Breaking Down the Books: How to Grow your Business with Basic Accounting
I’ve yet to meet an entrepreneur who started their business because they were excited about accounting.
In fact, most business owners feel quite the opposite—they view their books with dread or intimidation. Maybe you’re so passionate about your project, you feel that books are just slowing you down. Or maybe you stepped into entrepreneurship with zero business background and you’re yet to translate the jargon.
Bookkeeping doesn’t have to scary, even to the least mathematically-minded individuals. While books help you to see where your finances are, the mechanics of bookkeeping don’t require a financial analyst.
Disclaimer: In this article, we’ll break bookkeeping down to the basics so you can better grow your business. This is a crash course for small business owners, not accountants!
The basic function of a bookkeeper is categorizing transactions that pertain to your business. Transactions that have been correctly categorized (books that have been accurately “kept”), produce reconciled accounts and up-to-date financial statements.
Categories stem from your “Chart of Accounts”: the group of categories that your business’ transactions pertain to. Typically, you’ll choose from default accounts or create your own when you set up your books.
These categories have multiple levels. For example, while you might categorize a transaction as “Office Supplies,” that transaction would fall under the parent category “Office Expenses,” then “Expenses” and finally “Owner’s Equity” (more on this later).
What you need to know is that your categories/accounts will ultimately be reflected on your financial reports and your taxes. Choosing the correct category is essential, so that you can get all of your write-offs and don’t overpay.
As you categorize your spending, you will also reconcile your transactions in order to make sure that your books actually reflect reality (specifically, that they reflect your bank balance).
In the olden days (let’s say the 80’s), your mom used to balance her checkbook so that every transaction was accounted for. Then, ideally, the checkbook would match the bank statement at the end of the month. Reconciliation does the same thing.
These days, both paper-and-pen and manual data entry are things of the past. Modern accounting software allows seamless syncing with your bank and automatically pulls in every transaction. All you have to do is file each transaction in a category, then verify that it really happened—on occasion, the syncing systems aren’t perfect. That verification is the reconciliation portion.
Your software will indicate which account had money transferred and which category the transaction falls under—for example, there was a $20 decrease in your bank account, and a $20 increase in your “travel expenses” category. These two portions of a single transaction—the account and the category, are why you hear the term “double entry accounting.” Each portion is either a debit or a credit.
If you have an intuitive accounting software, you really won’t have to worry too much about how double entry works. Just know that it helps you get the best, most helpful data on your financial reports.
The Accounting Equation
As explained, every category is actually a child to one of three fundamental accounts: assets, liabilities and owner’s equity. Quickly:
Assets are some sort of property that has value to the business (cash, inventory, accounts receivable)
Liabilities are debts owed by the businesses (loans, credit card balances)
Owner’s Equity represents the owner’s (or an investor’s) claim on the business
These three elements work together to show you exactly what’s happening in your business, in what is called “the accounting equation.”
Assets = Liabilities + Owner’s Equity
In bookkeeping, this equation is always true. The equation works because you can’t make money (increase assets) without putting something else in (increase liabilities and owner’s equity).
Note: sales and expenses do contribute to a business’ financial position, but in context of the accounting equation, they both roll up to owner’s equity.
Categorization, reconciliation and the accounting equation result in powerful financial reports. These three reports—the Balance Sheet, the Income Statement and the Cash Flow Statement—are of great value to business owners.
The beauty is, if you’ve kept accurate books, most accounting products will produce the reports for you. You don’t have to do any complicated math to view your financial standing. You just categorize transactions and let your software do the heavy lifting.
The Balance Sheet is called such because it expresses a “balanced” accounting equation. It shows where you stand in terms of Assets, Liabilities, and Owner’s Equity, and, when you’re using accounting software it’s always balanced (in other words, your liabilities plus your owner’s equity will always sum up to your assets).
The Balance Sheet represents a single snapshot in time, where your financial standing is at any given moment. While a balanced accounting equation is essential to a functioning business, there is also great value in individual line items, such as accounts payable, receivable, cash balance, fixed assets, etc.
This data reflected on the Balance Sheet is invaluable to business owners because it helps you to see where your business stands right now, particularly in terms of cash in the bank and debts owed.
The Income Statement (also called “Profit and Loss Statement” or “P&L”) is arguably the financial report that matters most to small business owners.
While the Balance Sheet presents a moment in time, the Income Statement shows your total sales and expenses over a specified period. It does not reflect the accounting equation. Instead the Income Statement primarily shows Revenue, Gross Profit, Expenses, Operating Income and Net Income.
Your net income, or the “bottom line” on your Income Statement (yes, that’s where that comes from), is your profit, and it’s what you pay taxes on. It’s the heart and soul of your business, and most likely, the reason your business exists—to generate a profit!
Cash Flow Statement
While profit is important to business owners, it doesn’t necessarily equal cash on hand. This is where the Cash Flow Statement comes in.
This report combines data from the P&L and the balance sheet—giving you a summary of your cash position, and how you’re earning that cash (from your business’s operations, investment, or outside financing). Your ability to create and sustain positive cash flow, as reflected on your Cash Flow Statement, is what gives your business value.
Now that we’ve dug into the nitty gritty, let’s get back to the basics. Where even the most experienced business owners fall short is timeliness. Bookkeeping can be straightforward, even easy, if you do it right away.
I recommend updating your books once a week (once a month at the very least). Put it in your schedule, set an alarm on your phone, do whatever you need to do to make sure that bookkeeping happens regularly.
The older transactions get, the harder your accounting will be. It’s increasingly unlikely that anyone remembers what each transaction was for, meaning that you could miss out on valuable write-offs or overpay on your taxes.
If you are more than six months behind, consider contacting a professional bookkeeper to help you get caught up. Forgive yourself for your accounting mess and get to work. Bookkeeping does take time and resources, but if you can stay on top of it, it will never drag you down too much. Instead, it will help to inspire your financial growth.
Grow your Business
When you’ve got up-to-date and accurate books, you know all kinds of important things about your business—where your sales are coming from, how growth is looking, where you can budget more tightly in your expenses, which financing options are best for your business, and when new financings may need to happen. Armed with that knowledge, you can make the best decisions to grow your business.
Yes, bookkeeping is inherently dull, but the results of bookkeeping—they’re thrilling. There’s a thrill at the end of the month when balanced books show an actual profit. Or at the end of year when you’ve stayed within your budget. Or at tax season when you add up all your write-offs and you’re actually getting cash back instead of owing! This kind of invaluable financial data can only come from accurate books.
You put your time into the things you value most. If you truly value your business, you will put your time into your books and you will see financial growth because of it.