We recently had a few inquiries submitted to the Bean Counter (Have a question? Submit it here) about chart of accounts, what they are, and why they matter.
A chart of accounts is a way of sorting the information gathered from all the activities of your business. It is a list of categories used to collect information.
These categories could be something like:
- A Bank Account for all your checks and deposits
- A Sales account to accumulate all your information for invoices to you customers
- A Cost of Goods account to accumulate all the costs for the materials or goods that you sell
- Office Expenses for all the paper, ink, pens and pencils, etc that you purchase
A Chart of Accounts organizes these categories in a certain order so that you will know the status of your business and if you are making a profit.
We are well into March and for some that means saying hello to warmer weather and sunshine and goodbye to snow and ice. For me, it's usually dominated by one thought and one thought 
only: sports.
Not only are we inching closer to the start of the baseball season, but March Madness is in full effect.
So what does a basketball tournament have to do with accounting basics and financial statement preparation and analysis?
In honor of the Big Dance, I'd like to offer you the Final Four of Financial Statements Preparation.
There are four financial statements needed to give a owners and investors relevant information about the company.
1) Income Statement
An income statement reports revenue and expenses over a period of time. There are two parts of the income statement: operating and non-operating.
Investors and analysts pay special attention to the portion of the income statement that deals with operating items. This section deals with operating items gives information about revenues and expenses that are a direct result of the regular business operations. Let's use basketball as an example. If a business manufactures basketballs, then the operating items section would talk about the revenues and expenses involved with the production of the balls.
The non-operating items section tells about revenue and expense information about activities that are not directly related to a company's regular operations. For example, if the basketball manufacturer sold some old equipment, then this information would be in the non-operating items section.
2) Owner's Equity Statement
The Owner's Equity Statement reports the chances in equity over a period of time. Retained earnings on the balance sheet are usually influenced by income and withdrawals. In order to get the information you need for the owners equity statement, which in turn provides information for the balance sheet.
3) Balance Sheet
The balance sheet is a snap shot of a company's financial condition and reports assets, liabilities, and equities at a given point in time. Each portion of the balance sheet let investors know what is owned and owed by the company. Assets should must equal total liabilities and owner's equity.
4) Statement of Cash Flows
The statement of cash flows shows the company's amount of cash inflows and outflows for a specific period of time. That cash flow statement helps to gage the financial performance of a company by asking where the cash came from, what it was used for and the change in the cash balance.
Now that 2010 is here, people are scrambling to figure out how they're going to keep their New Year's Resolutions. They picked out their personal resolutions - lose weight, quit smoking, start a hobby, save more, spend less... but what about New Year's resolutions for your business? How are you planning on taking what you learned in 2009 and putting it into practice for 2010 and beyond?
Coming up with goals for the New Year is great, it gives your business something to work towards, but don't let it stop there. Planning out how you're going to achieve those resolutions is just as important as the resolutions themselves. They don't always have to be grandiose tactics, sometimes it's the simple steps that keep you on track.
Let's say your resolution is to pay more attention to the financial health of your business- take what we like to call "5 at 5"
Every day at 5:00 (or whenever your day at the office is winding down) take five minutes to review your key performance indicators. Here are some possibilities:
- Day's cash receipts
- Days' cash disbursement
- Current ratio
- Accounts Receivable (A/R) aging
Work your tactics into your daily routine, and your resolutions won't be as lofty as they seem.
What are some of your business resolutions this year? Better yet, how do you plan on keeping them?
Monica recently brought in a book that belonged to her grandmother Gladys, 20th Century Bookkeeping & Accounting by James W. Baker, published in 1919.
As we were thumbing through the pages, we couldn't help but notice not a whole lot has changed in the world of accounting. The preface of the books starts out like this:
"The successful business man should know what a profit will result from the transactions in connection with his business before they are completed."
He goes on to say there's a connection between success and accounting. In order to make money, you need to know how to manage it... not a whole lot has changed in 90 years.
