- 1 So I’ve set up my own business, but now there’s something called “accounting”?
- 2 I just want to earn profits, what’s with everything else?
- 3 What is accounting?
- 4 Why do I have to account?
- 5 For whom am I doing this again?
- 6 How do I start with my own accounting?
- 7 Debit-Credit
- 8 What to watch out for when first starting with accounting for your own business?
- 9 Where do I start with my accounting?
- 10 Common pitfalls when it comes to accounting
- 11 How to make sure my accounting is accurate?
- 12 Accounting is a continuous process
- 13 Best practices in everyday accounting
- 14 I bought stuff, now what?
- 15 I made a sale, help!
- 16 I got services – should I account for this? How?
- 17 Statements? What statements?
- 18 Things to always do
- 19 Making sure you don’t forget things
- 20 Documents in accounting
- 21 Referencing in accounting
- 22 One ground principle you must never forget
So I’ve set up my own business, but now there’s something called “accounting”?
Setting up your business is your first thing obviously – you’ve got your business idea and now you need a company to start putting this idea into reality in. Clients, suppliers, products etc., all of it needs some planning, communication, actions and keeping record of. It’s “keeping record” that amongst other things includes accounting.
Besides having order in contracts, client listings etc. you ought to keep a tight record of all your financial transactions – sales, purchases etc. Accounting is what helps you realize how much you spend on certain areas of business – marketing, rent, utilities and so on – but it also shows how much you’re earning from sales. It’s what tells you your assets, what you owe for purchases and how much cash you should have. Accounting will also help you realize if you’re making profits or losses and if you’re in cash inflow or outflow. In short it tells you how your business is doing. Something you should realize is that business is not just selling and buying, but also keeping it viable, i.e. making profits to sustain the activity and satisfy your as the owner’s needs.
In earlier ages with one-man shops you’d buy your goods, sell them on your own property, pay for the utilities, goods and what else you needed to keep yourself alive, like food, clothes etc. and whatever was left was the cash you could spend on either enhancing the property, buying something extravagant or go on a holiday. That’s how businesses were run like ages ago but even then there was little bit of accounting done. How else would you be able to plan for some bigger expenses or purchases? You also needed to keep record of all your debt balances and possibly also receivables from clients who always didn’t pay right at the spot.
Even if it’s this little, you’re still doing accounting. And it’s very doubtful you don’t see it being useful. I know it may sound confusing and difficult, but nonetheless it’s not a reason to not do it.
I just want to earn profits, what’s with everything else?
Obviously. Everyone wants to earn profits when they set up their business. I could ask metaphorically “What’s profit?” but I wont. Instead I’ll tell you a story.
There was this young man who settled in to make his first shop very attractive. He wanted lots of people to visit it, buy goods and leave all happy. Little did he know of accounting, but he was so sure that what he liked would also attract lots of young people to his store and would make them spend money there. He decorated all the rooms, bought allsorts of products and made it really beautiful. People indeed came and were amazed – everything was so bright, new, inviting and surprisingly cheap. They wondered around the aisles, picked up lots of goods and even bought quite a lot. At the end of the day however the young owner wasn’t able to pay off his suppliers. It’s not just the investment he made for the decorations, but the goods, the utilities, the rent. Why? Simply because he had no idea how much all of this would cost him regularly and even more, he wanted for the goods to be cheap so he didn’t even consider that the prices should in addition to his profit include all the other expenses he’d have.
Yes, not smart you’d say and even think that had he been educated in business none of this would have happened. Well, let me tell you that it would. Doing business is living your ideas and dreams, but what comes extra are real life expenses, situations etc. A business idea is your idea, but does it appeal to your potential clients? Can you afford such expenses you’ve planned per sale? For all of this you need accurate accounting.
What is accounting?
Accounting is keeping record of all your financial transactions – purchases and sales, expenses and investments made for the business. Accounting is the process of rules used to reach results for your business – your assets, liabilities and profit or loss for the period.
Accounting may also seem like it’s a big mumbo-jumbo and needed for just some officials or regulatory bodies. Trust me, once you get a hang of it, you will see benefits for yourself as well. I won’t lie, the government bodies also require your annual or quarterly financial statements etc. but it’s beyond this need that the accounting benefits you.
Proper accounting gives you an idea of your assets, what you’re being owed to, and your most liquid funds like cash. It also gives you an idea of what you owe and how much you spend and earn. Since accounting is on most cases done on accrual basis, meaning the entry is done at the time the transaction is for (i.e. rent expense for June should be accounted into June and not July when you receive the invoice) and not when the transaction is made, you can keep a record of your period’s results just as assets and liabilities as well. As a side note, we’ll come to more detailed description of accrual basis of accounting later on so not to worry here if you didn’t quite get it.
Generally speaking, accounting is a list of entries made into two statements – balance sheet and income statement both of which we’ll explain later on. Each entry has two sides – debit and credit both of which must always equal (if there are say two debits and one credit, the sum of debits must equal the credit amount). And that’s that. That’s accounting and we’ll show you basic entries in our other course for basic accounting.
Accounting may also seem like a huge deal of math – adding, subtracting, but truth be told, it’s not that complicated. Even experienced accountants are known to add up 2+2 on their calculators so it’s perfectly okay for you to use a calculator to add figures up and to double check yourself. Once we move onto the statements you’ll realize that making a mistake means you’ll discover it very quick so not to worry.
Why do I have to account?
I would say that you don’t. Who said you have to? You would want to, yes, but you hardly have to.
If regulators drive the obligation then they’re interested to see how your business is going and most of all, if you’ve calculated all your taxes properly.
Now, besides the officials who based on your local legislation require you to report on your business, you’d want to account for number of reasons. Most of them we’ve already covered – you’d know your assets, liabilities and earnings for the period to put into simple and short words. With accounting you could also however compare yourself with other companies that are in similar business and you’d also be able to determine your future plans – if you can invest into new machinery for an example or if you can expand your business. You can also budget your future period results and even cash flows – whether they are about to flow in or out.
