Module 6—Bookkeeping & Accounting

Module 7—The Financial Plan

Why do bookkeeping?

Bookkeeping has two primary functions:  to provide you with information that will allow preparation of tax reports, and to provide information that will help you manage your business, see trends and implement changes.  Satisfying the tax requirements is how many small businesses organize this function within their company.  I would rather see you focus on the management information systems, and make sure they do the job for the taxman.  The keeping of timely and accurate financial records is imperative if any business is to succeed.  You want to set up a system that is as simple as possible, yet acquires the necessary information to help you better manage the business.  Over time, you will learn to read your financial reports so that at a glance you can determine how you are doing, and look at making changes which will correct those things that you are not comfortable with.

Should I hire an accountant?

This depends on what your skills, time availability, and complexity of the business you are starting.  In general, most all business should be using the services of a tax advisor or accountant for some matters.  The tax codes change rapidly, and keeping up with all the changes and provisions make it difficult to be a do-it-yourselfer in this area.  You can do much of the work yourself, and then have an accountant review and make recommendations.  Another approach is to use the services of an accountant to begin, and then take over aspects of the job as you are comfortable with it.  You should evaluate your time, or the need to hire someone in-house, and determine whether it would be better for you to focus more attention on sales and marketing, where you can earn more for the company than you will pay for hiring a professional.  Do you have the need for a full time employee to do the books, or would you be better off having an outsider provide this? 

In general, most small businesses should do their own recording of entries.  Your accountant can help set up systems, advise on tax matters, prepare returns, do employment accounting and other functions.  But the basic records should be kept by the company.  This Module will present general bookkeeping requirements, based on manual entry (not computer), and the basic reports you will need to manage the business.  The format is less important than the need for this basic information.  Dome Systems sells a bookkeeping system that is very popular at stationary stores and other retailers that is used effectively by many small businesses.  You can contact your local H&R Block office that will provide a free manual bookkeeping system.  Or you can use the forms included in this module.    Later on in this Module we will discuss computer accounting, and the pros and cons of using a computer for your business.

Where do I begin?

You should keep track of all your costs in starting up your business, as in most cases these are deductible as start-up or organizational expense.  You should start by keeping a journal of your daily activities, where you go, who you see, what you spend.  Keep track of business classes, mileage, supplies purchased, telephone calls, professional materials.  Prior to actual starting of operations these expenses may be amortized, and expensed over a five-year period once your business starts.

As soon as possible open up a separate checking account for your business.  Writing checks on your separate account makes recapping these costs easier and more readily accepted by the IRS as a bonafide business expense.  Many banks offer low-cost or free checking, if your number of checks and deposits aren’t too high. 

What records do I need to keep?

There are many different types of general accounting records.  Their purpose is to record each transaction, and then develop financial reports and tax reports for management of the business and tax reporting, respectively.  You should set up only the records that you will need to accomplish these tasks.  To do more would be a waste of time and resource, to do less can lead to problems that could lead to audits, penalties or termination of your business. 

General Records

Every business will require certain records to keep track of its daily transactions.  These records are used to generate your monthly profit & loss statements and balance sheet.  You should set up a recordkeeping schedule and keep your records current at all times.  A copy of all these forms are included at the end of this Module.

Revenue & Expense Journal

This is the main general record used by a business.  It’s used to record individual transactions for which income is received and checks written by your business.  The transactions are recorded as revenues (moneys for sales and interest earned) and expenses (checks written to pay for products and services received by you).  At the end of the month, the columns in the revenue and expense journal are totaled.  The totals are then transferred to that months profit and loss statement.  Your checking account record can double as this journal, if set up properly.  This eliminates the need for a separate recording of checks and posting to a journal.  The more steps you can save in accounting the better.  We have included a form at the end of the module that combines the checking record and revenue and expense journal.

Petty Cash Record

Petty cash refers to all the purchases made with cash or personal checks when it is not convenient to pay with a business check.  These transactions are recorded in a separate journal and paid by periodically writing a business check that is recorded as an expense in the Revenue and Expense Journal and a deposit in the Petty Cash Record.  You then use your petty cash to make purchases, and replace the cash used with a receipt for the expense.  At month end you can do a recap and post all expenses to their proper categories, taking them from petty cash.  A word of caution:  the IRS frowns on the use of cash receipts for paying expenses, and a petty cash fund should be used sparingly for small purchases only.  Most businesses will accept checks for payment, which is preferable to IRS and gives you a record with your check copy.

Inventory Records

These are records that keep track of all products purchased or manufactured for resale.  The IRS requires a beginning and ending inventory for each taxable year for most businesses that would normally maintain an inventory.   Inventory control is a major factor contributing toward business success, or failure.  Internal use of these records can greatly enhance your profits.