It might not be the most fast paced and exciting aspect of business, but it's definitely one of the most important. We've preached before about knowing your numbers (here, here, and here just to name a few) but we just can't say it enough.
Sure, the process and speed of how we can access the information has changes, but the fundamentals haven't. There are a lot of great accounting software packages out there that have made accounting easier and more accessible to everyone to understand but what's just as important as learning the software, is learning the process behind it.
In order to make money you need to know how it manage it... some things never change.
Ding! Ding! Ding! It's time for the third and final round of the Debit and Credit Showdown, which means you're one step closer to understanding debits and credits. During Round 1, we learned some of the big punches that debits and credits pack. In Round 2, we bobbed and weaved our way around the double-entry system, and for Round 3 it's time to pull out our big guns because we're going to knock out the recording process.
There are three steps to the recording process:
- Analyze how transaction affects accounts
- Adding debits and credits to a journal
- Transfer journal information into ledger account.
Thankfully, we can enter this information into our financial management software once, and it takes care of everything else instantaneously. But in order to truly understand how it works, it is best if we understand what goes on behind the scenes.
The most important part of that process is to understand how the transaction will affect the debits and credits.
Let's say you invest $10,000 into your boxing glove company- Acme Boxing Gloves. First, we would debit cash to show an increase of an asset, and we credit owner's equity to show increase of capital.
The second step is to record the transaction into a journal. The general journal requires the date of the transaction, the name of accounts affected, the amount debited/credited and an explanation of the transaction. Let's use this as an example: You invest $10,000 into Acme Boxing Gloves (ABG), and then purchase some equipment for $5,000 and office necessities for $1,500 both with cash. You then purchase additional equipment for $1,200 and office supplies for $300 all on an account. It would look something like this in your journal:
Seeing how the transactions are recorded in the journal helps to understand that "law of conservation" effect we talked about in Round 2.
The third step is to transfer all of the entries into a ledger, which contains the sum of all of your T-Accounts. Acme Boxing Glove's Cash account would look like this:
In the cash account you enter all cash inflows and outflows for the period into the T-Account under either debit or credit. After adding each side together, the cash account should have a debit balance of $3,500. That means that during that specfic point in time, Acme Boxing Gloves has a cash balance of $3,500.
It may not have been a total knock out, but if you made it through these 3 rounds and came out with a better understanding of debits and credits, you've won the fight. If not, there's always a chance for a rematch, just make sure you train properly.
Ok, so the showdown isn't debits versus credits, its debits and credits versus our understanding of them... or lack thereof. Hopefully by the end of this match you'll come out victorious.
With that said- LET'S GET READY TO RUMBLE!
Any good boxing coach will tell you two things. The first is to get to know your opponent, so that's exactly what we'll do and the best way to do that is to throw out everything that we think we know about them.
Why? Because in the world of bookkeeping and accounting analysis, they mean the opposite of what you might be thinking.
Which brings us to the second thing a boxing coach would tell you: never underestimate your opponent...
For example: if you go to the bank and deposit money, the teller will tell you that you have credited your account. On the flip side if you go to your bank and withdrawal money, the teller will tell you that you have debited your account. But that is not the case in the accounting world...
Despite what you might be thinking, debit doesn't mean loss and credit doesn't mean gain. The true meaning of debit and credit are actually very simple, debit means left and credit means right on a T-Account (don't worry, we'll cover T-Accounts more in Round 2).
Debits are account entries that result in the increase of an asset or decrease in a liability.
Credits are account entries that result in the increase of a liability and the decrease of an asset.
Remember from before: Assets are what your business owns, liabilities are what your business owes.)
So why does the bank tell you that you credited your account when you put money in? It helps if you think of it from their end. When you deposit money into the bank, their liability to you increases, meaning it's a credit. When you withdraw money, the bank reduces their liability to you, which means it's a debit. It's tricky I know, but just remember that banks are thinking of their assets and liabilities, not the other way around.
That's it for the first round. Next round, we'll talk about the double entry system. Here's a little hint to give an edge: debits must equal credits for each transaction.
