Small Business Bookkeeping & Accounting

Small Business
Bookkeeping & Accounting

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WHERE'S THE STARTING LINE?

How to begin? Now that you're so fired up by possibilities that we'll have to hold you back, where do you start? In the next section, we will cover:

Financial Statements- Introducing your first business summary.
Cash vs. Accrual Accounting - Understanding the difference.
Chart of Accounts & Definitions - Organizing the categories. Before you begin, you might want to download our sample chart of accounts to use as a study aid.

Financial Statements. To enjoy bookkeeping and accounting, you need to understand why you are doing what you're doing with these numbers, and what knowledge your work will give you. The result you are working toward is good information that which will be available to you from your financial statements. Financial statements come as a pair: a balance sheet and an income statement. These are really two ways of looking at generally the same information.

The income statement (also called profit and loss statement) tells you how much money you've made (or lost!) in a period of time which you can specify. (This month, this quarter, this year).

The balance sheet tells you where your business stands as of the date you specify. How much cash you have, the value of your tools, how much you owe, on a given day. Although there is an early tendency to want to see the income statement and ignore the balance sheet, you need to use both together to see all of the facts. Over time, you might even become a balance sheet fan, as you begin to understand what it's telling you. So don't ignore, your balance sheet.

What makes accounting interesting is the relationship between the numbers on the financial statements, and the things you can learn when you understand them. I can almost promise you that the better you understand what knowledge can be extracted from your financial statements, the better job you will do of keeping your books, which will start you on an upward spiral of great financial record keeping.

Cash vs. Accrual Accounting. You have two choices of accounting method: cash and accrual. The cash method does not account for payments due or bills due - it says, when you write the check, you enter the expense, when you receive money, you enter the sale. The accrual method says that you keep track of what expenses actually apply to the current period...if you receive a $100,000 check for deposit on a house in December, and cut the frame in March, in the cash method you're going to be taxed one year on the money you've taken in, and the next year show a tremendous loss because of your expenses of cutting the frame. The accrual method, on the other hand, lets you put the money in the accounting period where it actually belongs - you pay the expenses the same month as you book the sale, so it all makes sense. All the instructions here are given for the accrual method of accounting.

Chart of Accounts. To develop a set of financial statements, you have to start with an outline of how you will organize the information. This outline is called your chart of accounts, and it is the framework upon which the financial statements are built. In your business, you have expenses that are going directly into your product - labor, materials, freight...then there are the costs that are more supportive (and ongoing) in nature - the utilities and telephone, stationery and the cost of this bookkeeping. An easy way to think about them is that the direct expenses stop when you don't have work - those indirect, or overhead costs don't.

A chart of accounts uses a numbering system to organize the data. All the data on all the reports you print comes out in numerical order. The first digit of each shows what sort of account it is, and the digits which follow put the accounts in order. As your system develops and you want to get more intricate, you can further refine this system - but the basic outline is as follows:

Balance Sheet Accounts:: 1000 Asset Accounts. What you own.; 2000 Liability Accounts. What you owe.

Income Statement Accounts:: 3000 Income Accounts. Sales. Everyone's favorite account.; 4000 Direct Expense Accounts. Expenses that will quit if you're not working.; 5000 Indirect Expense Accounts. Expenses they just keep going, whether you're working or not.

7000 - 8000 Non-Operating Accounts. Numbers whose meanings are pretty obvious (interest income, income tax, etc.), but which are kept at the bottom of the page separate from normal operating expenses or incomes.

Within this outline, you have a variety of subheadings, that further organize your data, as follows:

1000 Asset Accounts, what your own, comes in two forms. Current assets are cash or things you can convert to cash readily, like inventory that could be sold, accounts receivable which you've billed for and should be in the mail, etc. All of that gets an early number and gets put at the top of the page on your balance sheet under Current Assets. You need to make sure that you have enough current assets on hand to cover current bills.

