Accounting for beginners
So, this new and very exciting business opportunity has begun. How is it tracked on paper? Like it or not, every April 15, we are held accountable for our actions the year before to our friends (or enemies, depending on your mind) at the Internal Revenue Service or the IRS. Even if you have already started your business, I will write this as if it were the first day for you. For the purposes of this article, I also assume that you are starting a simple sole proprietorship business. In order for the IRS to consider your business legitimate, it must treat it as a business and not as a hobby. The first thing to do is open a separate checking account just for your business and keep all business finances separate from your personal finances. This is cardinal rule # 1 that I follow religiously in all my businesses. I NEVER take money out of the register to buy a soda. And if I use personal finances for business purchases, I keep the receipts and record them in my business books as an increase to my owner’s investment account.
Most of you are probably not accountants, and the word “accounting” sends you screaming into the streets. The word “taxes” also makes many of you cringe. But really, they shouldn’t, they’re just words, and both accounting and taxes can be very simple. As your business grows and diversifies, it may need to get a little more complex, but for now, you can keep your workbooks in a simple Excel spreadsheet or in one of the many accounting software packages out there. I personally like QuickBooks Pro because it is so easy to use and very forgiving when you make mistakes. For a beginner, it works fine. Accounting is really simple – there are three basic financial statements that you need to understand in order to run your business. Once you get it, filing a Schedule C for your taxes is easy.
The first of these forms is the Balance Sheet. It’s a comparison of your assets (things that make you money) on the left, and liabilities (things you owe) and equity (the net worth of your business). Assets include current assets such as: cash in the bank, savings, inventory, prepaid expenses (such as insurance), accounts receivable (money owed to you), and fixed assets. Fixed assets are the most expensive and usually tangible items that you buy for your business (such as computers, desks, equipment, etc.). As a general rule of thumb, anything that costs you more than $ 1,000 should be compounded and depreciated over time. (I’ll cover it in another article). The liabilities are: the bills you owe, the loans and the credit cards for your business. Equity is the money that you have personally invested in your business and the retained earnings from your business. When you add up your assets, the total should equal the total liabilities + equity.
The second and probably the most important financial statement is the income statement. It is a snapshot of your current business activity. I encourage you to prepare one at least once a month to keep up when it comes to earnings. The following is a simple income statement:
Dirty
Cost of goods sold (what it costs you to buy or make the supplies or products you sold)
Direct selling expenses (related only to the sale of your product or service)
Gross Profit (Sales – Cost of Goods Sold – Direct Selling Expenses = Gross Profit)
Expenses:
Office supplies
telephone
Utilities
Rent
Repairs and maintenance
Travel (separate travel meals from all other travel expenses)
Anything else you need for your business
Total expenses:
Net profit (Gross profit – Total expenses = Net profit)
The third financial form that you should prepare on a regular basis, at least weekly, is a cash flow statement. I’ve seen many forms of these over the years and they can be very complicated, but simply put, you want to see where your cash position is. It’s like balancing your checkbook. Initial cash + Sources of funds (such as sales and collection of accounts receivable) – Uses of funds (expenses paid, assets purchased and payment of accounts payable) = Final cash. It is not difficult, but it is very important.
Many startups fail simply because they do not keep track of their business activity on paper. Putting money in your pocket that is later used to pay for pizza and beer is not the way to go. Every action you take creates an action in your books. Keep a record of them. Organize. By keeping these three financial statements up to date for your business, not only will you have everything at your fingertips at tax time, but you will also have a monitor of how you are doing. While it is normal to lose money for a time when you start a new business, it is not normal to lose money continuously. The idea of having your own business is to MAKE money and gain wealth and financial freedom. With simple financial statements, you can monitor your business and make corrections when things go wrong. You can also see when you are making money and know what capital is available to grow your business or invest elsewhere.
I hope my simple explanation has been useful to you. Best wishes for your continued success!