Fixed asset log

This is a list of all assets (tangible and intangible) that will have to be capitalized (or depreciated over a specified number of years).  They are items purchased for use in your business (not resale), usually at a cost of $100 or more and not debited to an expense account.  They are depreciated over a period determined by tax regulations.  Examples would be as follows:  vehicles, office equipment, production equipment, buildings, etc.

Accounts Payable

This is a record of debts owed by your company for goods purchased or services rendered to you in the pursuit of your business.  You will need an efficient system for keeping track of what you owe and when it should be paid to get the best terms.  If you are going to have a good credit record, the payment of these invoices must be timely.  If you do not accumulate a large number of unpaid invoices you may be able to dispense with this record or get by with a folder or box on your desk which contains your unpaid bills.

Accounts Receivable

This record is used to keep track of debts owed to you by your customers as a result of the sale of products or the rendering of services.  Each client with an open account should have a separate page or ledger with account information and a listing of invoices, payments, and balance owing.  Statements of balances due are sent to your account holders at the close of each month.  If you do not have a large number of open accounts, you may also be able to dispense of these records, similar to the above with accounts payable.

Mileage, Entertainment & Travel records

These are the records used to keep track of auto and transportation expenses, meals and entertainment of clients and travel out of your local area.  Due to past abuse in these areas, the IRS requires careful documentation as proof that deductions claimed are in fact business related expenses.  We strongly recommend you organize a travel log, trip records and entertainment records so they can be carried with you.  It is much easier to keep track of them at the time they occur than to try to remember them and find receipts after the fact.  In addition, keep all your receipts.  You can read more about travel and entertainment in IRS Publication #334.

Payroll records

The IRS has strict regulations regarding withholding and payroll taxes and their reporting.  Payroll records are not easy to keep, even with a payroll software program.  Leave these records to a trained tax expert.  You will be informed what checks to write and these will be recorded in the Revenue & Expense Journal.  The accounting professional will do all the tax reporting for you.  No sample forms included.

Business Checkbook

Your checkbook is not only the means to pay your bills.  It also serves as a record of who was paid, how much was paid, and what was purchased.  Deposits are recorded and a balance of cash available is always at your fingertips.  Always reconcile your checkbook with your monthly bank statement and record any service charges, check purchases and interest earned.  Try always to reconcile to the penny.  Differences can represent a larger problem if left unreconciled.

Customer records

These records are kept as a means of helping a business deal more effectively with its customers.  The type you keep is up to you.  They are most effective is service industries or in small businesses dealing in specialty retail sales.  Your customer address list described in the previous Module is a good example of this.

Financial Statements

Financial statements are developed from the general records.  These statements are used to provide information for preparing tax returns.  It will also help you see the financial condition of your business and identify its relative strengths and weaknesses.  A copy of these forms are included at the end of this Module for your use.

Balance Sheet

The balance sheet is a financial statement that shows the condition of your business as of a certain date.  It is most effectively done at the end of every month, and your fiscal year end.  The closing balances from your general records will supply you with the information.

The balance sheet can be likened to a still photograph.  It is the picture of your firms financial condition at a given moment and will show whether your financial position is strong or weak.  Examination of this statement will allow you to analyze your business and implement timely modifications.

A balance sheet lists a businesses assets, liabilities and net worth (or capital).  The assets are everything your business owns that has monetary value (cash, inventory, fixed assets, etc.)  Liabilities are the debts owed by the business to any of its creditors.  The net worth is an amount equal to the owners equity.  If a business possesses more assets than liabilities, then its net worth will be positive.  If the business owes more than it assets the net worth will be negative.

Profit & Loss Statement

This financial statement shows your business financial activity over a specified period of time.  Unlike the balance sheet, a profit and loss statement can be likened to a moving picture.  It shows where your money came from and where it was spent over a specified period of time.  You will be able to pick out weaknesses in your operation and plan ways to run your business more effectively, thereby increasing your profits.

A profit and loss statement should be prepared at the close of each month.  The totals from your revenue and expense journal are transferred to the corresponding columns of the profit and loss statement.  Comparison of the profit and loss statements from period to period will reveal such trends in your business as high revenue periods, effective advertising times, increases or decreases in profit margins, and other valuable information. 

Monitoring your performance

It is recommended that you do a monthly balance sheet and profit and loss statement, and these should be evaluated and analyzed to see how your business is performing.  Comparisons of one period with another were already mentioned.  More significant can be comparisons relative to your plan.  I recommend that you do at least a twelve month projection at the beginning of each year, and show your actual monthly profit and loss statements next to budget for each month for easy comparison.  A copy of a monthly Budget vs. Actual Monthly Profit & Loss Statement is included at the end of this Module for your use.  Using this form makes it easy to analyze where you are off your plan.  Being either over or less than plan can be a cause for concern.  Sometimes selling more than planned can be a problem, too.  Do you have the cash to purchase more inventory or fund greater receivables?  Look at the balance sheet in the same way.  Unplanned changes in asset or liabilities can be indicative of a problem.