Fixed Assets are the ones that are bolted to the shop or office floor...the big tools, the computers, the vehicles, land, the shop itself, etc. Here is where you put the value of those items, generally expressed as the purchase price. Sorry, you don't get to put in new values as your classic vehicles become more and more valuable, or your land doubles in assessed value, or your tools take on the value of antiquity. No choices here; it's in the book. But then again, give yourself a break and put in the entire purchase price, not just what you've paid to date. You'll have a chance later on to admit how much you still owe on all those great tools.

2000...Liability Accounts. These, like assets, come in two types - current and long term. There's a pretty easy definition of which goes where - if it's due within the year, put it in the current category. If you have a loan you get to pay out over time, you can put it under long term, with the one small caveat that you have to take one year's worth of principal on each loan and put that part up under current liabilities- because you do, in fact, owe that within a year.

One thing you're going to find under liabilities, and under current liabilities no less, is customer deposits. I can hear my phone ringing already. OK,you say, that's really cash in hand, a serious asset, jobs sold, lucrative profits, trips to the Caribbean...sure! I'm in, and I'll go along with that thought...after you earn it. Until that product is made or service rendered, you are holding money that belongs to someone else, and even if you have spent money on contracts which claim it's non refundable, it still isn't earned. This is really protection for you - you have a long list of expenses to work your way through before you make that trip to the Caribbean. List this as a liability, and earn it. You will have a chance to earn it a bit at a time, reducing the liability as you go - but that's for a later chapter.

These numbers up until now are all what you call balance sheet accounts. The information here will show up only on your balance sheet. They all have a serious and intimate relationship with the numbers on your income statement, but the next discussion topics will actually make your income statement.

The 3000 series...Sales. This is where you enter the value of any sales you make.

4000 - Direct Expenses. Here is where you enter the expenses that will stop when you are not working. The costs that go directly into the product you are making...labor, materials, etc.

5000 - Indirect Expenses. This is the area of overhead. Those expenses which never go away.

Keeping the Direct Expenses separate from Indirect Expenses is very important. You'll need to know what your overhead (indirect expense) is when you price your work. You'll want to know what your gross profit is when you start analyzing your numbers (more later). Those sorts of things you will only know if, as you go along, you make a concerted effort to separate your direct from your indirect expenses. On the other hand, don't get too nit-picky about it. Just follow the simple rule -- costs that go into making your product or expenses related to your services are considered "direct".

As far as the people in your organization go: overhead is the support staff - office and sales, primarily. Shop and design is direct, the staff with billable time. Unless you're in retail sales, then the wage for your salesperson is a direct expense.

One last note - forget the word miscellaneous was ever invented. Do not allow it into your system. Everything is something, and if it doesn't rate a name on the page somewhere, what are you doing spending money on it? Not allowed. Go to the back of the class.

Equity There are some crazy sounding numbers at the bottom of the liabilities section, that have to do with equity in the company. You should talk about these with your accountant and get her help in setting them up. They'll be different depending on what sort of outfit you are - sole proprietorship, partnership, limited liability company or corporation. Equity accounts have different ways of relating to one another, and different ways of being treated at the end of the year. Generally, you won't be adjusting the Equity Accounts anyway -- leave them to your accountant. In the accompanying chart of accounts, the example I give for these equity accounts is for a partnership.

And of course no accounting lesson is complete without a word about taxes... There are tax rules to pay attention to in setting up your system - for example, where you might be tempted to lump all your travel expenses in one category, that would be a mistake because you can only deduct 50% of the meals...so do this: make up a chart of accounts that you feel contains everything you need, then choose a tax accountant and have that person add what (s)he needs, or make corrections. You'll save yourself money setting up as much as you are comfortable with in advance.

You need a chart of accounts whether you are doing bookkeeping by hand or using a computer - this system predates computers. But if you're not using a computer, give yourself a break and work with someone who is. Simple accounting packages are pretty cheap, and are worth their weight in time spent and frustration. But, don't wait to start your bookkeeping system while waiting on a computer system - get started with pencil and columnar pad as soon as you start your business.