We all get stars in our eyes when we think about the core services of our business. As a designer, you want to help your clients create unique, beautiful, individual spaces that provide inspiration and solace. That’s what you love to do!
But outside of your core design services, one of the biggest areas that needs to be organized and efficient is your accounting. Accounting is the backbone of the financial side of your business, and a solid accounting process can make sure you’re making decisions based on complete and accurate records. If you’re missing accounting information, you may make decisions that don’t contribute to the maintenance and growth of your business.
Below, we’ll discuss 5 ways a solid accounting system can help you understand and learn from the financial side of your business.
5 Important Financial Areas Solid Accounting Will Help You Understand
1. How Much You’re Making
This is understandably the BIG ONE for most business owners. Our designers want to know they’re running in the black for the entire year. Interior design in particular is a unique industry because revenues don’t necessarily match expenses for any given month. For example, if you have a project where you collect on a furniture invoice in January, but you don’t spend money on the actual product until February, you may have a profit in January, but a loss in February. This leads to fluctuations over time; having a solid accounting foundation can help you keep track of these differences and analyze your overall profit for a given time period, whether that’s one month, a quarter, or the entire year.
2. How Much Cash You Actually Have Available to Take Out of the Business
Looking at your bank account may seem like the best way to see how much cash you have available, but the calculation is actually much more complicated. For example, if you have $10,000 in cash but $8,000 in credit card debt, you don’t want to take $5,000 out of your business since this won’t leave you with enough cash to cover your credit card. Similarly, if you have a loan obligation, collect refundable deposits from clients, or pay sales tax on your products, you want to make sure you have enough cash available to cover these future obligations.
If you take more money out of your business than is actually available to you, you may not be able to pay the necessary obligations when they become due. So how can solid accounting help you determine how much cash you actually have?
Your balance sheet can tell you a lot about what you own and what you owe. If you’re recording your bank transactions and reconciling your accounts at the end of every month, you can see how much cash is in your bank under the Current Assets section, and you can see all of your current obligations in the Current Liabilities section. Then, it’s just a matter of subtracting your current liabilities from the amount of cash you have, similar to below:
$20,000 Cash - [$2,000 Accounts Payable + $4,000 Credit Card + $600 Sales Tax Liability + $1,000 Refundable Deposit + $5,000 Loan] = $7,400 Cash Available to Take Out of Business
As you can see, having solid accounting can really help you understand if your business is financially viable at any given time, and help you determine what you need to do in order to pay yourself and keep your cash flow positive.
3. Which Clients Owe You, And How Much
If you want to maintain or grow your business, it’s important to know if you’re being paid for your work. It seems obvious, but if you aren’t staying on top of your accounting, small amounts (and sometimes large amounts) can slip through the cracks. Alternatively, if payments aren’t being properly recorded, it may seem like a client owes you for an invoice when, in fact, they’ve already paid. This can cause friction between you and your clients and may lead to fewer repeat clients and referrals.
Keeping track of your Accounts Receivable with a good accounting system will help to avoid these types of mistakes and keep you organized when it comes to what your clients owe you. Your Accounts Receivable (AR) is an account that keeps track of what you’ve billed to the client and what the client has paid.
If your accounting system is solid and functional, every time you send an invoice to a client, the invoice amount will get placed in the Accounts Receivable account under the client’s name. This indicates to you that this client has been billed, but hasn’t paid for the invoice. Once you receive the payment for the invoice, the Accounts Receivable amount for your client will decrease by the amount they pay:
AR = what client owes - what client has paid
At any given time, you can run an Accounts Receivable aging summary, which breaks down how much each client owes on individual invoices. Within this report, you can see invoices increasing the AR and payments decreasing the AR. It’s very important to record exact payments in your accounting system so you capture exactly what the client has paid and what they owe. For example, if a client sends in a check for $10,000 for two separate invoices, one for $5,000 and one for $6,000, you’ll know they owe you $1,000 for the second invoice. While this example seems simple, we’ve seen clients of our designers send in incorrect payment amounts numerous times for more complicated invoices (often furniture invoices). By having a solid accounting system, we’ve helped our designers ensure they collect every penny they are owed on invoices.
4. The Profitability of Projects
While it’s great to know how much you’re making overall, it’s also a good idea to keep track of what you’re making on each individual project. This can help you make better decisions going forward with current and new clients. If you find you’re losing money on a particular project, it’s a good idea to consider why that may be happening, and put processes in place to ensure it doesn’t happen on any future projects.
Reports can be set up in a solid accounting system to show you how much you’re making on any given project. There are even ways to tag certain overhead expenses to specific clients. If you Uber to a project, spend money on meals on site, or have credit card processing fees associated with a particular project, good accounting can allocate those costs to show what you’re really making on a project. Instead of just looking at what you sold and what you purchased, you can break down every individual cost for a project and make sure each project is running a profit.
5. The Efficiency of Your Back-End Processes
Solid accounting obviously provides quantitative answers to your questions, but it can also help you peek into the processes of your business. As you review your accounting, you should continually be asking yourself these process related questions:
Is Your Collections Process Efficient? Look at your Accounts Receivable from month to month. If it is a low number that stays relatively constant, your collections process is working efficiently. If it’s a large number that continues to increase or has big fluctuations, you’re not collecting the money you’re owed as efficiently as you should. You can take this information and use it to research and implement a more efficient collections process.
Does Your Purchasing Line Up With Your Invoicing? If you have huge positive or negative differences in your product gross margin (product sales minus product costs) from month to month, you may consider a process where purchasing lines up more with invoicing. While monthly fluctuations are common in the interior design business, you can use monthly reports to analyze your entire year and see if you have any large fluctuations or consistent fluctuations. This is a sign that something on the back end may need to change to create a more consistent product gross margin.
Is Your Overall Product Markup What You Expected? Pricing can sometimes change between the time you markup products on an invoice and the time you actually purchase them. If you’re consistently marking up products 20%, you should be able to see a bigger picture 20% markup over time. You can do this with the following equation:
[Product Sales - Product Costs] / Product Sales
If your overall markup isn’t what you expected (whether higher or lower) consider why that is and see if you can put more consistent processes in place to ensure the correct markup on your product.
Is Your Pricing Model for Design Fees Working? Some designers work at an hourly rate while others work on retainer or a flat fee. By analyzing your accounting statements, you can see if your pricing model needs to be adjusted. There may come a time when your hourly rate needs to increase or your flat fee needs to be adjusted. There may also come a time when you’ll need to consider pricing increases in order to stay viable in the future. Without a solid accounting foundation, you won’t have the available data to analyze and adjust your pricing model in order to stay profitable.
While accounting isn’t the most glamorous part of your design business, it can speak volumes in terms of your financial health. Having solid processes in place from the beginning can help you understand the financial side of your design business, and help you create the lifestyle you love as you continue to maintain your business and grow.