Long story short, accounting is your business’ bread and butter. To keep it going, you need accurate accounting. I know it seems I’m going over and over it, but that’s how it is. It’s so important and sadly often forgotten or overlooked.
For whom am I doing this again?
No, not just for some regulatory body, but also for your suppliers who might be interested in your financial performance, your investors and other creditors should there be any and more importantly, for yourself
How it’s beneficial for you we’ve already covered more than enough, however accurate and proper accounting is something that may cast informational light to your financial statements from your creditors and investors perspective.
Your creditors may be interested in seeing if you have enough resources to meet your obligations and keep business going, i.e. in buying further more goods. It also shows how you manage your assets – most importantly your receivables and how they relate to your revenue – how well are you able to collect for the sales.
Investors however are generally interested in seeing how you’re performing compared to the investment they’ve made into your company and how you’re doing generally. How you’re managing your assets and what are your earnings compared to your assets (i.e. what are your assets earning to them), it’s what the investors are interested in.
Accounting isn’t just for you, but for numerous other parties that have different agendas with this information however they’re interested in the same figures – your assets, liabilities and earnings for the period. It’s where the get their information – from your company’s relevant figures.
How do I start with my own accounting?
Starting with accounting, if you set your mind to it, isn’t all that difficult. There are certain things that need to be done and it’s best to do them properly, at the right time and keep consistency in all things.
Your list of actions is as follows (note that the list is not exhaustive):
- Deciding on the form you’re going to keep your accounting – in an accounting software or some other electronic form or on paper;
- Listing your main transactions you’re planning – purchase of goods and services, sale of goods and services, dealing with cash etc.;
- To all of the identified transactions deciding on the accounting entries going to be used – by debits and credits with all relating accounts for specific transaction types;
- For all the entries define documents being used – type, formed by what and who, obtained how, digital or on paper etc.;
- Describe how and where the documents are being stored – digitally or on paper, in archives;
- Authorization procedures if applicable for certain types of transactions.
And about all of this it’s strongly suggested and in some countries even obligatory to keep a document including all the procedures deemed necessary for specific accounting areas relevant to your company (i.e. dealing with cash, bank accounts, receivables and so on).
This set of internal rules is about what sort of documents are required for entries, to which accounts entries are done, when are they done etc. It’s mostly meant for you so you’d have a structure to refer back to remind yourself how you deal in certain areas – mostly to ensure consistency and compliance with regulations and accounting rules.
No, not debit or credit card, but your accounting debits and credits. You may also say they’d be your assets and liabilities because with debits and credits you’re “creating” your balance sheet and income statement. Normally and simply put with the debit side of an entry you increase assets or decrease liabilities and vice a versa with the credit side.
How debit and credit work is that the total of each side needs to be balanced – as the assets are to equal with liabilities and equity – it’s your assets versus someone else’s assets and investments into your company. They’re always to equal.
When we talk about debits and credits what we mean is exactly that – your entries onto accounts on your financial statements – assets and liabilities, income and expenses. We’ll define the terms in more depth later on and also give you lots of example entries in our course about basic accounting.
What to watch out for when first starting with accounting for your own business?
Consistency, accuracy and compliance – ensuring these three things is the key thing to remember.
Try to build up a clear and easily maintainable entry system – numbering, referencing to documents and building up accounts on the statements (if you’re having your accounting done on paper).
Make sure it’s not excessive or too unreasonable as in forming unnecessary obligations you may not be able to keep in busy times (i.e. a complicated referencing system or documents specifically meant for certain types of transactions that are not needed to be formed in such detail etc.)
One key thing to consider is if and if so than how you’re going to deal with cash – the most liquid and the most tempting form of asset a company can own. Cash isn’t easily traceable (unless you’re registering every piece of cash and even then it’s not that easy) and since it’s light and tradable right away for whatever means one may need it for, it’s the most tempting asset a company can own and have accessible for it’s personnel. Now something you should consider is who, when and how has access to cash and how will you ensure such temptations are not given in.
Where do I start with my accounting?
You’d start from the very basic thing – writing down your main transactions and how you account for them. Before making any entries you should keep a clear description of how exactly they are to be done.
To ensure accurate and proper accounting the very basic ground rules need to be clear, concise and followed at all times. Now those rules is something you should think through thoroughly and write down in such a manner they’re easily to be followed and reasonable. There’s no need to make unnecessary rules that are too complicated or too excessive to follow.
Another thing you need to consider is where you’re going to keep record of your accounts – is it going to be on paper or in some form of software.
Accounting in software is the easiest option – normally the accounting software is meant for the most basic entries as a bare minimum and includes referencing system to source documents amongst other very basic things. Accounting on paper is trickier however – trickier in the sense that human errors are so easy to drop in and what’s more, one can easily damage the information written on paper. Now, keeping records electronically isn’t obviously all that safe either, but far more so than keeping record of all your transactions on paper.
So your first two things – where and what exactly are you going to account for.
Common pitfalls when it comes to accounting
Making mistakes is first off only human of you honestly. We all do them in our everyday lives and with that in mind you’re no different. No offense. Now, to help you with the most common pitfalls people do, we’ve listed down a few so you’d know what to avoid for sure:
- My own personal favourite as I’ve seen it happen so many times – having too many or too detailed rules and descriptions for procedures. What happens? You won’t be able to follow them all, you will ditch a few and even more until it’s too many and too often ignored. What’s the point with having those procedures then if they are not followed? Key thing they must serve is being reasonable and benefiting accurate and sufficient in compliance reporting. Nothing more or less. Just make sure your internal rules are set with this in mind.
- Changing accounting policies for types of transactions you have in your accounting is absolutely normal and happens. Yes, not like very often, but still – you may change account types, create new ones based on transactions changing, choose to approach something differently etc. It’s normal and you just change your everyday entries. However, something you should also do and something that’s not the first thing on your mind is updating the internal accounting principles. Why should you do it? Simply because you’d want to make sure you follow structure and you know how to treat certain transactions at a later date. And obviously you’d also want your other employees dealing with accounting to also know how you’ve deemed it necessary to be done.