Business owners really know how to provide quality products and services. But when it comes to simple accounting basics that can make an impact on the success of their business, some business owners are left in the dust.
Being a business owner isn't for everyone, in fact, most businesses don't make it through their first year. People who don't care to learn all aspects of owning a business especially accounting- probably didn't care about running a successful company in the first place. If you agree with any of the following, you'll probably find yourself in the same category as them.
1. You don't care if your business is profitable.
You should only bother knowing the simple accounting if you care about the health of your company. Accounting provides structure to help business owners keep track of whether or not their business has made any money over time and where that money is coming from. Knowing the nuts and bolts will tell you how profitable your business is by keeping track of how much money is going out and coming in.
2. You don't care about what others think.
As the business owner, you're not the only one who cares if your company is making any money. Banks and investors are very interested in knowing how well your business is doing financially. Banks will look at your business from a fiscal standpoint to determine whether or not they should loan your company money. More importantly, they want to be sure that if they give you a loan, you will be able to pay it back. Investors will also want to know if your company is a solid investment and a financial statement will tell them not only if, but how much they should invest into your company. The better you understand the ins and outs of your company's financial state, the more likely the bankers and investors will give your business the money that it needs.
3. You aren't concerned about employee theft; "they're like family."
This isn't to say that you can never trust your employees - there is no doubt that many employees are hard working and honest - but keeping tabs on your financial accounts can help you keep track of where your money is going. According to Score.org expense reports, payroll, purchasing, and suspense accounts are just a few of the places that disloyal employees are most likely to skim a little off the top. For a complete list of areas where employee fraud is most prevalent and what you can do as an employer to prevent employee theft, read the rest of the article.
4. You like selling products that lose money - you'll "make it up on volume"
Thinking about reducing prices to sell more products? Think again. While it may seem like it might make sense to slash prices to move more product, you are more than likely loosing out. Reducing prices reduces your gross profit margin and create more effort for your company to break even. Then again, if you knew accounting 101, you probably already knew that.
5. Cash flow isn't important to you
Your Cash Flow Statement gives you a snapshot of your company's short-term financial health. Knowing your company's cashflow is crucial, it will help you to determine if you have enough money on hand to pay employees and creditors on time. Companies who pay attention to their cashflow analysis know that if they have abundant cash on hand are able to invest the cash back into the business in order to produce more profit.
6. You don't really need to know if your customers have paid you yet
You don't care your customers don't pay their bills right? Of course you do! If you don't keep track of who has and hasn't paid you, how are you supposed to collect?
7. The IRS doesn't care if you've made your payroll tax deposits
Payroll taxes are the responsibility of every employer. Business' payroll tax responsibility consists of not only the taxes required to be withheld from employees' wages -Social Security tax, Medicare tax and federal income tax- but also that the employer's match their share of Social Security and Medicare taxes. Businesses that don't make payroll deposits can face some major penalties, including jail time.
8. Your suppliers never call you to collect their money
Just like you want to make sure that your customers pay you, the same holds true for your vendors. Keeping track of your invoices will help you stay up-to-date with liabilities and due dates for bills.
9. Your employees donate their time and don't expect to get paid
While satisfaction of a job well done is crucial for your employees to be happy and remain with your company, so is a paycheck. Not very many people can afford to volunteer 40 hours of their week. Knowing the basics, like cash flow, lets you make sure that you have enough money to pay your employees for all of their work.
10. Accounting is too difficult to learn anyway.
You don't need to be a mathlete to have a working knowledge of accounting. Chances are that if you're smart enough to learn how to run a company, you're smart enough to learn the fundamentals of accounting. Monica has put together an easy to understand course, Basic Accounting Structure that helps to explain the makeup of accounting, including the different kinds of accounts and basic financial statements that your business uses everyday.
Hopefully you don't find yourself agreeing with any of the reasons above, but if for some strange reason you might, then don't bother to learn anything about accounting; hire a mathlete to take care of all of your finances. But then again if you don't care about your money, you probably don't have enough to hire someone who does.
Photo credit: Carol Ester
