Bookkeeping 101: Common Facts and Terms Business Owners Should Know.
Fundamentals of Bookkeeping: Essential Knowledge and Terms for Business Owners
Business owners start a business because they are passionate about their industry, but usually they are not as well-versed in the administrative and bookkeeping aspects of business. This is why outsourcing a bookkeeping service is incredibly important and helpful because we are the experts that take the stress off your plate. However, this doesn’t mean you as a business owner can just blindly follow or hand off the finances to your bookkeeper, you also have to understand basic bookkeeping because ultimately, YOU are responsible for the final reporting of your financial statements and your tax liability.
BALANCE SHEET- This is a financial statement that is a snapshot of the cumulative balance (that is why it is called balance sheet) of your company assets, liabilities and equity on a single day. For example, if you pick today, the balance sheet will show today’s bank balance in the asset portion, total liabilities due as of today and your retained earnings as of today. You can pick any day but the balance sheet will only provide the balance as of that day. And the total assets will always equal the total liabilities plus the equity.
RETAINED EARNINGS- This is a line item on the balance sheet in the equity section and is a running total of your net profit (or loss) for the whole life of the company. For example, if in year 1 loss was $10k, year 2 profit was $2k, and year 3 profit was $6k, the year 3 retained earnings account would be negative ($2,000) (-$10k+$2k+$6k).
PROFIT AND LOSS- This is the report most business owners really want to see.. How much money am I making?! P&L report shows the revenue and the expense for a period of time, usually we look at the prior month, YTD (year to date) or the current or past year, and we also compare prior periods to see any changes or trends. P&L’s show how much money was earned during the period and how much was expensed. We can also see a breakdown of the expenses in different accounts, such as auto, insurance, payroll.
FISCAL YEAR- This is typically the same as a calendar year, but it can be any 12 consecutive months that your business has determined is an operating cycle. Fiscal years can start in any month and will run 12 consecutive months. Most companies maintain a calendar year for their fiscal year.
CASH BASIS- This type of accounting is the most straightforward. When money is deposited into the bank, it is considered revenue on that day and when expenses are paid for, they are considered expensed on that day. For example, if your technician has a service call on a Monday, the invoice is sent on Tuesday, the customer mails a check, the company receives the check a week later, then deposits the check another 2 days later. The revenue will be recorded on the day the check was actually received into the bank rather than when the customer received the service.
ACCRUAL BASIS- This type of accounting is more complex but shows a more complete picture of the flow of transactions. Revenue is recorded when earned and expenses are recorded when incurred. In the example above, the revenue would have been recorded on the day of the service call, even though no funds actually hit the bank. Accrual accounting uses accounts receivable and accounts payable to keep track of revenue and expenses, whereas cash based accounting does not.
EXPENSE VS PAYMENTS NOT CONSIDERED EXPENSE- have you ever wondered why the company profit and loss shows a profit and yet the bank account didn’t increase? I am often asked- “if my profit was $20k, where is it?” Well.. let me tell you, there are some “expenses” that are actually not expensed on the profit and loss statement, which means even though you spent the money, the P&L doesn’t reflect that money and will not provide a deduction. Some examples of money spent that is not considered an expense are 1) shareholder draws 2) car payments 3) investments 4) loan payments
NET INCOME- This is the bottom line of the profit and loss statement and it equals the revenue earned (either cash or accrual basis) minus the expenses incurred for a period of time.
SHAREHOLDER DRAW- This is when an S-Corp owner transfers money from their business bank account to their personal bank account. It is not an expense for the business, and it is not taxed as revenue to the owner.
BANK RECONCILIATION- This is the monthly process bookkeepers perform in order to ensure no revenue or expense transactions are missing from your financial statements. We use 3rd party statements and compare the information on the statement to the information in our system and match them up to the penny. Reconciliations are very important to ensure accuracy and completeness with the bookkeeping.
I do hope you have a better understanding of some basic bookkeeping terms. If you have additional questions or need further clarification, please feel free to reach out, I’d love to hear from you!