- Now something that happens and even more often than it would be good, is forgetting to make an entry. Especially when you haven’t set up yourself a routine of procedures or a daily or weekly of agenda of things that must be done. You no doubt understand why forgetting this isn’t that great so long story short – prepare yourself this list of actions so you wouldn’t forget. It’s nothing worth being ashamed for or anything because it’s a tool to ensure that even the most experienced accountants wont leave something undone. Even they use it!
- Doing an entry from your memory or quickly just somehow isn’t obviously forbidden, however dealing later on with entries done improperly can be a real pain. The reason you write down how certain types of transactions are accounted for in your accounting, what documents and how are obtained and stored etc. is done with a reason – so everyone would know that similar things are treated similarly, information is accurate in the accounting (and not so that one transaction is on one account and the very same transaction type is also accounted for on another account – all information is messed up in such a case) and easily traceable to documents with proper and compliant referencing system. There’s a reason for you to keep internal accounting rules easy, reasonable, detailed enough and up-to-date.
- Why is keeping proper records of all your transactions necessary? Why should you have detailed source documents for all the entries made in your accounting? When you think about it, it’s not that hard to guess now is it. Obviously the reason you’d want to have everything described on paper, authorized properly with signatures if applicable and also giving further information about the transaction as a whole is the need for going back in understanding some entries made in the past, looking for some proof for government officials etc. Every accounting entry is done based on some sort of information – basis for expenses and income, assets and liabilities don’t come from nowhere. This “somewhere” is what needs to be there and also kept there safe for required amount of years (determined by your local legislation, normally around 5-10 years).
- Whilst forgetting to make a specific entry is what happens every now and then, one pitfall we often face is the lack of routine that would be really effective and timely. Why not make sure when is the most optimal time for you to make those specific entries in question? The obvious goal is that you wouldn’t be overcome with the load of entries still to be done and those that are happening on daily basis whilst you’re still struggling with the older ones – not a situation you’d want to be in, is it?
- Why is it that we forget to check ourselves? Or is it even forgetting and not just thinking we weren’t wrong? From my own personal experience I can tell you, checking is what differs good accountants from great – great accountants know that double checking and by all means, implementing control procedures, authorization and 4-eyes principles etc. are just tools to ensure within their reach and capabilities they’ve done everything properly. Obviously there is still some room for error, but this room is tiny compared to the one left by those who don’t double check.
- It’s like with little kids or animals, depending on which you can relate to more – without discipline there’s anarchy and chaos. You’ve got files to keep track of (contracts, invoices coming in etc.), entries to make at a regular time, internal accounting rules to follow and regulations to comply. How to achieve all this? Make yourself a list of actions that you need to do regularly, add to the list your regular control procedures (like checking all contracts are there, reconciling detailed ledgers with balance sheet accounts, counting your assets etc.) and stick to it! There’s really nothing more to it. The reason I mentioned kids and animals (i.e. dogs or cats) is that it’s the same with them – make a list of things you need to do, agendas and daily routines – and stick to it. It’s the only way to ensure something actually gets done and do believe me, they appreciate structure in their lives and so does accounting (if it were a person obviously).
- With all these daily routines, internal accounting rules, control procedures it’s very easy to get all entangled in the beauty of having lots of rules and detailed procedures – ditch the ideas! List yourself only the procedures you do really, really feel are necessary and useful! Don’t overdo with regulating everything and more than needed. For an example think before writing down that you do stock counts every month – is it really needed or could you manage with once in a quarter or once a year? It’s the same with beauracracy – you don’t really appreciate it when there’s too much of it, do you. So, don’t make your life more complicated than it’s absolutely necessary!
How to make sure my accounting is accurate?
Number one thing when it comes to accounting is making sure it’s accurate – all your figures need to add up correctly, be accounted for using compliant measuring procedures and obviously be supported with source documents for all entries. Accounting is keeping proper books about your company’s financial performance. How else would you ensure you’ve really got a viable business for an example?
You wouldn’t. If your accounting is all messy and not really compliant nor supported or confirmed, not counted or measured for value routinely etc. nobody can really be sure of what you own and what you owe, what you earn and what you spend. Does your bank account on the balance sheet reconcile with bank statements for the same date? Does it? If it does, you would be surprised how easily it can go all not matching and how for some people it’s a load of work!
For assets there are things called stock counts, confirmations and obviously regular reconciliations. Just to list a few most common control procedures being used often in everyday accounting:
- Cash and bank accounts – perform confirmations with counting physical cash and confirm bank balances regularly. With cash being the most liquid asset a company can have it’s also the most tempting for someone to steal it and surprisingly it’s also what you pay your bills with. Reconciling the bank statements with your own accounts and ensuring your cash balances remain as matching is crucial – without cash there’s nothing to operate your business with!
- Account receivables – perform confirmations at least once a year and for most frequent clients even more often if deemed necessary. Why? Your accounts receivables to clients are your most important asset after cash and bank accounts – your bread and butter for keeping the business going. The importance of receivables derives from the fact they’re the residues of sales – you make a sale and you’re most commonly left with a receivable on your balance sheet. It’s your goal now to receive the balance as cash or as a payment to your bank account.
- Inventory – it’s what you sell! It’s your goods that generate revenue and if sold at the right price also profits. What you should do is ensure their safety (i.e. against theft, destruction etc.), proper and controlled access by other people and regularly check physical existence of all the goods in your accounts and vice a versa, check whether all good stored in your warehouse have also been accounted for. It’s one thing to check whether all the goods you’re supposed to have are really there, but it may also be so that not everything has been taken into the accounts – wrong shipments perhaps. And another thing, when doing the stock count, keep an eye out for goods that are older and not realizable, broken or long past their “best before” date for an example.
- Tangibles are assets being used to generate goods or support your business more or less (i.e. production lines, machinery or equipment like computers and buildings where the business is run for an example). Your regular control procedures when it comes to tangibles should be counting at least once a year to ensure they all exist and also check their usage and condition – whether some of them need to be written off or can be sold perhaps? Always something to be decided during those checks. Now something that’s not so much as a control procedure but rather something that needs to be done annually or more frequently if conditions arise is the evaluation of reasonableness of useful lives and residual values used. What you’re supposed to do is simply assess whether the periods and amounts set are still valid and reflecting the actual situation at the date.
