Chapter 1

So You Want to Do the Books

In This Chapter

Introducing bookkeeping and its basic purpose

Maintaining a paper trail

Managing daily business finances

Making sure everything’s accurate

Putting on a financial show

Few small business owners actually hire accountants to work full time. For a small business, that expense is probably too great, so the owner instead hires a bookkeeper who serves as the company accountant’s eyes and ears. In return, the accountant helps the bookkeeper develop good bookkeeping practices and reviews his or her work periodically (usually monthly).

In this chapter, I provide an overview of a bookkeeper’s work. If you’re just starting a business, you may be your own bookkeeper for a while until you can afford to hire one, so think of this chapter as your to-do list.

Delving Into Bookkeeping Basics

Like most businesspeople, you probably have great ideas for running your own business and just want to get started. You don’t want to sweat the small stuff, such as keeping detailed records of every penny spent; you just want to quickly build a business in which you can make lots of money.

Well, slow down there — this isn’t a race! If you don’t carefully plan your bookkeeping operation and figure out exactly how and what financial detail you want to track, you’ll have absolutely no way to measure the success (or failure, unfortunately) of your business efforts.

Bookkeeping, when done properly, gives you an excellent gauge of how well you’re doing. It also provides you with lots of information throughout the year so you can test the financial success of your business strategies and make course corrections early in the year if necessary to ensure that you reach your year-end profit goals.

Bookkeeping can become your best friend for managing your financial assets and testing your business strategies, so don’t shortchange it. Take the time to develop your bookkeeping system with your accountant before you even open your business’s doors and make your first sale.

Picking your accounting method

You can’t keep books unless you know how you want to go about doing so. The two basic accounting methods you have to choose from are cash-basis accounting and accrual accounting. The key difference between these two accounting methods is the point at which you record sales and purchases in your books. If you choose cash-basis accounting, you record transactions when cash changes hands only. If you use accrual accounting, you record a transaction when it’s completed, even if cash doesn’t change hands. I talk about the pros and cons of each type of accounting method in Chapter 2.

Understanding assets, liabilities, and equity

Every business has three key financial parts it must keep in balance: assets, liabilities, and equity. Assets include everything the company owns, such as cash, inventory, buildings, equipment, and vehicles. Liabilities include everything the company owes to others, such as vendor bills, credit card balances, and bank loans. Equity includes the claims owners have on the assets based on their portion of ownership in the company.

The formula for keeping your books in balance involves these three elements:

Assets = Liabilities + Equity

Because it’s so important, I talk a lot about how to keep your books in balance throughout this book. You can find an initial introduction to this concept in Chapter 2.

Introducing debits and credits

To keep the books, you need to revise your thinking about two common financial terms: debits and credits. Most nonbookkeepers and nonaccountants think of debits as subtractions from their bank accounts. The opposite is true with credits — people usually see these as additions to their accounts, in most cases in the form of refunds or corrections in favor of the account holders.

Well, forget all you thought you knew about debits and credits. Debits and credits are totally different animals in the world of bookkeeping. Because keeping the books involves a method called double-entry bookkeeping, you have to make a least two entries — a debit and a credit — into your bookkeeping system for every transaction. Whether that debit or credit adds or subtracts from an account depends solely upon the type of account.

I know all this debit, credit, and double-entry stuff sounds confusing, but I promise it becomes much clearer as you work through this book. I start explaining this critical yet somewhat confusing concept in Chapter 2. I also give you a chance to practice getting the numbers in the correct columns with practice exercises and answers in many chapters.

Charting your bookkeeping course

You can’t just enter transactions in the books willy-nilly. You need to know where exactly those transactions fit into the larger bookkeeping system. That’s where your Chart of Accounts comes in; it’s essentially a list of all the accounts your business has and what types of transactions go into each one. I talk more about the Chart of Accounts in Chapter 3.

