At a glance
- Accountants and businesses are navigating a challenging landscape
- During volatility it’s important to revisit the fundamental concepts of accountancy
- Nailing the basics supports transparency and adaptation, and spells success for clients
Small businesses are under pressure, with new research from Virgin StartUp showing that one in two small business owners are concerned their business might not survive the next 12 months. From the late invoice payment epidemic to the cost of living crisis, it’s a difficult time to run a business.
For businesses to run smoothly through these challenging times, they need their back-office and finance function to run without a hitch, and find cost savings wherever possible. We’re going back to basics with this cheat sheet that runs through the key essential accounting concepts, and the value they can deliver to struggling small business clients through mastering them.
Business equity
For businesses to grow, they often need to seek funding externally. Securing funding – whether privately or publicly – changes the structure and means that multiple stakeholders own portions of the business.
Business equity is the total amount of funds shareholders would have if the company paid off all debts and liquidated its assets. In other words, it’s the potential returns for investors. Equity can include outstanding shares, additional paid-in capital, retained earnings, and treasury stock.
Sarah Smith, Digital Services Manager at JS, explains that business equity represents the value of a business, and can be an indicator of a business’s financial health and stability: “Equity includes the business’s accumulated earnings that may be reinvested or distributed to shareholders, whereas a deficit can signal poor financial performance or health.”
Payment terms for invoices
Late payments to businesses is worsening, with a Xero study finding that the cost of late payments rose to an estimated £1.6 billion in 2023, more than double the 2021 estimate. Against this backdrop, businesses that need to maintain their cash flow must set effective invoice payment terms.
“Clear payment terms on invoices help set expectations for timely payments, which in turn reduces the risk of late payments and supports steady cash flow,” says Smith. “Knowing when to expect payment from customers also helps predict future cash flow.”
Ensuring they have the right payment terms can also help businesses forecast revenue for each month, manage their expenses, and determine how much they are able to invest. Shorter payment terms, prompt invoicing, clear wording, and payment reminders can improve the timely payment of invoices.
Accountants should make sure invoicing is clear and concise to help their clients’ customers understand their expectations. Reducing delayed payments can have a huge impact on keeping cash reserves steady.
Sunk costs
The ‘sunk cost fallacy’ is where an unprofitable investment continues to be funded, despite future losses being likely. Sunk costs are, therefore, those expenses that cannot be recovered after being incurred, for example equipment, leases, marketing, and salaries.
One role for accountants is monitoring sunk costs, to help businesses understand their expenditures and avoid the dreaded fallacy. Businesses can fall into the trap of resisting changes such as these, as the success of trying something new is uncertain.
For Smith, accountants can encourage clients to make sure decisions are data-driven to avoid emotional bias, by working together to regularly review investments and set clear goals.
“Sunk costs, often tied to past investments, do not directly generate revenue and must be monitored to avoid ongoing losses,” she says.
“By identifying and managing these costs, businesses can better allocate resources toward profitable ventures.”
Pro-rata salary calculations
As they grow, many businesses find that hiring part-time staff can be the most efficient way to manage. Calculating pro-rata salaries based on hours worked can help businesses manage costs and workload whilst ensuring pay and benefits are proportionate.
“Pro-rata salary calculations are vital for ensuring fair compensation across full-time and part-time roles,” Smith says.
“By prorating salaries, businesses can maintain fair remuneration, supporting staff morale and retention.”
Pro-rata part-time roles offer flexibility for both employers and employees. Businesses can test new roles whilst reducing the cost of pulling in full-time staff, while part-time employees have the freedom to balance work with other commitments.
Cost of capital
Before starting an expansion project, businesses need to assess the cost of capital. This is the minimum return a business needs to pay its investors for providing funding. The cost of capital helps business owners determine the feasibility of a project, and can also show potential returns to attract investors.
“Understanding the cost of capital is crucial for evaluating the feasibility of new investments,” Smith says.
“This metric helps businesses decide whether projected returns will outweigh financing costs, guiding smarter, more profitable investments.”
Cost of capital generally includes both equity and debt. The cost of debt is the interest expenses and tax adjustments, while the cost of equity is based on market rates and risk premiums. Combining these in the weighted average cost of capital (WACC) helps businesses to determine the minimum return required to satisfy investors, and make new investments.
Rapid technological advancements and shifting economic landscapes mean businesses face a future rich with opportunities, but also challenges. Accountants can get caught up in navigating these shifts for their clients, but staying grounded in these core principles of accounting can pave the way for success.