And, just to add, this list is obviously not complete meaning that there are many more controls or procedures you could perform to ensure your accounts are accurate.
Since a balance sheet consists of two sides (we’ll come to more detailed description later on), in addition to having your assets in check you’d also want to ensure your payables are accurate just as well. After all it’s what you owe! For liabilities the procedures to be performed as a minimum are as follows:
- As with costumers, you also should confirm your payables to your suppliers – in that sense they’re no different. Bit of advice here though, even if the balance is zero, consider confirming those even so if transactions have considerable during the last period (i.e. year if you’re confirming balances once a year). The more there are transactions the more there are bound to be invoices missing or wrongly accounted for (i.e. typos, to wrong account or with a wrong date etc. – the more different types of dealings, the more opportunities of things going wrong). So, make your choices and confirm selected or all payables to suppliers at a certain selected date.
- Loan payables are also something you might want to reconcile to bank statements if they were taken from the bank or if not so, confirm balances at least once a year to ensure you haven’t messed up somewhere or as it’s two parties, that the other side hasn’t made an error anywhere.
- I would say that if your liabilities include any other significant balance that can be confirmed or at least reconciled to some form of more detailed information, it’s suggested to do so. Seriously.
- One thing is to confirm those balances you’ve also recognized but it’s also crucial to identify those payables you’ve got not idea about. How should one do that? What I would suggest is either depending on the size of your company and the amount of employees you have who are authorized to buy stuff for the company to either set up a confirmation process to be followed prior to making the expense so that the accounting would already know there’s an expense coming in even without the invoice or simply inform those few making expenses about the importance of getting all invoices in in due time. The choice is yours and as I said, depends on the size of your company.
Whatever you decide and which procedures you choose, always make sure they’re efficient, sufficient and reasonable. There’s no point in having a procedure that’s hardly worth doing. Oh, and make sure you either stick to those procedures you’ve chosen or that you clearly ditch them and pick on something that works (unless you decided you don’t need anything because for an example you no longer have cash and you just use bank accounts). Either way as always make sure you’ve got your procedures you’ve found needed all written down, you do them timely and follow through fully.
Accounting is a continuous process
By now you no doubt have realized that accounting is not a one-off thing but a continuous process one must do on regular basis – normally more than once a day.
As it’s a ever continuing process you’ve got to make sure that you’ve got your internal accounting rules all written down, updated and in reach if needed. You should always consult your own rules when in doubt – your accounting should be accurate and compliant.
Make sure you list down the entries that need to be done in your books – sales, expenses, taxes, payroll, bank charges etc. – and add when and how often they should be done. For an example payroll calculation is normally something you either do on monthly or weekly basis whereas expenses and sales occur on daily basis normally.
Doing those two things ensures you’ve got your accounting all set to happen continuously. Well, you still have to find time for it, but then it’s the importance of accounting I’d remind you so you should find time for it. It’s like with everything else in life – schedule for it and you’ll find time.
Best practices in everyday accounting
We’ve covered quite a few tips and advice for you by now. You what’s generally expected in accounting and what to watch out for when it comes to common mistakes done. However, since accounting is a continuous process done on daily basis there are things to be done every day:
- As we mentioned before, one of the most important things in accounting is having and keeping source documents for all your entries. Now, when making an entry, make a habit to prepare or obtain a document for it and store it in orderly fashion – i.e. all purchase invoices in one place, all sales invoices in another etc. Make some sort of ordering for you but don’t forget to store a source document for the entry.
- It’s for your own good to have a daily routine when it comes to accounting procedures – when are you accounting for expenses, when are you checking the bank etc. Make yourself a schedule and do make it a habit again to follow it. Accounting is a collection of habits if you will.
- Every now and then it happens that you mess something up in your accounts. It happens and it’s perfectly normal. A point to take away from this is however that you should fix your mistakes when they become apparent and as always, leave a source document explaining the entry. When accounting entries is just debit one account and credit the other (or multiple accounts), its not telling the reason why this entry was done and what triggered it. That’s something a source document is for.
- In case you’re not the only one doing accounting entries in your company please make sure you’ve got clear roles and responsibilities communicated to everyone involved in accounting – everyone needs to know who is doing what exactly and when.
- Do you know where everything is? Keep order both on your desk and in your computer. It sounds simple and so obvious, but truth of the matter is that experience shows otherwise – documents laying around and piling up, files gone missing from the computer, too many working files for one thing etc. Keep order and see your life going a lot easier.
- You no doubt have various reporting dates – if not for investors or similar, surely you’ve got some reports to be filed for government bodies or tax officials etc. Something I strongly recommend is having those deadlines in front of you and possibly also a list of materials you need to obtain beforehand or statements you need to prepare for those reports. Have your list of actions ready and try to schedule those things to be done timely.
Accounting is a process of little things you do on daily basis. It’s best to be on track and make sure that what you do you do timely, accurately and with ease. Accounting as everything else in life should not be done with stress and believe me, those little best practices are what make sure you’re having as little stress as possible when it comes to your companies accounts.
I bought stuff, now what?
You bought something for your own business and now you know you should account for it. You’re not running a shop in some small village like 100 years ago where you could just get cash from the till, go buy something and be done with it. No.
The way we do things is quite the opposite. I mean we still take money if we are going to pay by cash, but there’s more to it. Yes, we also pay via bank transfers, but that’s not what I’m on about.
Accounting wise, what you ought to do when making a purchase is the following:
(1) Debit (2) Expense account / (3) Inventory
(4) Credit (5) Cash / (6) Payable to suppliers
Let me explain now what this accounting entry is about.
(1) Accounting entries normally start with debits to keep them similarly structured. So in case you’ve bought something, your debit entry can be two things – either you’ve made an expense as in you bought something to be used right away (expense) or just as an office supply to be used at a random time and either way, not to be sold. However, in case you bought something to be sold at a later date, it’s inventory on your accounts and not expense (increasing assets). Remember, increasing your assets and expense entries are always on the debit side.
