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Now that we have looked at the various financial statements and how you can use each of the statements for your business, I want us to look at some mistakes you should avoid. In this final chapter, we will mainly focus on errors and mistakes that could be costly in accounting. As we have already seen, there are some mistakes that may lead to errors in ledger books or the trial balance. You should try avoiding such mistakes at all costs. After looking at the mistakes, we will crown up our book by looking at the basic principles you must keep in your mind, and the frequently asked questions by some accountants.

If you are just starting to manage books of accounts, you should be cautious not to make some mistakes. Even if you are the owner of the business, it is important to keep track of all the transactions and get rid of stupid mistakes that may be costly at the end. Some of the expensive accounting mistakes that most people make include:

1. Failure to keep the accounts receivable: The most common mistake made by most people is that they avoid preparing the accounts receivable when dealing with the cash method of bookkeeping. Even if you will be dealing with the cash method of bookkeeping, it is important to maintain the accounts receivable. While small businesses such as sole proprietorships are allowed to use the cash method of bookkeeping, this does not eliminate the need for maintaining accounts receivable. Every business will have customers who purchase on credit. If you fail to maintain the accounts receivable, chances are that you will end up losing too much money due to failure in tracking down some cash.

2. Failure to track cash transactions: The other mistake is usually a failure to track cash transactions for those who use the accrual method of accounting. The accrual method of accounting requires that all transactions be recorded as soon as they happen. In simple terms, money doesn't have to change hands before a transaction is deemed complete. The downside of this method of accounting is that most accountants tend to focus on large significant transactions such as the purchase of raw materials, etc. If you fail to keep track of the smaller transactions that happen along the way, you may end up losing money through smaller transactions that pile up in the long run. For this reason, it is important for all businesses to maintain a petty cash book, which caters to the seller transactions. Such transactions mainly include operational costs that may pile up in the long run if precautions are not taken.

3. Poor communication between the accountant and bookkeeper: The other common mistake that happens in most companies is a lack of communication between the accountant and the bookkeeper. As already mentioned in our first chapter, the duties of an accountant and bookkeeper are complimentary. The accountant cannot do proper accounting unless he/she receives the right data from the bookkeeper. On the other hand, a bookkeeper may not offer any value unless the data recorded is used by an accountant. It is, therefore, necessary to have regular communication between the two parties. The accountant must supervise the work done by the bookkeeper and provide guidance. If you choose to carry out bookkeeping yourself, make sure you bring in an accountant from time to time just to ensure that the quality of your records is up to date with accounting standards.

4. Using improper or outdated bookkeeping software: The other common accounting mistake made by most accountants is using improper accounting software. The accounting software used will determine the quality of records that are kept. Today, most companies use automated accounting software. The automation helps in recording transactions in real-time to reduce the chances of fraud. However, you should never use any software without knowing how it works. If you wish to introduce new accounting software, it is recommended that you bring on board an experienced accountant to help guide the other staff on using it. This way, you get to use new tools that will ensure accuracy in all the work you do.

5. Failure to keep documents that prove the occurrence of transactions: Accounts are most often audited by government agencies or internal auditors. The work of auditing helps determine whether the bookkeeping and accounting methods are straightforward. In some instances, people may use fraudulent means of accounting to ensure that the books balance. The only way to prove the authenticity of all transactions is by keeping the documents. There are many documents that are used to prove that a transaction has occurred. For instance, you will need a bank slip to prove that cash was deposited or withdrawn over the counter. You may need a copy of the check to prove that payment has been made. You may need a receipt to prove that a certain item has been purchased. It is important to file and digitize all documents that prove the occurrence of transactions. If you digitize such documents, you can store them in multiple media and easily retrieve them if need be. Such documents are important since they are needed when you start tracking down errors. Errors made in the subsidiary books of entry can only be found and corrected from the source documents.

6. Failure to consolidate subsidiary books with the general ledger: The other common mistake that amateur accountants make is a failure to consolidate the subsidiary books of entry with the general ledger. If you take too long to summarize the subsidiary book entries, they may pile up and become challenging to consolidate. When you have recorded the important entries in the subsidiary books, you should add up all the summaries and transfer them to the general ledger. When transferring, make sure you double-check with the source documents so that you do not end up transferring errors from one book to another.

