So, you have started this new and very exciting business opportunity. How do you keep track of it on paper? Like it or not, every April 15th, we have to account for our actions the year before to our friends (or foes depending upon 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 though it were day one for you. For the purposes of this article, I am also assuming that you are starting a simple, sole proprietorship business. In order for the IRS to consider your business legitimate, you need to treat it like a business and not a hobby. The very first thing that you should do is to open a separate checking account just for your business and keep all business finances separate from your personal finances. This is the # 1 cardinal rule that I follow religiously in all of my businesses. I NEVER take money out of the cash drawer to buy a soda. And if I use personal finances to make business purchases, I save the receipts and record them in the books for my business as an increase to my owner’s investment account.
Most of you are probably not accountants, and the word “accounting” sends you screaming into the streets. The word “taxes” also causes many of you to tremble. But really, they shouldn’t, they are just words, and both accounting and taxes can be very simple. As your business grows and diversifies, you may need to get a little more complex, but for now, you can keep your books on a simple excel spreadsheet, or one of the many accounting software packages out there. I personally like QuickBooks®Pro because it is very user-friendly and very forgiving when you make mistakes. For a beginner, it works well. Accounting is really simple: there are three basic financial statements that you need to understand to run your business. Once you get that, filing a schedule C for your taxes is easy.
The first of these forms is the Balance Sheet. It is a comparison of your assets (things that make you money) on the left, and liabilities (things that you owe) and equity (the net worth of your business). Assets include current assets like cash in the bank, savings, inventory, prepaid expenses (like insurance), accounts receivable (money owed to you) and fixed assets. Fixed assets are the more expensive, usually tangible items that you purchase for your business (like computers, desks, equipment, etc.) As a rule, anything that costs you more than $ 1,000 should be capitalized and depreciated over time. (I will cover in another article.) Liabilities are the bills that you owe, any loans and credit cards for your business. Equity is the money that you have personally invested in your business and the retained earnings from your business. When you add up your assets, the total must equal the total of liabilities + equity.
The second and probably most important financial statement is the Income Statement. It is a snapshot of your business activity at a current point in time. I encourage you to prepare one at least once a month to keep up on where you stand profit-wise. The following is a simple Income Statement:
Cost of Goods Sold (what the supplies or products you sold cost you to purchase or manufacture)
Direct Selling Expenses (related just to the sale of your product or service)
Gross Profit (Sales – Cost of Goods Sold – Direct Selling Expenses = Gross Profit)
Repairs & Maintenance
Travel (separate Travel Meals from all other travel expenses)
Anything else you needed for your business
Net Income (Gross Profit – Total Expenses = Net Income)
The third financial form that you should prepare on a regular basis, at least weekly, is a cash flow statement. I have 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 is just like balancing your checkbook. Beginning Cash + Sources of Funds (like sales and collection of accounts receivable) – Uses of Funds (expenses paid for, assets purchased, and payment of accounts payable) = Ending Cash. Not difficult, but very important.
Many new businesses fail simply because they do not keep track of the activity of their businesses on paper. Stuffing money in your pocket that later goes to pay for the pizza and beer is not the way to go. Every action you take creates an action in your books. Keep track of them. Be organized. If you keep these three financial statements up to date for your business, not only will you have everything at your fingertips at tax time, but you will have a monitor of how you are doing. While it is normal to lose money for a little while when you start a new business, it is not normal to continually lose money. The idea of having 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 are making money, and know what capital is available to you to grow your business, or invest elsewhere.
I hope that my simple explanation has been helpful to you. Best wishes for your continued success!