(2) In case you bought office supplies, services or fuel for the car for an example, and not something to be sold later on, you made an expense and you should account this sum on the appropriate income statement account. Always make sure the account you’re charging the expense is correct and that you’re not putting office supplies for an example on the rent expense account.
(3) Now, as we mentioned, if you bought something you plan to either use in the production or sell sometime later, it’s inventory on your balance sheet and should be accounted for accordingly. It’s not put into expense right away but at the time you use it in the production or make the sale, i.e. sell the item. So with your debit entry you may also just increase your inventory.
(4) As accounting is always two-sided, there’s also the credit side of it. Note here, that with credits you decrease assets and increase liabilities. In case you’ve bought something you’re normally expected to do one of the two things – either pay for it right away with case (decreasing assets) or pay later on which means you’re taking up a liability (increasing liabilities). Makes sense, doesn’t it?
(5) One means to settle with your suppliers is to pay cash right at the spot. This means you take some of your funds – either you already have cash or you have to go to the bank, either way you’re decreasing your most liquid asset. So as you’re either putting sum paid into your expenses or inventory, you also should show how you’re paying for it.
(6) Another means for paying to your suppliers is as we said via bank transfer. Now as this normally is something that takes time and is to be done at the date when the payment is expected to be done (the payment date set by the supplier that’s on the invoice), you should show this as a payable to your supplier – you should show that you’ve got a liability you need to settle in due time. Paying the invoice is on it’s own another entry, but generally speaking, when making a purchase, you either pay cash right away or take on a liability to pay later on.
And this is how you account for your purchases. You charge it either into expenses or put into inventory and also on the other side make an entry for the payable or show that you paid right away.
How to account for paying those invoices and selling inventory is something we’ll explain in more detail later on.
I made a sale, help!
Making a sale is what the business usually is about – you sell things or services to earn your living. That’s what you’re expected and supposed to do when you’re in business. Now, there’s also this thing called accounting for the sale obviously.
Again, to start off, if you were living 100 years back and would own a shop for an example, you just charge customers money for the sale and put the money into your till. That’s your sale and your revenue. From the funds in the till you purchase more goods and charge your customers again when they make a purchase in your store.
Although nowadays in stores the system hasn’t changed much, you’re still expected to do something extra – you’re expected to account for your sales. Now I wont go over why it’s important not just for someone else but you so let’s move onto the accounting entries now shall we?
Your accounting entry in case a sale is made, should be something like this:
(1) Debit (2) Account receivables / (3) Cash
(4) Credit (5) Sales revenue
And in case you’re selling goods, the additional entry with every sale made is as follows:
(6) Debit (7) Cost of goods sold
(8) Credit (9) Inventory
Let me explain now what this accounting entry is about.
(1) You just made a sale and hence it’s expected you got an asset – hence the debit entry that’s about to increase your assets. Now note here that the asset can be in two forms – cash that you can use right away or receivable balance that’s still to be collected.
(2) Account receivable is something that you still have to work on in real life – you’ve got to ensure your client pays up their debt. Normally you’d expect no problems and as such there isn’t much to be done initially with it. Just wait until the payment is due and account for the payment. In case they are late, make sure you contact them and let them know you’re not leaving it just like that. But besides that the logic behind this receivable is the opposite when you’re owing to your suppliers. You made a sale, but your client is going to pay at a later date. You’re still accounting for the revenue and the receivable balance against it. It’s still your asset; just it’s a “receivable”. I think the name itself says it all.
(3) The other form as we mentioned is cash. It’s easy and simple. You sell something and you get paid for it right away. Nothing more to it. You account for the sale and the benefits received.
(4) Since there cannot be a debit without a credit, there’s something we should put onto the credit side with the “I made a sale” entry. When we’re putting expenses onto the income statement with a debit entry than consequently all revenue and income is credits. It’s something we’ll explain further on when we talk about statements and then describe how the balance sheet works, but for this lets just say that revenue is on the credit side.
(5) The most important line some people would say – sales revenue! You made a sale and obviously you should account for it. Doesn’t really matter by which means you’re getting paid – right away or later on – you made a sale and you should show it on your income statement.
(6) As we mentioned earlier, with debits you charge expenses onto the income statement. With buying inventory it’s not your expense at the time of the purchase, but at the time of the sale of the item.
(7) Cost of goods sold is as the name says, expense of those goods that you had previously bought and that you’re now charging into expenses since you sold them. They were your assets before the sale, but with selling them you don’t own them and hence they are expensed. Note here that with every sale made there should be corresponding expense recognized as well (unless there isn’t an expense like for real, for an example if you’re selling advertising space on the outer walls of your shop).
(8) When the debit side of this additional entry was expense onto the income statement then there’s bound to be this something we’re putting into expenses. In our case we’re selling our inventory hence we’re crediting our assets.
(9) Something that very often gets forgotten is crediting the inventory balance. You made a sale, you account for the cash received or the receivable balance, but the inventory is something that should be done in addition – you sold something from your assets hence you should show that you don’t own this asset any longer. Something I’d suggest from personal experience is making those entries, both sale and the expense entry together. Always.
Making a sale is the most important thing you do in your business. Without it you would not have a business. It’s the accounting entry your bound to do and hopefully pretty often. As a result I strongly recommend making it so that alongside with your revenue entry you’re also charging for the expenses made for the sale, namely the goods sold with this particular sale. It’s so easy to forget this at the start at least, trust me.
I got services – should I account for this? How?
The accounting for receiving services doesn’t differ much from the entry made when purchasing something. You essentially still bought something, but this something isn’t an item and you shouldn’t put it into your inventory hence there’s just one place to charge it – into expenses as you got the service or split over the period the service is received (i.e. if it’s a commercial that’s shown two months in a row, the expense should be accounted 50% in one month and 50% in another month making it a prepaid expense on your balance sheet at the end of the first month).
The accounting entry you do is as follows:
(1) Debit (2) Expense account
(3) Credit (4) Cash / (5) Payable to suppliers
Let me explain now what this accounting entry is about.