7. Failure to prepare the trial balance: Lastly, most people who are new to accounting may jump into preparing financial statements without preparing the trial balance. As we have already seen, although the trial balance is not one of the financial statements, it is deemed as one of the most important tools in understanding the financial position of a business. From the trial balance, we can validate the authenticity of the general ledger entries. It is important to double-check such entries to ensure that the final records presented through the financial statements reflect the true status of a company. If you end up preparing financial statements with plenty of errors, you may end up paying more taxes than you should.

There are some accounting basics you should never forget. These basics determine the ability of an accountant to provide accurate financial statements. If you are the owner or manager of a business, you must also keep such basics at the back of your mind to help you in decision making. Some of the accounting basics to keep at the mind include

1. Accounting software is as important as the accountant: The most important thing about bookkeeping and accounting is having the right software. Even if you have the best bookkeeper or accountant in the world, they may not be able to perform unless you provide the right software. Accounting software is particularly important when dealing with bookkeeping. Most businesses have automated transaction recording software that helps track down all the transactions that occur within the business. When you purchase bookkeeping and accounting software, find one that can be used by all employees while at the same time providing the ultimate security to the financial management departments.

2. Cash flow tracking is the backbone: As soon as you start operating your business, set up your business bank account. One mistake that most people make when getting into business is using one account for business and personal finances. The best way to manage your business is by maintaining a bank account that helps you control all your cash flows. When managing your cash flow, you should watch the timing of the money coming and going out. Through prudent management of cash, you will be able to plan for your future investments, run the day-to-day operations, and determine your profits without a problem.

3. Keep track of your inventory: The biggest problem that most people have to face is getting the actual count of inventory. Accounting for inventory becomes even more difficult when you offer services rather than goods. When accounting for inventory, make sure you include both direct and indirect costs. Account for the cost of all materials, any costs of packaging the products, and make a decision about the volume of inventory you wish to have at hand.

4. Understand your cost of goods sold: The other basic factor you must keep in mind when it comes to accounting is the cost of goods sold. If you do not determine the accurate cost of goods sold, chances are that you may end up making losses. The cost of goods sold determines the price of the products you sell and, consequently, the profits you make. To determine the cost of goods sold, you will have to calculate based on the business model you are operating. For business models that involve production, you must include the cost of raw materials, the cost of labor, power, and other components used in production.

5. Get your expenses right: Besides the cost of goods sold, there are other expenses that a business has to undertake. The other expenses may be less than the cost of goods sold. However, there are some business models where operating expenses can easily match up to the cost of goods sold. Start by determining the fixed expenses of the business. These are business expenses that are constant, whether your business is operational or not. Such expenses and indirect expenses will determine the overall profit of the business.

6. Figure out your break-even sales requirement: The other important factor to keep in mind is the break-even sales requirements. After determining the cost of goods sold and other expenses, it is your duty to determine the best pricing and the required sales volumes to meet all your expenses. If you fail to meet your break-even sales volume, your business will end up making losses. For all businesses, there is a level of production and sales that lead to profitability. You must target the sales that lead to profitability in the long run.

7. Track your sales and profits before tax: The other basic principle of accounting for managers is tracking of revenue and profits. If you can determine your revenue and expenses, you should be in a position to track your profits. By tracking your expenses and revenue, you can determine the possibility of your business making profits or losses even before we come to the end of the trading period.

8. Set up the proper tax rates for customers: As the business owner, you should implement managerial policies that provide room for the business to grow. When you want to set the prices and taxes for products and services, you must use accounting data. At the end of the day, financial statements should not only help you make informed decisions but should also establish the best rates for customers. If the company is already making losses, looking at the cost of production, revenues, and other expenses, can help determine the right process to sell your goods to make profits.

9. Plan for your tax payments: Financial statements are meant to help you plan to pay your taxes at the right time. Understanding your earnings and expenses should help you make the right tax payment decisions. The taxes paid by a business depend on the profits earned and the physical location of the business. Governments have different tax requirements that must be met for your business to continue operating. One of the most basic needs of accounting is to determine the profits and, consequently, the tax payable during a given trading period.

