How Much Accounting Do I Need to Know?

You could spend an endless amount of time mastering every accounting skill involved in running a business and keeping up on all the latest accounting rule changes. Or you could spend no time on accounting and have a bookkeeper pay your bills, process your payments and put together your monthly financial statements. Which is the best choice?

Neither. You should understand accounting to the degree that you can make the best decisions possible about running your business. But no more. You don’t need to know the latest IRS rules or precisely how to calculate depreciation or amortization, for example.

Even for creating your own financial statements you don’t need to have an exact number for depreciation and amortization. After all, these are not cash expenses, they are just an accounting approximation. What I will do is put in an estimate in my monthly profit and loss statement and then have my CPA do the exact calculation for tax purposes at the end of the year. Even if I’m submitting my monthly profit and loss statement and balance sheet to my bank, I am comfortable using estimates for depreciation and amortization.

So, what accounting skills should you be on top of? I believe that you should assemble your own monthly financials internally. If you are a one-person business that means that you should create them yourself. If you have an accounting manager or CFO, then he or she should assemble the statements. But you should have enough knowledge so that you understand how they are assembled.

What about the balance sheet? If you are running a very small business and not using borrowed funds, then you probably don’t even need to put together a balance sheet every month. If you are incorporated you will have to put together a balance sheet as part of your tax return each year. And even if you are not incorporated you should have at least an annual balance sheet of where you stand personally. If you are really uncomfortable with accounting, I think it’s fine to have your CPA or bookkeeper put together your balance sheet. But I think that you should at least understand the basic concepts involved.

The next most important financial spreadsheet I think that you should understand is the pro forma or projected cash flow statement. You should be able to estimate the cash inflows and outflows for your business for at least the next 6 months. Why is this important? Because if you are looking at a shortfall sometime down the road you want to take steps as soon as possible to try to avoid it, otherwise you might have to make draconian steps at the last minute.

What steps would you take? Typically, it means cutting expenses to reduce cash outflow.

Can’t you just have your bookkeeper project your future cash flow? No this is a bad idea. This is too important a task to delegate outside. If you have a highly skilled accounting manager or CPA you might be able to delegate to them. However, in all my years in business I only had one accounting manager (who had a CPA) who was capable of doing a good job projecting cash flow. It is hard to project cash flow and it is especially hard for an outside expert who is not familiar with the inner workings of your business.

Another important reason to project the cash flow yourself, is that you will be more familiar with the variables that go into cash flow and the changes that are impacting it over time. By having this deeper insight into your company’s cash flow, you will be in a much stronger position to make changes to future cash flows, if your company looks like it might be heading for a cash flow shortfall.

So, no you don’t need to know everything about accounting to run your business well, but you will need to learn the basics, and you should be up to speed on the key financial statements of your business.