(1) Normally accounting entries start off with the debit entry to ensure consistency. Now since you bought something, this debit shows that you made an expense.
(2) The amount paid is charged into expenses and namely onto the account the expense most relates to, i.e. when you bought some commercial services, it’s to be shown on marketing expense accounts (in case you’ve got several, do make sure you pick the most appropriate one).
(3) As every accounting entry has two sides, there’s something to be credited.
(4) One thing you can credit, in case you paid right away on cash, is the cash balance obviously. You had to give up some of your assets and hence the crediting of your resources.
(5) In case you didn’t have to or didn’t choose to pay with cash, you’ve got yourself a liability that’s to be settled later on – a payable to supplier. That’s also something that’s done with credit entry as you’re increasing your liabilities. You didn’t pay right away but you did get the benefit, the commercial. As such you owe something to the supplier and your balance sheet should reflect this liability.
As you can see, it doesn’t differ much from when you buy items. The only real difference is the fact that items you can put into inventory and expense when they are sold. With services you’ve got to follow one simple rule – charge into expenses when the service is received or into the period the service relates to. If you’re paying rent upfront for a period in two months time, it’s in your prepaid expense up until the month the renting is actually happening. Always, always check the period the service is received.
Statements? What statements?
The statements you’re making your entries into are called balance sheet and income statement. These are the ones that are the most important and the mostly used – for government officials, investors etc. Importance of those two statements is something we’ll cover in more detail further below, but let it be said that there are two or even three other statements one can present for a company – statement of cash flows, statement of comprehensive income and statement of changes in owner’s equity. Those are the statements that mostly just form from the main two and are not separate statements you make entries into. These statements come into play when you’re preparing your company’s annual report and you’ve got to present all sorts of detailed information about your company’s results and performance. However let us move now to those two main statements.
A show of your assets and liabilities, it’s what the balance sheet is all about. As the name says, it’s a balance and as such it’s where something balances with something else, i.e. your assets must always equal the sum of your liabilities and equity. You can look the balance sheet as two columns – assets are what your company owns and liabilities alongside with equity are something others (other than the company itself) have invested into your company. How does it always equal? Well, as you recall, all accounting entries have at least two lines – one debit and one credit and since they are always equal, the balance sheet will always have equal sides. It must balance. On one side you acquire something, but with acquiring until you haven’t given up your other assets, you owe something, which means someone else “invested” money into your business. Until you haven’t paid up this debt, they are your investors (or creditors). But enough about arithmetic and philosophy, let’s continue with the balance sheet itself.
On your company’s balance sheet what you do is group similar assets into one category – i.e. current and non-current assets. The similar grouping should be done with liabilities – current and non-current liabilities. What’s similar about those? Current means it’s either to be made liquid, meaning you get cash in return (for assets) within next 12 months from the balance sheet date or to be settled (for liabilities) within next 12 months from the balance sheet date. And consequently everything else is non-current meaning they are to be settled (made liquid or paid up) within more than 12 months from the balance sheet date. Yes, as you may have gotten the 12-month period is the key here. What it means literally is within next financial year and hence the split of assets and liabilities. Investors and everyone else reading your reports are interested to know of your liabilities you’ve got to pay up during the next financial year and what have you got in return to settle those debt balances, i.e. your current assets you should be able to collect as cash and obviously cash balances themselves. That’s what the current and non-current balances are all about.
Obviously, a more detailed balance sheet would include different account numbers and accounts on their own, but if you’re presenting your balance sheet to someone, it’s wise to group similar type of assets into subgroups, like prepaid expenses for an example. You may have separate accounts for prepaid rent, fees, subscriptions etc., but on the not-so-detailed balance sheet they’re all “prepaid expenses” for an example. And it’s the same with liabilities, nothing different here when it comes to showing those balances.
What a balance sheet in short is, it is a summary of what your company owns on its own and what it owes for what it owns or will own or did own (as liabilities are something that a company can still have even after they’ve already disposed of the asset they acquired). Note here that the balance sheet is always for a specific date – balance sheet date. This date represents the date when the reporting period ended. It’s the date, when reported together, your income statement should have its period’s ending date. For an example, if your balance sheet date is 30.06.2012 and you’re reporting for the period of 31.12.2011 until 30.06.2012, your income statement is prepared for the period of 31.12.2011 until 30.06.2012.
The income statement is something that shows your incomes (as the name says) and your expenses just as well. The reason it’s called “income” statement is because it starts off with your revenues and by taking off all your expenses you made to get to those sales, we’re left with net profit, which is your income. Income in the sense that it’s what you can say you earned.
Another reason it’s called income statement inevitably comes from the purpose of a company – making profits, i.e. earning income. It’s to show if and if so how much your company earned during the reporting period the statement is prepared for. Something that’s different when it comes to income statement compared to the balance sheet is the fact that this statement is prepared for a period and not for a specific date. An income statement is for a certain period – a month, a quarter or a year – whatever is required and you choose to report. When you present your income statement, do make it a point to present it with a heading that’s for a period and not just the ending date of the said period. It’s such a common mistake to make and yet so easily avoidable.
Something to also note about the income statement is grouping. Similar types of revenue are always grouped together and so are expenses. You wouldn’t want to show your renting expenses under car fuel expense accounts, would you? Well, you shouldn’t. So what you should do is just show similar transactions grouped under lines which describe the expense the best, i.e. if your company rents cars, buys fuel for them, pays for the insurance and maintenance, why not group them under something called “car expenses” for an example?
And it’s not all. When it comes to showing your income statement to those that are interested, you would want to group it more – group expenses based on their function or nature.
It’s something we’re explaining in more detail in our course, but very shortly I’ll fill you in. When we talk about grouping expenses based on their function it’s meant so that you group expenses which are made for similar business division, i.e. marketing, production, administration etc. All personnel expenses, depreciation, office expenses made etc. are grouped under which division they are made within. If for an example you have marketing activity, you’ve got people responsible for it, all of their expenses are shown under marketing expenses on the income statement – payroll, car rent, car fuel, room renting, utilities etc.
