Guide to Bookkeeping and Accounting

While bookkeeping and accounting will probably not be the most interesting elements of being in business for yourself, they are a necessary part of running a business. By having accurate and current financial information available, you can make important decisions concerning the business, monitor your ongoing financial status, and make sure you comply with legal and government requirements.

It is typically to your advantage to have a professional accountant and/or bookkeeper maintaining your finances and keeping you abreast of your financial situation. But it is also important that you have a working knowledge of the bookkeeping and accounting process that is vital to nearly all businesses. This will allow you to always keep a watchful eye on your financial situation and make sound business decisions.

Income statements

One of the most common and important documents will be your income statement. Also called a profit-and-loss statement, this document provides you with a periodic summation of the profits and losses of the business during a specific time period, which may be one month, three months, six months, or a year. The income statement provides you with an overall statement of your net income during the selected time period. It will prove advantageous for:

Paying taxes
Evaluating your current financial position
Making financial projections
Attracting potential investors

The manner in which an income statement works is relatively simple. By listing both revenues and expenses, you can determine how much money you have earned. It is a simple formula in which you add up your revenues, add up your expenses, and subtract the expenses from the revenues (revenues – expenses = net income).

The income statement answers the question “How is the business doing?” during a given time period. It allows you to see if you are spending too much money and, if so, in which areas you could cut back. It also allows you to compare time frames such as the first quarter of this year versus the first quarter of last year. This way, you can compare your profits or losses and determine where you need to make adjustments. Your income statement should also help you determine your tax liability.

Typically, an income statement lists all revenue and expenses. The degree to which you break down each expense category will depend on the size and nature of the business, along with the types of categories with which your business is most closely involved. For example, one business may have a general category for computer costs but a company in the technology industry, which relies heavily on the purchasing and maintenance of their computer system, might list specific items including hardware costs, software costs, maintenance and repairs, and so on.

The income statement will typically include:

Total or gross sales. This sales figure shows the amount of revenue generated by the business from sales.
Net sales. This is the total sales, less returns or refunds.
Cost of goods sold. This includes all costs associated with manufacturing or acquiring the products you sell. In the service industry it is the cost of performing a specific service.
Gross profit. This is the net sales, less the cost of goods sold.
Operating expenses. This includes individual categories for employee salaries, payroll taxes, advertising, rent, office supplies, utilities, depreciation, and all else necessary to operate the business.
Operating profit. This shows you the difference between your gross profit and your operating expenses.
Net income (before taxes).
Income taxes. Here you list the amount owed to the federal government. If you pay state or city taxes, include them here as well.
Net income (after taxes).

The net income after taxes is your profit (or loss). By looking at your net income on periodic income statements, you can determine how the business is doing. If you are seeing steady losses, you will need to make changes in operations or cut the costs of goods or services sold.

The balance sheet

Along with the income statement, the balance sheet will provide you with the data necessary to make sound financial decisions. The balance sheet lists the assets and the liabilities of the company. The difference between your assets and liabilities will be the net worth of the business at the end of a specific period (assets – liabilities = net worth). The net worth of your business at a given time is of particular interest to prospective investors and lenders.

The assets of the business are that which have a cash value, including:

Investments held by the company
Equipment
Machinery
Display cases
Inventory
Cash and cash equivalents
Accounts Receivable

Capital assets, or fixed assets, are the company's long-term assets, such as any building the company owns or the machinery used to produce goods. These are assets that are expected to be around for several years. They are also assets that can depreciate over the years, such as the new computer you purchased last year. Accumulated depreciations are deducted from your list of fixed assets. On the other hand, a building that you own might appreciate in value. This, however, is not reflected on the balance sheet until the building is actually sold.

The liabilities are all of the debts that the business owes. This may include:

Money owed on equipment
The mortgage on your building
Accounts payable
Accrued wages (which are wages owed to employees)
Insurance and health benefit payments

Once you get a total of your liabilities, you will add the owner’s equity in the business, which consists of how much he or she has invested into the business and how much of the profits are still in the business. This is essentially the net worth of the business. Therefore, you would list on the balance sheet:

Invested Capital
Retained Earnings

Added together, you will get the owner’s equity. This total, together with the total liabilities, should balance with your total assets. Hence the name “balance” sheet.

Statement of cash flows

In addition to a balance sheet and income statement, you will want to keep a statement of cash flows, which allows you to track the cash in and out of your company throughout the year. All manners in which the company uses cash can be recorded, including operating, financing, and investing activities. By listing both the previous and current cash amount on the statement of cash flows, you will be able to determine the increase or decrease in each activity for a specified time period.

