Accounting for Dummies - Part 1
when I talk about accounting with people who run a small business, the words I hear most often are "I don't understand it", "I hate doing it", "It takes forever" and similar attitudes. So, is accounting really that mysterious and hard to understand? Well, I'm no accountant (just to get that out of the way), but I'm of the opinion that it is not such a big deal. Admittedly, the laws and regulations about taxation will test even the most dedicated but we won't go there in this article. That's what specialists are for. We will just deal with the basic things here and talk about why we even need accounting.
Let me start by asking you to go and get a couple of shoeboxes. If you don't have any of those, just get any two boxes and place them in front of you, side by side. Ready? Ok, good, now get a pen and write on the front of the box on the left "Payments" and on the other box write "Receipts".
Look around the office for any vendor invoices you paid recently, any receipts you got for purchases you made for your business and any other money you spent on behalf of the business. Put them in the box at left. Include phone bills, utility bills, gas receipts, infact anything that had something to do with your business. If you have paid it, in they go. This lot represents your Expenditure, your cost of doing business. Now take out the jumble of paper from this box marked "Payments", get your calculator out and add up the total you paid from each piece of paper. When you're done, write down that total and weep. This is where your money goes and I bet the total is bigger than you thought. We haven't even mentioned that other kind of document - all the bills you have not yet paid and which are not in the box yet. We'll get to those later. Put them on a pile behind the left box.
Next, we need to put some stuff in the box at right. If you have any cash lying around that you received today and that hasn't been banked yet, put it in the box. Look for any checks from customers or deposit receipts of money paid in by customers (like, by credit card, for example). Put all that in the box at right. We'd all be broke if it weren't for this 'box'. So, go and add up all that money from the box marked "Receipts" and be happy. This represents your Income. What is not in this box is all the invoices you have sent out that haven't been paid yet by your customers. We'll get to those later, as well. Meanwhile, put copies of unpaid invoices on a pile behind the box at right.
When you look at your bank statement, you'll notice that the first money column is your payments (money going out). The next one is your deposits (money coming in). Just like our two boxes. There, that's one of the principles of accounting explained simply - you put all your receipts from stuff you paid for in one "box" and all your income receipts in the other "box". Take the total of your income and take away the total of your expenditure. If your 'Payments' box is overflowing and the 'Receipts' box rattles like a beggar's bowl, we call this a loss - in plain English, you spent more than you earned. Not good. In the 'old' days, businesses in this situation used to get a loan to keep going until income improves, but these loans are not so easy to come by what with the financial crisis and everything. So here is the next principle: we do accounting so that we can measure if we have kept our expenses lower than our income. By knowing what we have spent, we will know where to cut, prune and snip until the box on the left starts looking lean and mean.
On the other hand, if you have some money left over after paying everyone you owe, it's called a gross profit - here is where the tax man enters. That is another principle of accounting - in general terms, a business gets taxed on its gross profit and accounting is the tool to determine that. We do accounting, so the tax man, the IRS, or whatever you want to call them, can apply the taxes we all need to pay.
Get into a habit of keeping all the receipts you get when you pay for something and put it in the left box. Also, when your invoices get paid put a copy of that invoice into the right box. Some people make a file copy of every invoice they raise and file it somewhere, then when each invoice gets paid, they write a date on that copy and maybe the amount, if not paid in full.
So, what about the papers and stuff BEHIND the boxes? Well, those placed behind the box at left are your liabilities - they represent bills you will have to pay eventually. By adding up the total on each of these documents, you get an idea of what you owe people.
To pay for this you need income. So look at the documents behind the box at right. These are your debtors, the people you did business with but who have not yet paid you. You might need to get on the phone and start rattling their ears if they are too slow in paying. You can even sell your debtors to others (it's called factoring). These businesses will take over your debt collecting because you assign your unpaid invoices to them and they pay you immediately. Of course, they don't do this out of charity. There's a handsome fee attached to this, but it can be worth paying if you need the cash right now, or feel it is awkward having to chase debts yourself.
You may have heard of "cash flow" and wondered what that means. It's a way of determining what needs paying and when, and how much income is due and when. If you put these two columns next to each other, it will tell you if you can afford to pay your bills at a certain time.
One more little task I'd like you to do: look in the box at left. It's quite a mess, isn't it. Bills and receipts for everything imaginable, all in one great jumble. Go and get a handful of large envelopes or folders. Write on the first one "Vehicle", then pull all bills and receipts that have something to do with your cars from the box - gas receipts, repair bills, tires, registration, warrants of fitness and all that motor stuff, and put them in 'Vehicle' envelope. On the next envelope, write "Utility", then put all the bills regarding electricity, gas, water and the like into that envelope. Let's try one more, called 'Communication' and put phone bills, SIM card purchases and the like in that envelope, any bill or receipt that has something to do with how you communicate with your customers and business associates. You are getting this now, aren't you? We are dividing our cost into categories, to make it easier to measure where our money goes. Once we know this, we can work out where we could make savings, which of course will increase our profit. Accountants call these categories 'ledgers' - we'll stick with envelopes for now
The same applies for income. Not every dollar we receive is ours. For starters, you may have charged taxes on some of your invoices. When you get paid, the tax part should be put in a different 'envelope', so that when it comes to handing over the tax we collected on behalf of the state, we know exactly how much that is. You may also get money that is part business, part personal, so here again, we can use different envelopes.
In the next episode we will ditch our envelopes and boxes and start replacing them with a simple software system. So simple, you wonder why you haven't done this earlier. So stay tuned...
Bernard is founder and CEO of The Scrambled Card Company, based in Auckland, New Zealand. His software invoiceit! includes easy accounting and has been sold across the US and Canada (and more than 70 other countries) since 1999. You can contact him via the author's profile or visit his website also noted on his profile to get more information about invoiceit! and download the software for a free 30-day trial. Now there is also his very affordable Simple Accounting, a spreadsheet accounting solution which is very VERY simple to use. You can get it for a one-off payment of just $14.95.
Have a question for Bernard or want to leave a comment? Click here.