Now, when we talk about grouping expenses by their nature though, it’s like the name says, by their very nature – personnel costs (payroll, social tax etc.), depreciation, operating expenses etc. You paid salaries, it’s personnel costs and by nature it’s grouped under there.
And that’s very shortly what the income statement is about. It’s to show all your revenues and all the expenses your company along with all your employees made for those revenues. And obviously what’s left of your revenues after those expenses, i.e. your net profit. Something making a business is all about.
Things to always do
Keeping your business going is an everyday job mostly – there are things you’ve got to do to keep it all running smoothly and to ensure you’ve got your customers happy, you’ve got your invoices paid and last, but not least have your accounting in order. If you don’t have this last thing, you can kiss your business goodbye pretty soon, trust me. I’d say it’s like the basic foundation you start building on a good and sustained business. Why so?
Think of it as having your body running on healthy food. It builds strong base inside, but also shows it outside. It’s similar in business – keeping order, having discipline and understanding the importance of accounting is what makes sure you can keep your customers happy (FYI, you get a lot more time to make sure they are so when you follow our simple steps to make sure your accounting is properly set). Putting effort into accounting also ensures your suppliers are well treated, i.e. you pay invoices on time; don’t get into their “bad client” list etc. And most importantly, good accounting gives you an overview of where you are with your business – are you making profits, have you got enough resources to fulfil orders, to pay up debt and so on.
However, as with keeping your own body healthy, there are things you’re expected to do with accounting just as well. There are things that don’t exactly result in accounting entries per say, but are done just as well. Most important I’d say is keeping in mind that they are to be done regularly and making yourself a habit of doing them rather than forgetting and them remembering and guess what, realizing you’re in a mess all of a sudden. How does it happen? When you forget to:
- Do regular stock counts. How regular? It depends on your locations where you keep your goods and how many you have them. Normally bigger store chains do them at least twice annually and more regularly for goods that are more attractive to be stolen. How regular then, I’d say at least once a year since you’re mostly expected to report your financial year results and as such, obviously as close to year end as possible and practicable.
- Do count your fixed assets. Why? Truth is that the more you’ve got them the more they are prone to get lost, get broken without you actually realizing it or having an oversight of it. When you count them, you inevitably think whether you’re using this asset or if it’s even usable. Getting an overview of your fixed assets helps you understand how much of what you thought to owned and had in use is actually so and can decide on further actions. I can tell you that this is something every business does when it has considerable amount of fixed assets and even more so if it’s spread between people and is carried around like laptops for an example.
- Do confirm balances with third parties – your customers and suppliers. Why you ask? Well, I’d ask what are your arguments against it. By your legislation you’re most probably obliged to “confirm” all your assets – your cash balances, your inventory (by stock count), your fixed assets by physical counting and then there are your receivables. How else could you “confirm” that you really have them as your assets if you don’t confirm the balances with said parties – the customers the balances are against? I don’t know, but for me it makes sense. And with payables it’s similar situation – wouldn’t you want to ensure you’ve got your liabilities in correct amounts? What if you think you owe a huge amount, but in fact it’s apparently already settled or credited and your records for some reason don’t show it? Or what if it’s vice a versa, like you don’t even have a balance, but it turns out you didn’t receive an invoice for a purchase and forget yourself you should have asked for it and obviously didn’t account for the acquisition as such as you didn’t receive the invoice. How often should you perform confirmations? Again, I’d say that at least once a year and as close to year end as possible of course. If possible, I’d do the confirmations for the balance sheet date itself.
- Do reconcile your bank balances with bank statements. I find it remarkable of how much you can check on yourself if you check whether your balance sheet bank accounts match with those in the bank. You make payments via bank statements? You can easily ensure you’ve accounted for all on your balance sheet. And it’s the same when you’re dealing with cash – regularly keeping track of all your in- and outflows and reconciling your physical cash to what it should be according to your transactions ensures you really made all entries and what’s more, if they were correctly made.
- Do accrue expenses regularly. What’s accruing? It’s something we explain furthermore in our course about basic accounting, but for points sake I’ll explain shortly of what it is. There are times you already received the service or bought something, but didn’t get the invoice for it just yet. If it’s just a question of few days in the middle of the month you may say that I’ll wait for the invoice and then account for it. Well, if it were not a regular case for you I’d say okay. However, keep in mind that it’s always better to have a clear track record of everything you’ve done and not keep something pending. What I mean with it is accruing for the expense already without having the invoice. What accruing in essence is is recognizing you’ve got a liability, making an expense entry alongside with the liability one, but it’s not under payables to suppliers just yet, but under accrued expenses.
- Do store your source documents. It’s one thing to have them for each accounting entry and understanding the importance of having them, but there’s no point in having them if they’re lost somewhere under piles of other documents or thrown accidentally away or something similar. Right? So what you’ve got to do is ensure they’re safely and orderly stored away somewhere. For how long? It depends on your local legislation, but the periods are around 5-10 years normally.
- Do keep your internal accounting rules up-to-date. Why? Well, we’ve covered the importance of it already, but I’d say very shortly that’s the only way you may know what and how is exactly done in your accounting. If you’ve set a transaction to be accounted in a certain way with certain documents to back it up by then it should be done so. If you decide it’s impracticable or conditions have changed you should update the accounting rules just the same. Why? How else would others know how things are done in your accounting should they need to know? And you yourself. Trust me, you forget especially those not so everyday entries – how were they done again? If it’s all written up clearly in your accounting rules, it’s like your manual to follow. Why not make the best use of it instead of reminding yourself every time and messing it up as you do something differently each time. When you later on have to back in time in your accounting and you realize some entries are done one way and others differently, you’re going to be quite upset. Trust me on this.
Obviously you’re expected to do your accounting entries regularly, but as you can see, there’s a bit more to it. The actions listed (note that it’s not all obviously, but just the most common ones) are also something often called “control procedures” – something you do to ensure everything is accurate and correct in your accounts. Accounting is not just blind entries – real physical world and other parties reflect on what you have going on – your assets, your liabilities. It’s all confirmable and reconcilable and my recommendation is to do it as often as reasonable and practicable, but at least once a year.