Good record keeping can indicate on paper how your business is doing and whether or not you are making a profit. You can get a good idea of which items are selling, which services are being used, or both. Typically, business owners look at their records to analyze the current situation and determine what changes or improvements can be made. Essentially, good record keeping can be the difference between business success and failure.

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In addition to monitoring the progress of your business, good records will help you when preparing financial statements and .

Inventory, expense tracking, payroll and salary records, employee information, client information, receipts, bank statements, accounts receivable, billing and accounts payable are among the many records you will typically need to maintain while in business. Record keeping should be done in a diligent, consistent, and timely manner, regardless of the type of system you choose to use.

As you operate your business, one important aspect of bookkeeping and accounting is to create an ongoing “paper trail,” which will provide the source of all business transactions through purchase orders, receipts, deposit slips, and so on. Gross receipts will help you indicate how much income your business is generating. Likewise, keeping records of all purchases will tell you how much you are spending on materials used for the business or items for resale. You need to maintain records of all of your income sources and expenses. Also, employee-related records, including all employment taxes, need to be maintained.

While many small businesses using software to handle their bookkeeping and accounting, it is not imperative. Maintaining ledgers and using proper forms, available in most business stationery stores, can serve your purposes as well. For those business owners looking to set up their record keeping procedures on a computer, you’ll need to keep some things in mind:

You want to purchase the bookkeeping and accounting software solution that fits your specific needs and not be lured by one that simply has the most features.
The goal is to save time by using a software program. If it takes you too much time to use the digital record-keeping system, you might be better off just using ledgers and paper.
If bookkeeping and accounting tasks—whether managed digitally or on paper—are cutting into time better spent in other areas of the business, then you should consider hiring someone with bookkeeping skills for a few hours a week to handle the task and free up your time.

Some of the more popular accounting software solutions include:

To track money coming and going, most small businesses typically use a revenue and expense journal. This is a single-entry method of accounting in which receipts and expenditures are recorded. The other method used, a double-entry system, is more time consuming, but records both a debit and a credit for each entry, marking the item sold as a credit and the money taken in as a debit.

Inventory records

Another set of records you may need to maintain (depending on the type of business) are inventory records. Keeping good inventory records will allow you to better manage your inventory holdings. Such record keeping will also help you keep track of buying trends, seasonal activity, and pilferage. You’ll want to know how much stock is on hand versus the amount that you purchased, and you can do so by keeping records of the purchase date of the items in stock, purchase price, sale price, and dates of items sold. You can use inventory software packages or a ledger or notebook.

Break-even analysis

It helps any business, particularly a startup, to determine at what point you will break even. By projecting how much revenue in sales you will need to take in versus your ongoing expenses, you will be able to determine approximately when you should break even and subsequently show a profit. Such a break-even analysis can help you monitor your progress so you can see if your projections are on track. If not, you can make adjustments. Many established companies also look closely at the break-even analysis to determine where to make cuts.

Budgets and projections

Your budget will assist you when tracking the flow and progress of your business by providing you with a picture of how much you are spending, and in which areas you are exceeding your projected spending limits. A budget can be prepared for a specific area, such as promotion and marketing, a special project, or as an overall guideline for your small business.

To formulate your budget, you will need to come up with a reasonable projection of your sales. The budget will set forth the cash available to the business. For a new business you will include the funding you have obtained through personal financing, loans, investments, selling shares of stock, and other sources. Once you have a realistic forecast of the money you anticipate having available, you can look at the potential categories of expenses and determine a realistic amount to spend in each category. Most budgets are works in progress with several revisions.

You need to establish several numbers, including the total you anticipate spending in each category and a finite ceiling (the maximum on spending that you do not plan to exceed). Create your numbers based on specific research. For example, you should have a good idea of the types of advertising that will best benefit your business and get realistic costs for such advertising options. Then determine an amount that will benefit you in the advertising category. Can you, for example, reach your target market for $10,000 per month? If you are budgeting for this category in a major market, the answer is probably no. In a small market, however, this might serve as a workable number. For a small, locally based business, you might start with a much smaller amount.

You will also need to evaluate exactly how many employees you need to operate your business. Therefore, you should research the going rate of pay for such services and look into the cost of benefits packages. Study the workforce statistics in your area or region and see if you can offer a comparable package to attract quality employees. Then budget the proper amount for salaries.

