by Lita Epstein, author of Bookkeeping Kit For Dummies®
When you first started your business, you probably ran out of the gates with lots of energy and ideas. You were focused on the big picture. Bringing in customers. Creating new products and services that those customers would love. Hiring great employees. Making the big bucks! You probably didn’t spend too much time sweating the small stuff, such as learning how to read your business’s books.
If that was the case then, now is the time to correct your course. As a small business owner, if you don’t understand the accounts your bookkeeper uses to keep your business up and running, you’ll have absolutely no way to measure the success (or failure, unfortunately) of your business efforts.
No matter what business you’re in, the ability to understand your books is essential. Often small business owners are great at winning over new customers or creating new products or services, but they’re not so great at keeping a clear financial picture of their business. As a result, they run into cash flow problems. They rack up huge amounts in accounts receivable. Or they pay bills late.
When you take the time to learn how to read and understand your books, you’ll have 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.
To give you an idea of the kind of information you need, let’s start with a lesson on accounts. Each and every account has its purpose in bookkeeping, but all accounts certainly aren’t created equal. For most companies, some accounts are more essential than others. When you have a firm grasp of the accounts your bookkeeper uses to manage your business, you’ll have a solid financial picture of your business, enabling you to make better decisions and to run your business more efficiently.
Here’s a look at the most common, must-have accounts used in small businesses:
All your business transactions pass through the Cash account, which is so important that often bookkeepers actually use two journals, Cash Receipts and Cash Disbursements, to track the activity. It’s your bookkeeper’s responsibility to be sure that all cash — whether it’s coming into the business or being sent out — is handled and recorded properly in the Cash account.
If your company sells its products or services to customers on store credit, you definitely need an Accounts Receivable account. This account is where you track all money due from customers. Keeping Accounts Receivable up-to-date is critical to be sure that you send timely and accurate bills to customers.
Every company must have products to sell. Those money-making products must be carefully accounted for and tracked, because it’s the only way a business knows what it has on hand to sell. Your bookkeeper contributes to this process by keeping accurate inventory records in an Inventory account. The numbers you have in your books are periodically tested by doing physical counts of the inventory on hand.
No one likes to send money out of the business, but you can ease the pain and strain by tracking and paying bills in your Accounts Payable account. You certainly don’t want to pay anyone twice. But you also want to make sure you pay bills on time, or else your company may no longer get the supplies, inventory, or other things needed to operate the business. Suppliers often penalize late-paying companies by cutting them off or putting them on cash-only accounts. On the flip side, if you pay your bills early, you may be able to get discounts and save money with suppliers, so the early bird definitely gets the worm.
Inevitably, your company will need to purchase major items such as equipment, vehicles, and furniture. Unfortunately, you may find that you don’t have the money to pay for such purchases. The solution is to take on long-term loans to be paid over more than a 12-month period. The Loans Payable account allows you to monitor the activity on these loans in order to get and keep the best rates and make all loan payments on time and accurately.
No business can operate without taking in cash, mostly through sales of the company’s products or services. The Sales account is where you track all incoming revenue collected from these sales. Recording sales in a timely and accurate manner is a critical job, because otherwise you can’t know how much revenue has been collected every day.
Purchases are unavoidable. In order to have a tangible product to sell, your company has to either manufacture the product, in which case you have to purchase raw materials, or purchase a finished product from a supplier. In the Purchases account, you track the purchases of any raw materials or finished goods. The Purchases account is a key component of calculating Cost of Goods Sold, which you subtract from Sales to find your company’s gross profit.
You must pay employees to get them to stay around; that’s a fact of business. No matter how much you beg, few people want to work for nothing. To keep up with what is for many businesses their biggest expense, you track all money paid to employees in the Payroll Expenses account. Accurate maintenance of this account is essential, because it ensures that all governmental reports are filed and payroll taxes are paid. And if you don’t take care of these responsibilities to the government, you’ll find yourself in some serious hot water.
One key expense that can drain a company’s profits is office expenses. From paper, pens, and paper clips to expenses related to office machinery, these expenses tend to creep up if they aren’t carefully monitored in the Office Expenses account.
Accounts related to owners’ equity, which is the amount each owner puts into the business, vary depending on the type of business. Many small businesses are owned by one person or a group of partners; they’re not incorporated, so no stock shares exist to divide up ownership. Instead, money put into the business by each of the owners is tracked in Capital accounts, and any money taken out of the business by the owners appears in Drawing accounts. In order to be fair to all owners, your bookkeeper must carefully track all Owners’ Equity accounts.
The Retained Earnings account tracks any of your company’s profits that are reinvested for growing the company and not paid out to the company owners. This account is cumulative, which means it shows a running total of earnings that have been retained since the company opened its doors. Although managing this account doesn’t take a lot of time, the ongoing accuracy of the Retained Earnings account is important to investors and lenders who want to track how well the company is doing.
Many business owners think of bookkeeping as a necessary evil. But in reality, if you understand and make effective use of the data your bookkeeper collects, bookkeeping can be your best buddy when it comes to managing your cash. The key to taking advantage of what bookkeeping has to offer is understanding the value of basic bookkeeping principles and using information collected. When you do this, you can run your business more efficiently and effectively. Happy accounting!
Lita Epstein, MBA, designs online courses about reading financial reports, investing, and taxes. She’s the author of Reading Financial Reports For Dummies® and also writes periodically for AOL’s Daily Finance.