Video: Bookkeeping 101

This one is an oldie, but a goodie. We’ve had this video in past versions of QuickBooks for Mac. It’s a little dated in the look and feel, but still has some great information. If you’re brand new to running your business with QuickBooks, it’s a good intro to some basic concepts. In this video, Tom Dorr of the Small Business Development Center uses the example of the Avenue Bread and Deli to show you the basics of bookkeeping for your business.

[Editor’s note: I edited out the long intro to get right to the heart of the video. You don’t miss much, just an introduction to Wendy and her bakery. But you’ll hear Tom talk about them so I didn’t want you thinking, “What’s he talking about? Who is Wendy?” – Shelly]

Video Script:

Hi, I’m Tom Dorr from the Small Business Development Center. Organizing your finances can seem overwhelming. But I’m here to help you learn how easy it is to manage your business finances as part of your daily routine. I’m going to show you the basics of accounting, how these concepts relate to your day-to-day activities, and how financial software can make the whole process easier.

Financial management can help you:

• Know where your money is coming from and where it’s going.
• See which customers or products are most profitable.
• Save time by organizing your critical information in one place.
• Help you prepare for tax time with accurate and complete records.
• Make more informed decisions with financial reports.

The core activity of any business is money coming in and money going out. The cycle of money is called cash flow. Of course, the goal of the bakery or for any business, is to bring in more money than it’s paying going out. Let’s follow the cash flow of the Avenue Bread and Deli.

Money comes in from sales: a customer buys a dozen pastries, another buys a sandwich for lunch, a student buys a croissant on the way to class, and a commercial order is shipped to a local grocery. Each of these sales adds money to the bakery’s cash flow.

Now as heavenly as pastries are, they don’t appear out of thin air. The bakery pays money out to purchase ingredients, like flour, sugar, and eggs for the goods that are sold. The bakery also buys supplies, pays utilities, and pays rent. Plus, Wendy, the bakery owner, pays herself and her employees. All of these transactions are expenses that take money out of the bakery’s cash flow.

The Profit and Loss Statement

The Profit and Loss Statement is how Wendy’s accountant sees the same information. Also known as an income statement, the Profit and Loss Statement summarizes the money going in and out of a business over a specific period of time, a month, a quarter, or a year. All sales are recorded as income and all expenses are listed by type and totaled together. By subtracting the total expenses from the total income, the report shows the net profit—the money Wendy has to leave in the business or take for herself.

What’s more, because the bakery used financial software to record all their sales and expenses, their Profit & Loss Statement can created quickly and easily. Now according to the Profit and Loss Statement, the bakery was profitable during the reporting period, which is great news, but it’s only half of the picture.

Here’s what we’ve learned:

• The cycle of money in and money out of a business is called cash flow.
• A Profit and Loss Statement reports your net profit for a specific period of time.
• The Profit and Loss Statement is only half of the picture.

In order to see the whole financial picture, we need to consider every transaction from the moment Wendy invested her money in the bakery and took a loan from the bank. While the bakery’s Profit & Loss Statement showed a net profit for that month, there are other transactions which factor into the bottom line. These transactions are categorized into three sections: assets, liabilities, and owner’s equity. Now, don’t be scared off by these accounting terms. They are basic concepts I’m here to explain.

• Assets are everything your business owns, like cash, bank accounts, accounts receivable (what customers owe you), and equipment.
• Liabilities are everything your business owes to others, like credit cards, sales taxes, and loans.
• Owner’s equity is what the business is currently worth to you. It includes your original investment, called capital investment, and your retained earnings, which are simply the combined total of all sales less all expenses since you began your business.

The Balance Sheet

The Balance Sheet is how Wendy’s accountant views the same information. It categorizes the bakery’s assets, liabilities, and equity to show the financial health of Wendy’s business at a given point in time. It’s called a Balance Sheet, because the total of all the assets must equal the total of all the liabilities and equity. They always balance, or have equal value, because the liabilities and equity were used to obtain the assets.

To determine the financial health of the bakery, the best place to look is the ratio of current assets to current liabilities. Current assets are assets that will be converted to cash within the next 12 months and current liabilities are liabilities due within the next 12 months. A healthy business should have at least a 2 to 1 ratio, that is, twice as much current assets as current liabilities. In this case, the bakery has a much higher ratio and should consider investing the money or paying off loans.

The Profit and Loss Statement and Balance Sheet together give you the overall picture of your business finances. The Profit and Loss Statement reports your net profit over a specific period of time while the Balance Sheet shows you the overall health of your business from the moment it began.
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Here’s what we’ve learned so far.

• Assets are everything your business owns.
• Liabilities are everything your business owes.
• Owner’s equity is the overall value of your business at a point in time.
• The Profit and Loss Statement and the Balance Sheet give you the overall picture of your business finances.

But where does all this information come from? And how do you know it’s in the right place? To make sure your financial statements and reports are accurate, you need to understand where, why, and how each business transaction is categorized. The key is the Chart of Accounts.

The Chart of Accounts

The Chart of Accounts acts like folders where you file away your transactions.

• Income accounts include sales and other revenue accounts like fees and interest.
• Expense accounts are costs associated with running your business like supplies, rent, salaries, and raw materials.
• Asset accounts include your bank accounts, accounts receivable and equipment. Assets can also include buildings, land, and vehicles.
• Liability accounts include credit cards, sales tax payable, and bank loans. They may also include unpaid bills known as accounts payable and payroll liability accounts.
• Equity accounts include capital investment – the money you invested to start the company – and retained earnings accounts—the remaining profits since you started the company.

The Chart of Accounts is the framework used to categorize the information you rely on to create Profit and Loss statements, Balance Sheets, and valuable reports that help you guide your business.

The Chart of Accounts is made up of the income and expense accounts used by the Profit and Loss statement; and the asset, liability, and equity accounts used by the Balance Sheet. These five account types are common to all businesses. Each time Wendy enters a transaction into her financial software, she categorizes it into one of these five types of accounts.

Setting Up Your Accounts

Most financial software products will make it easier by providing a basic chart of accounts for many types of businesses. You can customize the accounts to meet the specific needs of your business. Be careful to avoid these common mistakes:

• Don’t create too many accounts. Too much detail can be burdensome. You can always see the details by running a detailed report.
• Be as descriptive as possible when naming your accounts. Descriptive names help you find the correct account quickly and easily.
• Be consistent when entering your transactions. For meaningful reports and comparisons, it’s very important to use the same accounts for the same transactions each time.

A simple, straightforward Chart of Accounts is a great benefit when managing a large number of transactions in your busy business day.

Reports

One of greatest benefits of financial management software is on-demand access to reports to see how your business is doing. For example, at the bakery, Wendy can instantly see information like:

• What’s selling? The sales report gives Wendy an overall view of the sales of her business. By clicking on a sales category total, like Bakery, Wendy gets an instant breakdown of the sales total by item.
• Who is buying? Wendy can run a report to see the sales of each of her commercial accounts for a given period. She can compare periods to see which accounts are growing.
• Who owes her money? Wendy can run a report detailing all of the invoices owed to her and when they are due.

Reports and financial statements provide a complete financial view of Wendy’s business with increased visibility into her profitability and cash flow. Wendy can feel more confident about the decisions she makes because they are based upon solid financial management.