Remember to include rent, taxes, insurance, and all other necessary expenses. You will then have to prioritize and make adjustments as you go. Obviously, you won’t be able to change the amount you pay in rent, but you can change the amount you put toward marketing if there is not a sufficient amount left in your budget. It’s always better to be conservative than to make unrealistic assumptions and base your numbers on pie-in-the sky hopeful thinking. It’s also advantageous to give yourself some room when budgeting for purchases.

Using a previous budget as a guideline is always advisable. From year to year, a business will typically need to make various adjustments, but the basic categories of expenses typically remain the same. If you are starting a new business, look for similar business models to your company. Keep in mind that such a similar business should be serving a similar market.

Timing also needs to be factored into your budget. Many businesses have peak seasons when revenue is higher, and times of the year when they have additional expenses. For example, a seasonal business might not budget for advertising costs in its quiet time of year but budget more money toward advertising just prior to its busy season.

Tips on developing a budget:

Set maximum spending limits that you won’t exceed and monitor your budget closely so you’ll know when your spending is approaching such category limits.
Don’t juggle unless you absolutely have to. Try not to take from one pocket and move to another too often. It becomes increasingly harder to balance the budget if you keep moving money around.
Be realistic with your projections.
Make sure everything is clearly explained. While different businesses may categorize items in their own various ways, what matters for your business is that you can look at the budget and understand which items fall under which categories. Note: Go over each category carefully with your accountant, bookkeeper, or anyone else who is working on your financial statements.
Over-budget for areas in which you are more likely to have unexpected expenditures.

How to find and work with accountants and bookkeepers

Accountants

When looking for an accountant for your business, the emphasis should be on finding someone who will not only help you file tax returns, but can also provide ongoing financial advice and guidance. Typically, to find an accountant in whom you can place your trust, it’s advisable to ask other business owners for recommendations. When speaking with candidates, discuss the type of business that you are starting and see if they have experience working with that type of business. Some accountants specialize in working with specific types of businesses, and some are familiar with the needs of small businesses in particular.

Use a similar hiring process as you would when . Set up interviews and get to know the strengths of each individual. It’s also important that you have a good rapport and a strong sense of trust in this person, who may hold your financial future in his or her hands. Remember that you should be working with an accountant, and not relying on them to make key financial decisions for you. Therefore, keeping up on the activities of your accountant, or anyone working with your finances, is a must.

A good accountant is someone you can:

Trust implicitly
Expect to be up on the latest changes in tax laws and guidelines
Rely on for specific advice as it pertains to your business
Expect to maintain the confidentiality of your financial information

Bookkeepers

Most people who start out in business are fairly convinced that they will be able to keep their own books. With the proliferation of software solutions on the market it would seem that the process should be fairly simple. The belief is that you will:

Save money by not hiring a bookkeeper
Keep a closer eye on the financial aspect of the business
Maintain privacy

While a small startup business may allow for such self-management, as a business grows it is typically in the best interest of the business owner to hire bookkeeping help. Someone who specializes in the field can, in the long run, save you time and money. The details involved in maintaining accurate books can be lost when combined with the many other tasks and responsibilities of running a business. A business owner’s time is too valuable to spend on journal entries. For this reason, there are individuals who specialize in the field.

Prior to hiring a bookkeeper, estimate the amount of hours this person will need to prepare your books on a monthly basis. Small startup companies generally do not need a full-time bookkeeper. Use word of mouth and ask another business owner who handles their books, and whether or not they would recommend their bookkeeper. The local Chamber of Commerce, industry associations, job websites, or even your accountant can also prove to be worthwhile sources for finding a qualified bookkeeper.

Bookkeeping and accounting do's and don'ts

While the vast majority of employees are trustworthy, you can inadvertently hire someone who will steal from you in some manner, whether they are padding the payroll, making deposits into a personal account, or flat out embezzling funds. Employee theft has been steadily on the rise in recent years. It is therefore worthwhile to be cautious and follow some basic do’s and don’ts when it comes to putting your financials in the hands of others.

Establish clear and specific guidelines from the start
Review the books periodically, but not at any “regularly scheduled” time
Review all financial statements
Read your own mail

Don’t

Put too much financial responsibility in any one person’s hands
Let your accountant/bookkeeper use software that you are not familiar with
Give check-signing authority to anyone until they are proven to be reliable and trustworthy
Hire someone who is unfamiliar with your type of business