10. Understand your balance sheet: Most importantly, it is necessary for any business owner or manager to understand the balance sheet. The balance sheet is the financial statement that shows the net worth of a business. Just by looking at the balance sheet, you can determine how much assets the business owns, the level of debts, and the value of the owner's equity. If you wish to establish your business well for future growth, you should be able to interpret your balance sheet and use it accordingly.

As the owner or manager of a business, your main aim of reviewing financial statements is to ensure that they are accurate. When you look at financial statements, you should be able to tell whether the information provided is true or false. If you don't know how to review financial statements, you may end up making losses even if the business is profitable. When reviewing financial records, there are some ways you can detect errors. Here are some of the pointers to look out for to avoid using misleading financial statements.

1. Exclusion of financial transactions: Any prudent business manager will not only focus on financial statements but also review the ledger book and other books of entry. As a matter of fact, all financial statements can be manipulated to give a false image of the operations of a business. For instance, an accountant can choose to eliminate certain transactions completely. In such a case, the business might end up making losses without the owner or the manager noticing discrepancies. To ensure that you track all the errors that might occur, you should take a day or two just to review the other financial records. Go through the general ledger and the subsidiary books of entry to determine any errors. If the accountants have left any transactions out, you can detect by looking at the source documents and comparing the transactions to those recorded in the general ledger.

2. Lack of correlation to previous financial statements: You should start asking questions if the financial statements prepared in consecutive accounting periods are completely unrelated. For instance, if the financial records for the trading period ending December 31st, 2019 are completely different from those prepared in June 2019, chances are that the figures are being cooked. If the figures are being cooked, the accountants may not be keen enough to maintain consistency throughout all the financial statements. You can look at the financial statements and compare them to those from previous trading periods to see if there are any discrepancies. For financial statements such as the income statement, it is okay to have significant variations. However, six months is not enough time to cause significant changes to the balance sheet or the owner's equity.

3. Lack of source documents to prove transactions: The other way to determine possible errors in your financial statement is by looking at source documents. One of the best indicators of the accuracy of your records is the cash and bank accounts. The cash account will help you determine all the transactions that have happened throughout the trading period. For all the cash account transactions, you should be able to find the supporting documents. At the same time, the bank account can also help you determine the authenticity of transactions. Source documents such as bank slips and checks are important in proving that certain transactions took place over the trading period in question. Whenever you receive financial statements from your accountant, just pick one account and request for source documents regarding transactions in that account. For instance, you could ask for all transactions regarding cash going in and out of the bank. From such transactions, you will determine whether the figures provided on your income statement or the balance sheet are true.

4. Financial statements don't reflect reality: Besides proving the authenticity of the statements by looking at source documents, you should also use your best judgment. By best judgment, I mean you should be able to gauge the average income of the business based on the day to day activities of the business. For instance, if your business spends a lot of money on production and you happen to make a lot of sales, you should expect that your business brings in substantial revenue. However, if you realize that the value of goods sold or the accounts receivable is way higher as compared to the revenue, you must investigate the reasons behind such discrepancies. In some cases, the accountants may make adjustments to the true figures of your accounts and siphon money out of your business if you don't make a critical analysis of the financial statements.

5. Analyze financial ratios: The other way to find out if there are errors in your financial records is by analyzing financial ratios. For instance, we have seen that the debt to equity ratio can be used to determine the stability of a business. If you happen to produce such ratios for each trading period, it will be easy for you to spot errors in your financial statements. If the ratios from the previous trading periods vary greatly, chances are that your accountants are using unscrupulous methods to siphon money out of the business. For instance, if you realize that your debt to equity ratio has increased yet you have not borrowed more, you are probably losing money to the accountants. The accountants can mess up with your owner's equity or the value of liabilities to find a way of stealing from the business. While the other figures on the financial statements may have significant differences as compared to the subsequent accounting period, financial ratios do not change much.

6. Hire an Internal Auditor: Last and most importantly, you must be ready to bring an internal auditor to look at the financial statements once they are prepared. Financial auditors are professional accountants who specialize in auditing financial records and are better placed to fix errors made by other accountants. In accounting, errors can occur whether made intentionally or by mistake. Unfortunately, with errors of omission, the balance sheet and the trial balance will still balance well. Relying on documents such as the trial balance or the balance sheet to determine the accuracy of your financial records is not the best approach. These documents can only help you prove a few facts but will not show some serious errors. For this reason, you must find a way of reviewing the books of subsidiary entries. Have an auditor go through all the books of original entries and confirm the entries with the source documents. While hiring an accountant to audit your books might be the best way for those who lack accounting skills, you should be careful who you choose to trust. Some auditors may collude with accountants to steal from the company. You must make sure all the important source documents are available to help provide the best results for your audits.