Making sure you don’t forget things
Should you ever see my desk – it’s filled with yellow, pink or blue post-its each with a note, a comment or an idea on it. I get an idea, a phone call or something similar and I need to do something later on, remember an important thing etc. How do I do this? With post-its, that’s my thing.
Now, a post-it may not be your thing, it may be a notebook or something completely different, doesn’t really matter. The point is to ensure you’ve got all your “things I need to do” listed somewhere you can see them and somewhere you can see them sooner rather than later.
What else? Keep a list in front of you of things you must do on daily basis. Have them listed in the order you’re supposed to do them and most importantly, schedule time for them! It’s usually not the things you forget, but the time that you need for them. How often you’ve noted that you still have loads to do, but no time for it? Too often I’m guessing.
How you make time for it? You schedule for it. I schedule for everything and I do it into my calendar. If I know that certain activity will take 2 hours of my time, I schedule 2 hours for it. If there’s a list of things I estimate will take 0.5 hours, I schedule for it. This way I can see how my day will look like and when exactly I have time for specific things I need to do. Trust me on this; it will make your life a lot easier. Knowing when you’ve got time prepared for something will ensure you’re able to almost forget all about until the time arrives. Without scheduling I know I will have it in the back of my head pounding and leaving me wondering when exactly will I have the time and how long will it take etc. Order of actions to take should be like this:
(1) Think how long will it take of your time.
(2) Look up all other obligations and when will you realistically have time for it. Do consider the due date and possible involvement of others as well.
(3) Schedule the time in your calendar.
(4) Deal with other things in the mean time.
My life went a lot easier when I discovered this method. I know that there are people who think I’m crazy and overthinking etc., but truth of the matter is that those people are always doing more working hours and have a lot messier projects than they could. This applies to your everyday life just as well when you’ve got to share your time between too many things. You’ve got to schedule time for things in your life or the time will pass by so fast and you’re still left with things that are not done.
Documents in accounting
I think I cannot stress the importance of documents in accounting enough.
When it comes to documents in accounting though I don’t just mean source documents like invoices or cheques. What I also mean are contracts, minutes of meetings etc. It’s also your internal accounting rules I’m talking about.
Accounting is not just entries into your accounting software or Excel or whichever form you’re keeping your financial records, but also lots of documents. The form of them is mostly optional – either on paper or electronically, but depending on your local legislation, please ensure you have the appropriate form. I know that there are countries where keeping digital source documents and other documents is absolutely acceptable, but they have to be physically producible (i.e. printed out) and something that also has to be there in such a case is digital signatures. If you’re not able to sign documents digitally or it’s not legit you’re still obliged to have lots of documents on paper. However, in case digital signatures are totally okay by law in your country and you prefer having your documents as much as possible stored digitally then go for it! I’d say that keeping digital documents all organized and safe is a lot easier than doing so with physical ones. Obviously you’ve got to keep back-ups, but that’s easy nowadays where you can outsource almost everything.
With documents you have to ensure that they are also there after a certain time. This “time” is something that’s determined by law mostly. You must keep all source documents for x amount of years from the time they were used in accounting or something similar is what’s usually said in the regulation. Why? The reason being is mostly for government officials. When they’re investigating something, they may want to go back in time and hence the obligation to keep those documents. It’s also for your own good or for investors or auditors and whatnot. Everyone who may be interested in going back in time in your accounting to see what was done and on which ground, i.e. with which documents, would be interested in those documents as well. Hence keeping them safe, organized and in such form that they are readable after this x amount of years is important.
Referencing in accounting
It’s like you made an entry into your accounts and you had your document for it. How do you connect those two? I mean yes, of course right now you know and after a short while you may still remember the document this entry is made based on, but what about tomorrow or the day after tomorrow? Will you still remember the document? I sincerely doubt it and this is why referencing was invented.
Referencing in accounting is something you should do naturally, but also systematically. Naturally in the sense that you just do it and you always do it without forgetting or arguing yourself whether to do it. The system itself is entirely up to you to work out and in doing so I’d like you to think about few things:
- It’s the same with everything – keep it easy – there’s no point in making your system overly complicated, for an example giving all documents numbers that are like 10 digits long. Is there a reason for it? I doubt it.
- You’re making your own life a lot easier if the system is understandable. For an example, why not but the letter “P” in front of all invoices you’ve received from your suppliers? It would refer to a “purchase” and in this case you’d know where to look for your document (from the invoices folders obviously).
- Think which documents you want to number separately (i.e. documents you’ll be storing separately) – is it the invoices, purchase orders, tax statement and whatnot. If you’re storing them separately, it’s advisable to also keep their numbering separate and keeping our previous point in mind, have a meaningful letter for an example in the coding.
- I know that it sounds like so silly, but do make it a habit to write those numbers in one understandable format, on the same place on documents and preferably also in different colour, i.e. if the document is all with black text the reference number should be written in blue for an example. Just so it’s easily notable.
Referencing properly is the key to having meaning of all of those documents you’ve stored. Without references how would you ever find what you’re looking for? And what a mess it would be. So take the time and think through which numbering system works the best for you. Remember, there are no ground rules by law or some such, it’s all you and it’s also you who has to work with it.
One ground principle you must never forget
There’s no excuse for this and what’s even more, you’ve got to retain those documents for 5 or so years, depending on your local legislation. Yes. If there’s no source document for an expense than how did you know the amount to account for? Or to which account it should go to – is it really rent? I know that keeping source documents is something we’ve discussed over and over again, but it’s really important.
It’s important and yet it’s neglected and not considered as one at the spot but considerably regretted later on. Trust me on this. Keeping things on track with having source documents for each entry, referencing them properly to the entry itself and storing those documents whether physically or electronically in the end makes your life a lot easier.
So please keep this one rule in mind – have source documents for each entry. For each entry in your accounting make sure it states the sums the entry is made in, the reason for the entry or what the entry is about and most importantly that it’s also referenced to the entry (i.e. the entry has the same document number than the source document carries).