Recognizing the Importance of an Accurate Paper Trail

Keeping the books is all about creating an accurate paper trail. You want to track all your company’s financial transactions so that if a question comes up at a later date, you can turn to the books to figure out what went wrong.

An accurate paper trail is the only way to track your financial successes and review your financial failures, tasks that are vitally important in order to grow your business. You need to know what works successfully so you can repeat it in the future and build on your success. On the other hand, you need to know what failed so you can correct it and avoid making the same mistake again.

All your business’s financial transactions are summarized in the General Ledger, and journals keep track of the tiniest details of each transaction. You can make your information gathering more effective by using a computerized accounting system, which gives you access to your financial information in many different formats. Controlling who enters this financial information into your books and who can access it afterward is smart business and involves critical planning on your part. I address all these concepts in the following sections.

Maintaining a ledger

The granddaddy of your bookkeeping system is the General Ledger. In this ledger, you keep a summary of all your accounts and the financial activities that took place involving those accounts throughout the year.

You draw upon the General Ledger’s account summaries to develop your financial reports on a monthly, quarterly, or annual basis. You can also use these account summaries to develop internal reports that help you make key business decisions. I talk more about developing and maintaining the General Ledger in Chapter 4. You get a chance to practice ledger entries, too.

Keeping journals

Small companies conduct hundreds, if not thousands, of transactions each year. If every transaction were kept in the General Ledger, that record would become unwieldy and difficult to use. Instead, most companies keep a series of journals that detail activity in their most active accounts.

For example, almost every company has a Cash Receipts journal in which to keep the detail for all incoming cash and a Cash Disbursements journal in which to keep the detail for all outgoing cash. Other journals can detail sales, purchases, customer accounts, vendor accounts, and any other key accounts that see significant activity.

You decide which accounts you want to create journals for based on your business operation and your need for information about key financial transactions. I talk more about the importance of journals, the accounts commonly journalized, and the process of maintaining journals in Chapter 5. Getting used to journal entries can be a challenge, so I give you a chance to practice them as well.

Consider computerizing

Many companies today use computerized accounting systems to keep their books. You should consider using one of these systems rather than trying to keep your books on paper. You’ll find your bookkeeping takes less time and is probably more accurate with a computerized system.

In addition to increasing accuracy and cutting the time you take to do your bookkeeping, computerized accounting also makes designing reports easier. You can then use these reports to help make business decisions. Your computerized accounting system stores detailed information about every transaction, so you can group that detail in any way that may assist your decision making. I talk more about computerized accounting systems in Chapter 6.

Instituting internal controls

Every business owner needs to be concerned with keeping tight controls on company cash and how it’s used. One way to institute this control is by placing internal restrictions on who has access to enter information into your books and who has access to use that information.

You also need to carefully control who has the ability to accept cash receipts and who has the ability to disburse your business’s cash. Separating duties appropriately helps you protect your business’s assets from error, theft, and fraud. I talk more about controlling your cash and protecting your financial records in Chapter 7.

Using Bookkeeping’s Tools to Manage Daily Finances

After you set up your business’s books and put your internal controls in place, you’re ready to use the systems you established to manage the day-to-day operations of your business. You’ll quickly see how a well-designed bookkeeping system can make your job of managing your business’s finances much easier.

Maintaining inventory

If your company keeps inventory on hand or in warehouses, tracking the costs of the products you plan to sell is critical for managing your profit potential. If you see inventory costs trending upward, you may need to adjust your own prices in order to maintain your profit margin. You certainly don’t want to wait until the end of the year to find out how much your inventory cost you. I talk more about how to use your bookkeeping system to manage inventory in Chapter 8.

Tracking sales

Everyone wants to know how well their sales are doing. If you keep your books up-to-date and accurate, you can get those numbers very easily on a daily basis. You can also watch sales trends as often as you think necessary, whether that’s daily, weekly, or monthly.

Use the information collected by your bookkeeping system to monitor sales, review discounts offered to customers, and track the return of products. All three elements are critical to gauging the success of the sales of your products.

