Today’s Biz Ladies post comes to us from Design*Sponge’s very own bookkeeper, Mandy Miller. With more than 10 years of financial experience, Mandy has assisted businesses in establishing budgets and maintaining financial accounts. Today, she offers some of her extensive knowledge on the subject with a comprehensive guide to managing your business finances. Thank you, Mandy, for this incredibly helpful guide! — Stephanie
Read the full post after the jump . . .
Small business owners often come to me a few years into their business operations looking to get a handle on their finances. In some cases, they have been keeping receipts in drawers or boxes and handing them to their accountant at tax time. In other cases, they keep Excel spreadsheets of income and expenses. And while this kind of system may work for your accountant for now, it’s likely to become unmanageable as the business grows, plus it will be difficult to measure performance over time. After a few years, most business owners want to know how they’re doing — where they’re profiting and where are they’re losing money. In order to fully grasp a business’s performance, the best advice I can give when it comes to finances is to learn how bookkeeping works and invest in bookkeeping software.
By regularly entering your business income and expenses into accounting software, not only will your accountant love you at tax time, but you will be able to use the data to measure your business’s performance throughout the year and over time as you grow.
QuickBooks and its sister product, Quicken, are the most popular accounting software options. They’re pretty affordable and relatively easy to use. However, you should do research and find the best product for your business. Some industries have specialized accounting software products that could be a better fit than the out-of-the-box option.
The Income Statement
The backbone of bookkeeping is your income and expenses. By tracking these carefully, you can produce what’s called an Income Statement (also known as a Profit & Loss report or P&L). The Income Statement is your most important financial management tool. In any given period, it will show your total income and total expenses and calculate the difference. By deducting expenses from income, you calculate your business profit or loss — aka, the bottom line. While the Income Statement is handy at tax time to send off to your accountant, it is also a valuable tool to help manage your business. If you are regularly recording your income and expenses, you can measure your business performance throughout the year, which can also help you make important decisions. Can I afford a new sewing machine? Is it time to move out of my home studio and get a studio space? Am I ready to take on a full-time employee? Am I a good candidate for a bank loan or line of credit?
Income is the money you receive for goods or services, via cash, check, credit card, PayPal, etc. In many cases, income is just one category, either a product or a service. For example, if you make and sell bags, you would categorize your income as Product Sales. If you offer interior decorating services, you would categorize your income as Services. You can even break out these categories further if you’d like. Say you make and sell bags, purses and wallets. Then you may want to track each type of product separately; in that case, you could add subcategories to the Product Sales account: Bag Sales, Purse Sales, Wallet Sales. I mention this because as you expand, you will probably want to get a sense of which products sell best and worst, or what products sell best at certain times during the year. This kind of tracking can help you with decision-making and planning. The total of all the money you receive for Sales and Services is your Gross Income.
Expenses are the costs of running your business. Expenses should be broken down into categories. For most of you, expenses will be divided into two types of categories: Cost of Goods Sold (COGS) and Operating Expenses. Below is an example of a very basic list of expenses. I’ve also provided a few examples of typical expenses that would be posted to each category.
Cost of Goods Sold (COGS)
COGS are items you purchase that are directly related to the products you sell. For example, sticking with our Bag Sales example, any material you buy that will go to make the product would be considered a COGS — textiles, thread, buttons, snaps, etc. The cost to have the materials shipped to you would also be a COGS. For example, if you buy Italian leather to make your bags, the freight to have it shipped to you would be a COGS. The cost to ship to your customers would also be considered a COGS. COGS differ from Operating Expenses in that by deducting your COGS from your Income, you can determine your Net Income — what’s left after you purchase your materials.
Note: COGS are not used for service-based businesses. Basically, if it walks out the door with your customer, it’s a COGS.
- Product Materials
Example: textiles, thread, yarns, buttons, snaps, zippers, dyes
- Freight and Shipping
Example: freight and shipping charges associated with Product Materials, freight and shipping charges associated with order fulfillment (shipping orders to customers)
Operating Expenses are all the other day-to-day expenses required to run your business, but they aren’t directly associated with your products. To get to your bottom line, you deduct the Operating Expenses from the Net Income. That’s how you get your Profit or Loss. Of course, we’re hoping for profit!
- Advertising and Promotion
Example: advertisements, flyers, email marketing
- Computer and Internet Expenses
Example: internet access, computer equipment and accessories, software
- Dues and Subscriptions
Example: professional dues, magazine subscriptions (business-related)
Example: business or commercial policies
- Finance Charges
Example: bank fees, interest expense
- Meals and Entertainment
Example: business meals (meals with colleagues, vendors, customers), business entertainment (promotional events such as parties for your business)
- Merchant Fees
Example: credit card processing fees, PayPal fees
- Office Supplies
Example: paper, pens, paper clips, staples, filing supplies, etc.
- Payroll and Wages
Example: wages paid to full- or part-time employees
- Professional Fees
Example: legal, accountant, consultant
- Repairs and Maintenance
Example: equipment repairs, office/space repairs
Example: office phone, cell phone, fax line
- Tools and Equipment
Example tools: sewing needles, knitting hooks, crochet needles, printing materials, jewelry tools, and so on
Example equipment: sewing machines, knitting machines, jewelry-making equipment, screen-printing equipment
Example: business-related travel
Example: electricity and gas
The Balance Sheet
Okay, so now that we’ve covered the Income Statement, which is your tool for tracking business profits, I’d like to introduce you to the Balance Sheet. The Balance Sheet is a snapshot of your company’s financial standing. It tracks your assets, liabilities and equity.