The Cash Flow Statement

A major cause of business failures is the lack of cash flow.  You can be both profitable and short of cash if you have not planned adequately or your growth is too great.  In the next Module we will go over how to prepare projections, and you should consider operating under a monthly cash flow budget for short term cash management.  This can be done using the Budget vs. Actual Monthly Profit & Loss Statement form which allows you to budget and monitor your monthly cash flow performance.

General recordkeeping schedule

There is a specific order to recordkeeping.  It must be done in a timely manner if the records are to be effective.  Since the two goals of recordkeeping are the retrieval of information for tax reporting and analysis of information for internal planning, your schedule will have to provide for these goals.  When records are not timely, the value of the information becomes less in terms of ability to use for either purpose. 

Recordkeeping Schedule

Daily tasks

Þ   Go through mail and sort according to action

Þ   Unpack and shelve incoming inventory

Þ   Record inventory information

Þ   Pay any invoices necessary to meet discount deadlines

Weekly tasks

Þ   Prepare income deposit

Þ   Enter deposits in Checkbook and/or Revenue & Expense Journal

Þ   Enter sales information in Inventory Record

Þ   Enter weeks checking transactions in Revenue & Expense Journal (if using separate form)

Þ   Record petty cash purchases in Petty Cash Record.  File receipts.

Þ   Pay invoices due.  Be aware of discount dates.  File invoices.

Þ   Enter other purchases (such as fixed assets) in appropriate records.

Monthly tasks

Þ   Balance checkbook and reconcile bank statement.

Þ   Enter interest earned and bank charges in Revenue & Expense Journal and/or Checkbook.

Þ   Total and balance all Revenue & Expense Journal columns.

Þ   Check Accounts Receivables and send out statements

Þ   Prepare monthly Profit & Loss Statement and Balance Sheet

End of year tasks

Þ   Pay all invoices, sales taxes and other expenses that you wish to use as deductions for the current year.

Þ   Transfer twelve monthly totals from Revenue & Expense Journal to the Profit & Loss Statement.

Þ   Prepare the end of year Balance Sheet.

Þ   Set up new records for the coming year.

Record Storage

How long should a business hang on to its financial records?

The rule of thumb is three years, the length of the normal statute of limitations on federal tax returns.  Under certain circumstances, however, it is six, and if you fail to file or there is fraud involved, there is no statute of limitation.

Many Certified Public Accountants suggest these time limits:

THREE YEARS

·        Canceled checks and bank deposit slips, expense reports, entertainment records, inventory records.

·        Keep employee records for three years beyond the employment period.

·        Depreciation schedules, journals and general ledgers should be kept for three years beyond the life of the business.

SIX YEARS

·        Bank statements

PERMANENT

·        Tax returns, financial statements, contracts, corporate stock records, real estate records

LIFE OF COMPANY

·        Minutes of meetings

Computers & Accounting

The computer can make bookkeeping and accounting tasks more simple or more difficult, depending on the situation.  To use your computer effectively you must have a good working knowledge of bookkeeping and the computer.  You should analyze what you do on the computer to make sure it will really save you time and be convenient to your situation.  For instance, many business owners find it advantageous to have a checkbook that they can have on their desk or take with them to record transactions on the go.  To computerize this function may involve more effort in posting transactions from a check record to the computer.  Another example might be keeping a record of accounts receivable.  There are many good software programs that will do a great job using the computer, but having a folder on your desk with copies of outstanding invoices may be all that’s required.  On the other hand, preparing financial statements is time consuming when done by hand from your Revenue & Expense Journal, both in terms of posting and balancing. 

The key is to find systems that are as simple as possible to serve your purpose.  As a business grows and gets larger, it becomes more and more difficult to maintain manual systems.  There is no software that is perfect for every business, and the larger the business gets the more difficult the bookkeeping management becomes.  A listing of basic software accounting packages is included in the Resources section at the end of the book.  I have worked with clients using most of the software packages, and there are pros and cons to each.  People will tend to prefer those programs they have experience with.  Once you have invested time in learning a program you can usually get what you need from it.   Northland Pioneer College’s Small Business Development Center, recognizing that Quicken and Quick Books are the leading selling accounting software programs, have begun offering training classes to orient businesses to these programs.  Contact your local Small Business Development Center for information on offerings and times.