At this stage, we have covered all the information you need to know about financial statements. You should be able to prepare and analyze financial statements without a problem. At the same time, you should be in a position to determine the errors within the financial statements.

There are three key financial statements that are made up of 5 main elements. These elements include:

1. Assets: Assets are items of value that are owned by the company. Items that can be listed under assets include cash, equipment, real estate, etc.

2. Liabilities: These are items that decrease the net worth of the business. In other words, liabilities are what the company owes other companies, individuals, or investors. Liabilities include items such as accounts payable, long term and short term loans, etc.

3. Equities: These refer to cash or cash equivalents that are used to represent the ownership of the company. The term equity, as used in accounting, determines the value of the company and its ownership.

4. Revenues: Revenue is one component of financial statements that mainly appears on the income sheet and the cash flow statement. Revenue represents all the money that is earned by a business over a given trading period. The revenue of a business can vary from one accounting period to another. The revenue of a business determines the net income of business after expenses have subtracted.

5. Expenses: The expenses of a business are usually used in preparing the income sheet and the cash flow statement. Expenses represent the ways a company uses its funds. Among the expenses include direct expenses such as the cost of goods sold and indirect expenses such as rent and taxes.

The owners of a business and managers are the main beneficiaries of financial statements. Although most people think financial statements are prepared for external investors and tax authorities, the truth is that business managers and owners need the statements more. Financial statements are used by managers to plan on the cost of production and reduce expenses. This way, managers are able to reduce operating expenses to increase the net income of a business. The board of managers also use the financial statements to determine the net worth of the business, the debt level, and the assets of the company. From the balance sheet, the managers can determine whether the business is in a position to borrow more to finance its activities.

The accounting office is responsible for preparing financial statements. Within the accounting office, we have accountants and bookkeepers. The work of bookkeepers is mainly recording transactions and preparing auxiliary statements such as the trial balance. The work of accountants is mainly preparing financial statements and interpreting them. However, there are companies that only hire an accountant without bookkeepers. In such a case, the accountant performs the duties of a bookkeeper.

There are 3 main financial statements; the balance sheet, income statement, and cash flow statement.

1. The balance sheet: This is the financial statement that provides a snapshot of a company's net worth at a given point in time. The balance sheet mainly lists the assets, liabilities, and owner's equity. From the balance sheet, you can determine the net worth of the company and the debts of the business.

2. Income statement: The income statement is the other important financial statement. It shows the income and expenses of a company. From the income statement, you can determine various sources of income and expenditure. You can also determine the net profit or net loss of the business.

3. The cash flow statement: Third most important financial statement is the cash flow statement. It shows the sources of money for business and how the money of the business is spent. The cash flow statement is used to determine the liquidity of a company and the possibility of the business to sustain its operations.

All the three financial statements mentioned above are very important to the management. However, if I were to choose one as a business manager, I would go with the income statement. The balance sheet and the cash flow statements are important, but they can't match the value of the income statement. The income statement provides a true picture of the current operations of a business. From the income statement, you can determine where to invest and how to improve the income of the business. You can also find ways of cutting down expenditure to make the business more profitable.

Besides managers and owners of the business, financial statements are also very important to the owners of the business. External investors can use financial statements to determine whether a company is a possible investment partner. For instance, suppliers need to look at the statement of cash flows before they supply goods to a business. If a company has sufficient amounts of money in circulation, investors are confident that it can pay its debts. Investors also have to look at the balance sheet to determine if the company has a future. A company that has a future should have more assets and fewer debts. From the balance sheet, investors can determine the stability of the business financially.

As already mentioned, the work of accounting is done by bookkeepers and accountants. However, the bookkeeper cannot handle the duties of an accountant. One of the important duties of an accountant is to prepare financial statements. The bookkeeper cannot prepare financial statements since bookkeepers are not certified, accountants. However, an accountant can perform all the duties of a bookkeeper, including recording transactions.