Accounting 101 part 2

From the previous post we had put $128,987 as the cost of goods. This section of the Schedule C is where that number came from.

cost of goods

This is not very complicated is it? The first entry is our inventory at the end of last year, which is going to be zero or the number from last year’s Schedule C.  The next line is all of the stuff we bought that went into inventory. Do you need accounting software for this number? Well it would help, but it isn’t necessary. If you have one Credit Card that you use for all of your inventory purchases then you can just look at your statements. No Accounting Required!

A quick note about inventory. I worked at a big company that didn’t know for sure what their current inventory was. This is physical stuff that sits on the shelves. It was somewhere between $6 million and $9 million. The only way to know for sure was to pay someone to go into the warehouse and count it. They had no motivation to do that. The accountants/book keeper wanted the number. They just looked at what they had purchased and what they had sold and figured what was left was inventory.

Inventory is the easiest way to lie about your taxes. More inventory at the end of the year means more profit and less inventory means less profit. Generally accepted principles of accounting say that inventory should be valued at cost. I paid $1 for an apple and even though I can sell it for $4 it is only worth $1 until I do sell it. We generally mark up things 100%. When I sell $100 worth of gifts I estimate that it cost me $50. That is very inaccurate. Sometimes shipping (which is a legitimate inventory cost) makes us round numbers up or down. Inventory sales are only about 10% of our sales so our count is accurate enough.

We are a shipping company so cost of goods includes postage and fees to companies like FedEx. This is a snapshot of our cost of goods for each major category of our sales. cost of goods

If you are quick you noticed that the total cost of sales here does not match the total cost of sales above. The reason is that I put my Franchise Fees in a separate category on the taxes even though I have it in cost of sales here. That intuitively makes sense to me since it is directly related to sales even though for tax purposes I put it in another place. That is the only difference. Interestingly the item I spent the most on “stamps” were my least profitable. I do put Bank Card Charges under cost of sales in my taxes. I am not sure that is the right place for them. They work just like the Franchise Fees.

So I have my beginning inventory, my ending inventory and how much I spent on cost of goods. I can easily calculate my cost of goods sold. Without an accounting system I would use bank account or one bank card for all costs of goods and the ending inventory from last year to give me this year’s beginning inventory. How would I calculate the year’s ending inventory? I would count everything I had. That would be more accurate than any accounting system.

Is it worth it to track the individual cost of sales. I think so. I am not certain. Am I going to do something different depending what the numbers look like? I don’t know. It does make me feel better to see the numbers improving, but do I really need these numbers? Well sometimes yes. Let’s look at the cost of shredding. I spent $845 on shredding. Some stores do their own shredding. We are trying to do that this year. I could save $845. That is money right in my pocket. But I am focusing on taxes first. This part was easy. The next part isn’t that hard. It is the deductible expenses. There are 20 different expense categories. Some are simple and straight forward. Some require a little more.

I like Excel and I like QuickBooks. I am going to show you how I would set this up in Excel.



First I create a column with all the types of expenses. Then I Define the Name of those items in Excel. I could have added the inventory as part of this. I would be a little worried about 27 – Other. You will want to have those defined. For example franchise fees or something else that you are going to list on your taxes. There is no catch-all for expenses on your taxes.

I would then create another sheet where I am going to enter in all of the expenses




I would set the Data Validation so that only one of the categories can be chosen. Then as an expense happens you could enter it in and choose the right category. This is very simple. You could also list how it was paid or from which account it came from, but this is just book keeping for tax purposes.

Finally I would add an array function so that I could easily sum the totals. That looks like this:






If you are not familiar array functions, they are gold. If you enter in the formula as it is listed above it will NOT work. You have to hold down the Ctrl-Shift buttons and hit enter. It will add the curly brackets.

There you have it for accounting made easy. You could use Google Sheets instead of Excel and you would have a complete free solution.

I did not go into details on the individual expenses allowed for tax purposes. That might be good for another post. Here are mine for 2015:


So if you subtract all of these expenses from my gross profit according to my taxes I made about $48,000 in 2015. This does not seem like a lot when you compare to a W-2 that you might get as an employee, but it is actually pretty good. It is equivalent to probably about $60K W-2 income. Not enough to live in Southern California, but it is improving and that is the point of running a business. The upside of minimizing this number is that there is a self employment tax that will come into play here. Keeping this number low will minimize that tax. The upside of maximizing this number is that it is used for financing and evaluating the value of the business. It is not uncommon to value the business at 2 to 3 times the Schedule C net profit. I am looking at purchasing another business, but because he wanted to pay lower taxes he actually showed a loss on his schedule C. He wants $340k for his business, but it is worth about $50K because that is all the assets are worth. His ongoing business is worth $0. He might get someone to pay that, but they would not be a very smart buyer. That is what he did and why he wants to sell now. He found out that he bought a business that is not making any money. I guess he hopes to find someone dumber than himself. Those people are out there.


But I digress. There you go simple accounting.


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