As a business owner, you will be required to produce financial statements for outsiders, such as banks, and to report financial information for tax purposes to federal and state governments. But equally important, the biggest beneficiary of good record keeping and reporting is you, the business owner.
Effective bookkeeping and accounting practices greatly increase your ability to control your understanding of your business finances.
Your system for keeping track of receipts and expenditures is bookkeeping. While there are many good systems that you could use or adapt for your own use, there are no rules as to which process you must follow. If by some chance you are audited for tax purposes, you will be asked to produce the detailed records kept with your bookkeeping system.
Depending on the size and complexity of your business, you will want to produce reports that help manage the business and meet tax and other regulations. For this, you may want to get the help of an accountant.
How do I set up a bookkeeping system?
Setting up a bookkeeping system has several stages.
- Keep track of your receipts and associated payors, dates and products or services purchased.
Your system might be as simple as logging checks received against copies of invoices you have sent out. Or it could be a system in which your cash registers are connected with a sophisticated computer system. The number of receipts you receive will help determine the way you keep track of them.
- Record your transactions in a ledger.
A ledger summarizes revenues and expenses and the pertinent data that you will need later. Whenever you feel it will be useful, you can use the ledger to create reports that will help you analyze the flow of your business. You can create reports for special purposes; for instance, you might want to know how many boxes of stationery have been sold over the past month, and your bookkeeping system can help answer the question.
When you transfer the information about your receipts and purchases into the ledger, it is called posting. There are many software programs available that automatically post to ledgers and later reports that you can use as managing tools. An alternative or supplement to a computer program is an outside bookkeeping service.
- Use your financial information to create financial reports.
Financial reports allow you to see the forest and not just individual trees. They allow you to analyze your sales, your expenses and to see trends in your business. Again, the nature of your business will determine which types of reports are most valuable for you and how often you want to look. Comparing the results of two or more time periods can be a useful business tool.
The three most common financial reports are the balance sheet, income statement and cash flow statement.
What is a balance sheet?
A balance sheet is often called a “snapshot” of the business’s financial situation. It takes a look at the company at a certain point in time, often the end of a quarter or a year.
The “balance” part of the balance sheet comes into play with the left side and the right side adding up to the same total at the bottom. On the left side are listed the assets of the company—the resources that it is using to do business. Beginning at the top with the most liquid item, cash, other categories might include inventory, accounts receivable (what is owed the business), equipment such as trucks or machinery and finally real estate.
On the right side of the balance sheet is a list of items that show how the assets were paid for. At the top are liabilities such as accounts payable, short term loans or notes, long-term bonds or other loans. Below the liabilities, the equity of the business is listed. Equity is the owner’s contribution to the assets of the business, coming either from a contribution the owner made when the company was established or by earnings which were retained in the business and not paid out in any way.
What is an income statement?
An income statement shows how money has come into the business and been paid out over a period of time. At the top of the income statement is the revenue generated by sales. Items subtracted from revenue include the cost of goods sold, operating expenses and interest payments. Net profit (or loss) is the amount that is left after all expenses have been covered.
What is a cash flow statement?
The cash flow statement is similar to the income statement, but it does not include noncash expenses like depreciation.
What are “cash” and “accrual” accounting methods?
Cash and accrual accounting methods treat time in two different ways. The cash method is like a check book; revenue is recognized when it is received, and expenses are recognized when they are paid. Accrual accounting attempts to match the timing of revenue and expenses with their source. For example, if you purchased a 1-year magazine subscription on July 1, accrual accounting would recognize only half of the expense in the current year and the other half of the expense in the following year.
What is an “aging” report?
An aging report lists accounts that are owed by customers along with the length of time the debt has been outstanding. This tool can help alert the business owner to show payers or changes in payment patterns that will require attention.
What is the difference between “inventory” and “cost of goods sold”?
Inventory and cost of goods sold are related. Inventory consists of the items your business is holding that you expect to sell to customers. Cost of goods sold is the cost of your inventory once it has been sold to customers.
How long should I keep my financial records?
Hang on to your supporting paperwork—receipts, cancelled checks, etc.—for 7 years. Tax returns should be kept for at least 7 years, ideally for the life of the business, as you may want them for information regarding retirement accounts.
What else should I keep forever?
Financial statements, general ledgers, legal correspondence, contracts, real estate documents and corporate records should be kept in perpetuity.
Is there anything that I can eventually get rid of?
Bank statements and deposit slips, records of sales and employee-related records can be tossed after 6 years. After 3 years, you can get rid of invoices that you have paid, payroll records, inventory records and cancelled checks.
If I do a good job of bookkeeping and can create my own reports, why do I need an accountant?
An accountant or accounting system may be needed for closing the books at the end of a quarter or year and to help prepare financial statements. You may want financial statements every quarter, or even monthly.
Why else would I want to hire an accountant?
An accountant will be an expert in tax regulations, and you will most likely call on him or her to prepare your income tax returns. An accountant also can help to make sure that you pay sales taxes, which are usually collected by local governments on a monthly basis. Maintaining payroll payments and records requires constant vigilance, and this is another area where an accountant can help keep you on track.
It can be helpful to have an outside perspective in understanding your finances, and a good accountant can be an excellent resource for information and advice.