I talk more about how to use the bookkeeping system for tracking sales, discounts, and returns in Chapter 9, where you can also find exercises to practice using your bookkeeping system.

Handling payroll

Payroll can be a huge nightmare for many companies. Payroll requires you to comply with a lot of government regulation and fill out a lot of government paperwork. You also have to worry about collecting payroll taxes and paying employer taxes. And if you pay employee benefits, you have yet another layer of record keeping to deal with.

I talk more about managing payroll and government requirements in Chapters 10 and 11. I also talk about year-end payroll obligations in Chapter 20. Bonus: The CD accompanying this book has samples of the forms you need to file with the government. If you are reading this text in an electronic format, please go to the table of contents for access to the additional content.

Running Tests for Accuracy

All the time it takes to track your transactions isn’t worth it if you don’t periodically test to be sure you’ve entered those transactions accurately. The old adage “Garbage in, garbage out” holds very true for bookkeeping: If the numbers you put into your bookkeeping system are garbage, the reports you develop from those numbers will be garbage as well.

Proving out your cash

The first step in testing out your books includes proving that your cash transactions are accurately recorded. This process involves checking a number of difference transactions and elements, including the cash taken in on a daily basis by your cashiers and the accuracy of your checking account. I talk about all the steps necessary to take to prove out your cash in Chapter 14.

Testing your balance

After you prove out your cash (see Chapter 14), you can check that you’ve recorded everything else in your books just as precisely. Review the accounts for any glaring errors and then test whether or not they’re in balance by doing a trial balance. You can find out more about trial balances in Chapter 16.

Doing bookkeeping corrections

You may not find your books in balance the first time you do a trial balance, but don’t worry. Finding your books in balance on the first try is rare. In Chapter 17, I explain common adjustments that may be necessary as you prove out your books at the end of an accounting period, and I also explain how to make the necessary corrections.

Finally Showing Off Your Financial Success

Proving out your books and ensuring their balance means you finally get to show what your company has accomplished financially by developing reports to present to others. It’s almost like putting your business on a stage and taking a bow — well . . . at least you hope you’ve done well enough to take a bow.

If you’ve taken advantage of your bookkeeping information and reviewed and consulted it throughout the year, you should have a good idea of how well your business is doing. You also should have taken any course corrections to ensure that your end-of-the-year reports look great.

Preparing financial reports

Most businesses prepare at least two key financial reports, the balance sheet and the income statement, that they can show to company outsiders, including the financial institutions from which the company borrows money and the company’s investors.

The balance sheet is a snapshot of your business’s financial health as of a particular date. The balance sheet should show that your company’s assets are equal to the value of your liabilities and your equity. It’s called a balance sheet because it’s based on the balanced formula I present earlier in the chapter:

Assets = Liabilities + Equity

The income statement summarizes your company’s financial transactions for a particular time period, such as a month, quarter, or year. This financial statement starts with your revenues, subtracts the costs of goods sold, and then subtracts any expenses incurred in operating the business. The bottom line of the income statement shows how much profit your company made during the accounting period. If you haven’t done well, the income statement shows how much you’ve lost.

I explain how to prepare a balance sheet in Chapter 18, and I talk more about developing an income statement in Chapter 19.

Paying taxes

Most small businesses don’t have to pay taxes. Instead, their profits are reported on the personal tax returns of the company owners, whether that’s one person (a sole proprietorship) or two or more people (a partnership). Only companies that have incorporated — become a separate legal entity in which investors buy stock (which I explain further in Chapter 21) — must file and pay taxes. (Partnerships and LLCs don’t pay taxes unless they’ve filed a special form to be taxed as a corporation, but they do have to file information returns, which detail how much the company made and how much profit each owner earned plus any costs and expenses incurred.)

I talk more about business structures and how they’re taxed in Chapter 21. You can find forms for filing taxes included with this book.