So, this exciting new business opportunity has begun. How do you keep track of paper? Like it or not, every April 15th, we have to report our actions from the previous year to our friends (or enemies, depending on your mindset) at the Internal Revenue Service or the IRS. Even if you have already started your business, I am going to write this as if it were the first day for you. For the purposes of this article, I’m also assuming you’re starting a simple, sole proprietorship business. In order for the IRS to consider your business legitimate, you must treat it as a business and not a hobby. The first thing you should do is open a separate checking account just for your business and keep all business finances separate from your personal finances. This is the number 1 cardinal rule that I religiously follow in all of my businesses. I NEVER get money out of the register to buy a soda. And if I use personal finance to make business purchases, I save the receipts and record them in my business books as an increase in my owner’s investment account.
Most of you probably aren’t accountants, and the word “accounting” sends you screaming to the streets. The word “taxes” also makes many of you tremble. But really, they shouldn’t, it’s just talk, and both accounting and tax can be very simple. As your business grows and diversifies, you may need to get a bit more complex, but for now, you can keep your books in a simple Excel spreadsheet or one of the many accounting software packages out there. I personally like QuickBooks Pro because it’s very easy to use and forgiving when you make mistakes. For a beginner, it works fine. Accounting is really simple: there are three basic financial statements you need to understand to run your business. Once you get that, it’s easy to file a Schedule C for your taxes.
The first of these forms is the Balance Sheet. It’s a comparison of your assets (things that make you money) on the left, and liabilities (things you owe) and equity (the net worth of your business). Assets include current assets such as: cash in the bank, savings, inventory, prepaid expenses (such as insurance), accounts receivable (money owed to you), and fixed assets. Fixed assets are the most expensive, usually tangible items you buy for your business (such as computers, desks, equipment, etc.). As a general rule of thumb, anything that costs you more than $1,000 should be capitalized and depreciated over time. (I’ll cover that in another article.) Liabilities are: the bills you owe, any loans and credit cards for your business. Capital is the money you have personally invested in your business and any retained earnings from your business. When you add up your assets, the total should equal total liabilities + equity.
The second financial statement and probably the most important is the Income Statement. It is a snapshot of your business activity at a current time. I encourage you to prepare one at least once a month to stay on top of your earnings position. The following is a simple Income Statement:
Dirty
Cost of goods sold (what it cost you to buy or make the supplies or products you sold)
Direct sales expenses (related only to the sale of your product or service)
Gross Profit (Sales – Cost of Goods Sold – Direct Selling Expenses = Gross Profit)
Bills:
office supplies
phone
utilities
Rent
Repairs and maintenance
Travel (separate travel meals from all other travel expenses)
Everything you need for your business
Total expenses:
Net Income (Gross Profit – Total Expenses = Net Income)
The third financial form that you should prepare regularly, at least weekly, is a cash flow statement. I’ve seen many forms of these over the years, and they can be very complicated, but simply put, you want to see where your cash position is. It’s like balancing your checkbook. Beginning Cash + Sources of Funds (such as sales and collection of accounts receivable) – Uses of Funds (expenses paid, assets purchased, and payment of accounts payable) = Ending Cash. It is not difficult, but very important.
Many new businesses fail simply because they do not keep track of their business activity on paper. Putting money in your pocket that later goes to pay for pizza and beer is not the way to go. Every action you take creates an action in your books. Keep track of them. Organize. By keeping these three financial statements up-to-date for your business, you’ll not only have everything at your fingertips at tax time, but you’ll also keep track of how you’re doing. While it is normal to lose money for a while when you start a new business, it is not normal to lose money continuously. The idea of owning your own business is to MAKE money, and gain wealth and financial freedom. With simple financial statements, you can monitor your business and make corrections when things aren’t going well. You can also see when you’re making money and know what capital is available to grow your business or invest elsewhere.
I hope my simple explanation has been helpful to you. Best wishes for your continued success!