This is a good question, especially if you prefer to play golf than maintain a set of accounts.
Good accounting records are necessary for the following reasons:
- The law requires it.
- If you do business in your own name, failure to keep proper records is an offence against various tax legislation. You may be able to get by without keeping records of transactions. But this will end the minute an inspector from a tax office walks in the door. If you do business through a company, you have to comply with the requirements of tax legislation (see above) and the requirements of Corporations Law. To meet this requirement a set of accounts must:
- be capable of being readily audited
- enable the profit or loss to be disclosed
- enable the state of the company’s affairs to be ascertained
So you can see that there are laws which demand that proper records of business transactions be kept if you are operating a business. Penalties for not keeping records range from fines to imprisonment or both.
- To inform you of the profit or loss you are making.
- You might say, “I can tell how much profit I am making by my bank account!” Don’t be fooled. You can accumulate a large sum of money in your bank account from your business and still make a loss! Conversely, money in your bank account might decrease and you are making a profit. These paradoxes can arise in several ways, for example:
- The bank account may be distorted by changes in debtors or creditors or both.
- Drawings or capital injections may distort the real picture.
- Accumulated tax receipts (i.e. Goods and Services Tax) are not profit! If you make a mistake on this point, it will eventually catch up with you.
- Capital expenditure or receipts.
- To inform you regarding the condition of your business.
- This may appear almost the same as the previous point above, but it isn’t. This refers to the financial condition of your business. However, the previous point made above is part of the financial condition but not the whole of it. Other factors in the financial condition include:
- How much is owed to you and by whom. This should enable you to assess the degree of risk in each debtor and the debtors as a whole. It is no use fooling yourself that your debtors owe you $100,000 when you are likely to get only $50,000.
- How much you owe to your creditors and when payable. I have known business people ignore the tax instalment deductions from employees’ wages and then claim that they have made a “profit”.(Ostriches are reputed to be good at this). In fact anyone can make a “profit” by refusing to acknowledge selected liabilities. Another type of liability which is easy to gloss over is sometimes called an “off Balance Sheet” liability such as a lease. Modern accounting standards require these to be disclosed.
- The level and condition of trading stock. This can be a real trap for the inattentive business manager. Obsolete, useless or damaged stock can get merged in the total value of trading stock. Unless an audit is done on the stock, these unsalable stock items can remain in obscurity until it is too late to do anything about it.
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