took place. No transactions are made up or are duplicates. For example, if the client records its telephone bill on the day it's received and then records it again a few days later, that's a mistake: The duplication overstates accounts payable and the telephone expense. Completeness: All transactions needing entry into the books are recorded. The business excludes nothing. For example, the accounts payable clerk's desk drawer doesn't have a pile of unpaid bills waiting for entry into the accounting system. This situation would understate accounts payable and any expenses that relate to the unpaid bills. Authorization: All transactions have been approved by the appropriate member of company management. For example, many companies have restrictions on check-signing authority, stipulating that any check written in excess of a certain dollar amount requires two signatures. Accuracy: The transactions are entered precisely. The right financial statement accounts reflect the correct dollar amounts. The telephone bill is for $125, and the clerk enters it for $125. If the clerk inadvertently transposes the numbers and enters the invoice as $215, that's a failure of the accuracy assertion. Cutoff: You need to keep a close eye on the cutoff assertion. Some clients just love to move revenue from one period to another and shift expenses from one period to another. Make sure all transactions go into the correct year. If the company has a year-end date of December 31 and receives a bill on that date, it can't move the expense into the subsequent year to increase income. A good way to catch problems with the cutoff assertion is to use the subsequent payment test. To do so, select payments made within a month to six weeks after the end of the financial period. Pull the supporting invoices, and check to see whether the expenses are recorded in the appropriate year. Classification: The company records all transactions in the right financial statement account. Say the client has a high-dollar equipment asset purchase. If the clerk assigns that transaction to repairs and maintenance expense on the income statement instead of the balance sheet asset account, that action definitely affects the correctness of both the income statement and balance sheet and misleads users of the financial statements.