While there are literally millions of small business owners that are absolute masters at creating great products and services, building cooperative teams and winning over customers, a great many of them would flunk a basic bookkeeping test.
Here’s the thing. If you’re a business owner and you don’t understand the different types of “accounts” your bookkeeper uses to organize your books and finances, measuring the success of your business will be impossible. It doesn’t matter how good you are at online marketing if you don’t have a clear financial picture of your business you’re going to run headlong into cash flow problems.
How do your accounts receivable look? Are your own bills being paid late? Lita Epstein, author of “Bookkeeping Kit for Dummies” (Wiley, 2012) and designer of online courses that teach about reading financial reports says that not sweating the small stuff like understanding your own books is trouble in the making.
Here are the 10 most common types of bookkeeping accounts that a small business owner should know about:
Cash – This is where the rubber meets the road. Every business transaction passes through the Cash account. It’s so important that often bookkeepers will use two journals–Cash Receipts and Cash Disbursements–to track the activity.
Accounts Receivable – If you’re selling products or services and not collecting payment immediately, then you have “receivables.” The Accounts Receivable account tracks money due from customers and keeping it up to date is critical so to ensure that you send timely and accurate bills or invoices.
Inventory – All that stuff sitting back there on a shelf or in a warehouse that you plan to sell. These products are like money and must be accounted for and tracked. The numbers you keep in your books should be periodically tested by doing physical counts of inventory on hand.
Accounts Payable – As much as we like to hold on to our money, sooner or later you have to pay the bills. But paying the bills is not quite as painful if you have a clear view of what you owe via your Accounts Payable. Good bookkeeping helps assure timely payments. It can also keep you from paying someone twice. In some cases, you can also qualify for discounts by paying your bills early.
Loans Payable – If you’ve borrowed money to buy equipment, vehicles, fixtures or other items for your business, here’s where you’ll track what’s owed and what’s due.
Sales – All the incoming revenue from what you sell goes through the Sales account. Recording sales in a timely and accurate manner is critical to knowing financial condition.
Purchases – Raw materials or finished goods that you buy for your business are tracked via the Purchases account. It’s a key component of calculating “Cost of Goods Sold” (COGS) which are subtracted from Sales to find your gross profit.
Payroll Expenses – Employees. Most of the time they won’t work for nothing. The Payroll Expenses account is where you track those expenses. Payroll Expenses not only shows how much you paid to your employees, it also keeps track of the taxes that you are going to owe the government so you can file accurate reports. Not filing accurate reports can eat up a lot of the time you should be spending on growing your business because you’ll have to be dealing with the government.
Owners’ Equity – The Owners’ Equity account tracks the amount of money each owner puts into the business. A lot of small businesses are owned by one person or a group of partners and are not incorporated, so no stock shares exist to divide up ownership. Instead, money put into the business is tracked in Capital accounts and any money taken out appears in Drawing accounts. To keep things on the up-and-up, your books must carefully record all Owners’ Equity accounts.
Retained Earnings – This one tracks any of your company’s profits that are reinvested in the business and are not paid out to the owners. Retained earnings are cumulative, they appear as a running total of money that has been retained since the company started. Managing this account doesn’t take a lot of time and is important to investors and lenders who want to track how well the company has done over time.
Lot’s of business owners think of bookkeeping as an unwelcome chore but if you understand and make effective use of the data your bookkeeper collects, bookkeeping can be your good friend by helping you run your business more effectively.