I want to go a little deeper into Accounting, but I first must get on my soapbox. Accounting is great for many reasons. You can find out how your business is doing in an infinite number of ways. However analytics and analysis can do damage. Let me give an example.

I can measure payroll as a percentage of sales. Last year it was 12.75% This year so far it is 16% of sales. Accounting is good at getting these numbers. But what do they tell me? At a first glance it would appear that things are worse. If that was my conclusion I might be tempted to cut costs. But that spiral could lead to lower sales and then more necessary cuts. But let me ask first. Are things worse? We are more profitable and our cash flow feels stronger. So maybe the rise in payroll cost as a percentage of sales is not telling me to cut costs.

My point is that running a business by the numbers can be dangerous. Numbers are tools and they can be used for building a business or as they can be used as crude weapons.

So now lets talk about accounting. It is nice to have numbers and to be able to dive in to details. The first thing to understand about accounting is that there are no negative numbers. Well at least you never enter in a negative number. Money just moves from one place to another. That is what double entry means. There are credit and debits, but even experienced accountants have to think hard about when an entry is a debit or a credit. The point is not whether the entry is a debit or a credit those terms are completely arbitrary and meaningless. The point is that if you debit one account you must credit another. That is the basics of accounting. Remember accounting is the setup, analysis, and strategy behind the numbers. Bookkeeping is the entry of the numbers in the accounting system.

The most basic accounting setup must have at least two accounts. The list of all the accounts is called the Chart of Accounts. You have to debit one and credit the other. Here is a picture or Quickbooks without any accounts in the Chart of Accounts.

Quickbooks tries to be helpful, but in doing so it can get in the way. If you setup a company and you can’t delete some accounts, then just make them inactive. An account is one of 5 types. I know I said that there are not any negative numbers and this little chart makes it look like there are. Ok so some accounts will look negative but you (as the bookkeeper) will never enter in a negative number. So here is the basic categories of accounts and how they are related.

Quickbooks gives you a lot of other options. For example they have an option of setting up a bank account (an asset) or a bank loan (a liability) There are reasons to choose those, but I am going to force it to be simple for a little bit. I am going to have exactly 5 accounts. 1. Income which I am going to call sales. 2. Assets which I am going to call Cash. 3. Liabilities which I am going to call Credit Card. 4. Expenses which I am going to call Cost of Goods. And finally 5. Equity which I am going to call owner’s equity. Here is what that setup looks like.

 

Now I am going to do some bookkeeping. The way I am going to do that is to make a general journal entry. At the bottom of the chart of accounts you can select it below activities.

Now remember I said that Accounting is double entry. This means that the debits and credits have to add up. If you try and save a General Journal entry that is not balanced Quickbooks won’t let you do it. Good for them. So here is a simple journal entry where we sold something and the customer gave us $50 for whatever it is that we sold them

I am going to make another entry. In this entry I used my credit card to buy something I am going to sell. I didn’t pay cash for it. That looks like this.

And now we can look at our chart of accounts.

It shows that we have a balance of $25 on our credit card and that we have $50 in cash. Now the two most important reports are the income statement and the balance sheet. Quickbooks calls the income statement a profit and loss report. Here they are:

That is it for now. You know how to setup accounts although you may not be sure which accounts you want to setup. You can have a lot of detail that provides no added value. I guess you could have a cash account for each denomination including coins, but why would you do that? I have three registers with cash in them. I have one account called Drawers. I don’t need to know how much is in each one. Having a separate account for each bank account will make it easy to reconcile and find missing or incorrect information. Surely you want to have sales accounts for major product lines can be helpful. That is what accounting is all about. Deciding what accounts you will have and what information you want. The bookkeepers will enter the information in wherever they are told to enter it.

In the next post I am going to talk about accrual accounting. Accrual accounting is important to get a better picture of what is happening in a business. The IRS allows you to select your accounting method as cash, but it really never should be done.