I don’t want to get too heavy into the Balance Sheet, since most young companies will not need to use many Balance Sheet accounts in the early years, but I do want to provide a little understanding of the Balance Sheet because it really is an important part of your bookkeeping. The more you understand early on, the better!
Typical assets include:
- cash in the bank
- petty cash on hand
- any money owed to you by your customers (Accounts Receivable)
- inventory on hand
- NOTE: In some cases, equipment is an asset. It will usually depend on the value of the equipment and its typical lifespan. You should check with an accountant to help make this determination, or you can go directly to the IRS (http://www.irs.gov/publications/p946/index.html).
Typical liabilities include:
- money you owe your vendors (Accounts Payable)
- outstanding credit card balances
- loans from the bank or from individuals
- tax liabilities such as sales tax or payroll tax
Equity, or Owner’s Equity, includes:
- capital contributions made by you, such as investments made for start-up costs
- capital contributions made by investors if you’ve accepted investments in exchange for equity shares
- any draws or distributions you’ve taken from the company would also be posted to the equity accounts
For most small businesses, the Balance Sheet is pretty simple and straightforward. You haven’t taken out a bunch of loans, and you probably haven’t amassed a lot of expensive equipment. However, as you grow, the Balance Sheet will most likely grow with you. Let’s say you get to a point where you want to expand and open a storefront. You may need a business loan to get that going. Thus, you would add the loan as a liability, and what you spend on building out and furnishing the store would become an asset. Or maybe you are ready to open a small factory. The money you spend on building out the factory and for equipment like sewing or knitting machines or other industrial equipment would be assets. Or perhaps you are ready to take on a partner. The partner would make a capital contribution to your company in exchange for equity.
One Balance Sheet account that you are likely to already use is the credit card liability. If you use a credit card to fund some of your expenditures, you will carry the outstanding balance as a liability. QuickBooks makes it pretty easy to set up a credit card account; you can post the charges to the account, and then any payments you make are deducted, thus tracking what you owe.
When I work with new business owners, one of the concerns I hear most is that they are unsure about what they can expense through the company. This makes them nervous to take on the bookkeeping function, worrying that they will make a fatal mistake. Once you start to do bookkeeping, you should track all business-related expenses. When it’s time to do your taxes, you will provide your accountant with your Income Statement and your Balance Sheet, and your accountant will sort out which expenses are 100% deductible and which are deductible at a lower percentage or not at all. For example, most meals are only 50% deductible for tax purposes, but your company lays out the entire cost of the meal. Don’t only record the tax-deductible portion. Record the full amount of what you spent, and let your accountant sort out what’s deductible. Your job is to track your spending, and to calculate your bottom line, you need to record everything you spend for your business.
As I mention above, it’s important to work with an accountant to help you with your taxes (unless of course you are a tax whiz or an accountant in your other life). There are many rules and regulations to follow that can be confusing, and you should always seek expert advice when in doubt. A good accountant can also provide guidance on bookkeeping. When you are stuck on what seems like a monumental obstruction, it could just require a quick 5-minute explanation from your accountant, a quick phone call that will keep you moving forward. Many accountants will even provide some basic training.
And don’t be discouraged if finance, bookkeeping and accounting don’t come naturally to you! If bookkeeping feels way out of your comfort zone, you may want to consider hiring a bookkeeper to come in once a month or a few times a year, depending on your volume. It’s probably worth the cost for you to stay focused on what you do best and not get overly distracted or bogged down with the bookkeeping. But I do strongly recommend that you stay involved. Ask your bookkeeper to generate the Income Statement and Balance Sheet each time they visit. Make sure you carefully review it with them and ask questions. Every once in a while, I come across a client who doesn’t want to know anything about their bookkeeping, and I promise you, it’s never a good situation. It usually means that the business owner is not making informed decisions, and as such, the finances can easily fall to the wayside. So having a bookkeeper alone is not the solution; make sure you have a bookkeeper that you work closely with.
There are many bookkeeping resources on the web, everything from free articles to online classes. You can even get QuickBooks training online. So if you feel overwhelmed as you begin this process, be sure to do research and find the right answers. A few websites I love and use a lot myself are:
www.sba.gov — The US Small Business Administration website has so many resources, you could spend days there. They offer everything from articles to free online courses. Be sure to check out the Finance section!
www.businesstown.com — This site provides in-depth yet user-friendly accounting information, especially help with accounting terms and concepts.
www.netmba.com — This site covers a variety of business topics, including comprehensive articles on finance and accounting.
In order to fully understand the finances of your business, it’s important to get yourself familiar with bookkeeping and invest in accounting software. The earlier in your business life that you do this, the better grasp you’ll have on your growth and performance. By developing a bookkeeping system, you can arm yourself with the tools you need to measure performance and thereby begin to make important decisions about the direction you can take your company in. Business owners, regardless of financial acumen, should educate themselves on accounting basics. As you grow, finance will only become an increasingly important part of your responsibilities, so be sure to get a handle on it early on!