As a small business maintaining good accounting records is a critical business practice for a number of reasons. These records provide a history of where the business has been, where its assets are currently, and the baseline financial information for where the company can afford to go tomorrow. As a result, for those who understand how to read accounting reports, the information plays a vital role in running a business. Additionally, accounting books need to be structured properly to be able to explain how profits and expenses occurred for tax reporting. Regardless of whether the books are maintained in electronic or paper format, certain elements need to be included.
Choosing a Format
Accounting books refer to the records kept about the business’ financial activities. These can either be recorded in a software program or entered by pencil into actual accounting books with pre-designed paper for just such purposes. Most small businesses use software to track their finances.
Whichever format is chosen, it needs to include basic elements that meeting general accounting rules. These follow a setup that incorporates assets, liabilities, and owner’s equity. Within each of these categories a number of sub-elements exist, tracking the ins and outs of the company’s money as it gets used or earned. Software program will automatically set up these cost groups if a business accounting mode is chosen by the user. However, the business manager still needs to understand what each category is for to understand how the accounting works.
Every business at some point is going to pay money out to someone or another business. This could be a supply vendor, employees, a janitorial company, or any other expense paid to help the given business operate. Accounts payable allow tracking of such expenses to then roll up in reports on how the business money is spent. When there are a number of different expense types, accounts payable are set up with sub-accounts to track similar expenses. These could include labor and payroll costs, general expense, professional service expenses, and so on. Some businesses even separate their regulatory fees and taxes from other expenses to track them properly.
A company’s accounting books should also include an accounts receivable component to track any money owed to the business. This can include sales that still need to be paid, service charges that are only partially paid, and debts owed to the business. By tracking receivables, the business can estimate how much money will potentially come into its bank account in the future if fully paid.
For a business to know what it has in the bank to work with financially the assets need to be tracked. This can include cash, investments, appraised equipment, and property. Each of these categories can be used to establish a business’ worth which can then be used to obtain financing if necessary. Asset accounts also provide a running checkbook for the business to know how much it can spend in the near future until new sales and revenue come in.
If a business uses financing to grow or has debts to pay these are considered liabilities. They have to be tracked as well to show how much the business is effectively compromised. Otherwise, a company’s accounting books would inflate the business’ value. Liabilities spell out financially how much the business owes someone else, both in short-term and long-term accounts. Ideally, if a business has liabilities, they are long-term with manageable payments, allowing the business to grow without being too leveraged.
Accounting Reports that Matter
The income statement is probably the easiest to understand. This report tracks how much total income the business brings in every month. Then the company’s expenses are subtracted. At the bottom is what is referred to as net income. That figure is what’s left to either put back in the business or take as profit at the end of the day.
The cash flow statement is more technical but just as important. A business may be resource strong but still cash flow poor. Cash flow reports track exactly when real cash, not owed money, actually comes into the business to meet obligations. For example, a business may be owed $10,000, but only has $2,000 cash on hand. Payroll is due, costing $5,000. The cash flow report will only show the $2,000 on hand, making it clear something needs to be done to get payroll taken care of. In comparison, the above income statement would have counted the owed $10,000 making it look like the business could easily manage payroll costs, which was not true.
The balance sheet report combines all the above categories of tracking and presents them in a summary report. The display shows how the businesses assets and liabilities measure up against ownership of the company. Ideally, liabilities should be smaller and manageable. If the opposite the business needs to be right-sided quickly to survive.