Many people are intimidated by the idea of ‘ACCOUNTING’. The goal of this article is to dispel some of that trepidation.
While most people relate ‘accounting’ to finance, other meanings may help us gain perspective.
Accounting is also defined as: “A convincing explanation that reveals basic causes.” (Source: http://www.thefreedictionary.com/accounting). For example: “The prosecuting attorney must provide an accounting of why the defendant is being brought to trial.”
Our example is similar: “The CFO must give an accounting of where the money came from and where it was spent.”
We note by referring to the definition above that tracking the flow of money is simply a tool used to provide a convincing explanation of proof. This is accomplished by collecting two categories of information: 1) income or money that is received - accounts receivable (A/R) and 2) expenses or money that must be paid to others - accounts payable (A/P). The total income less the total expenses results in either a ‘profit’ (money remaining) or ‘loss’ (expenses exceed income). A statement showing this breakdown is a ‘Profit/Loss statement’, also referred to as a ‘P & L’ report.
Without computerized records, manually tracking the receipt of income and the disbursement of expenses is a daunting task with great potential for error. Fortunately, tracking the flow of money can easily be reduced to numbers. As a result, it is relatively easy to develop a mathematical ‘proof’ to help ensure the system is accurately symbolizing the actual flow of money. An accounting ‘system’ that successfully passes that ‘proof’ is said to be ‘in balance’. The ‘Balance Sheet report’ is generated to show that ‘proof’ and consists of a statement of Expenses on the left, a statement of Income on the right followed by the ‘Proprietorship’, the positive or negative result of Income minus Expenses.
Moving away from theory, here is a real world example to help illustrate the concept:
A checkbook register is a form of accounting system. Ideally, you remember to enter every deposit made into your checking account, every check written, and all ATM or Debit card transactions into the register. The monthly bank statement is an opportunity to verify or ‘reconcile’ your register against the bank’s records and provides you with the information to complete the ‘proof’ discussed earlier.
A typical bank statement lists the starting balance - logically this is equal to the ending balance of the previous month- a listing of all deposits added and checks, penalties, service fees, etc. that were deducted from your account, and the ending balance for the statement. It should be mentioned that the bank statement represents a moment in time. It is information available to the bank as of the closing date for the statement. Some things implied by that statement deserve more attention.
One is the ‘float’ - the dead time between events. The following is an example of a ‘float.’
On Monday you write a check for $75.00 to pay the electric bill. The bill is mailed to the power company on Tuesday and delivered on Wednesday. On Thursday, the power company’s processing center processes your check and deposits it with their bank. That bank notifies your bank of the transaction to ‘relieve’ or ‘make payment for’ the $75.00 which is ‘transferred’ into the power company’s bank account. Your check is mailed back to your bank as proof of the transaction, is received on Friday and processed on Saturday. It is important to note that this example simplifies the process, and purposely exaggerates time frames and ignores any regulatory requirements, etc. The point is that significant amounts of time pass between the event of you writing a check and your banks awareness of that fact.
Keeping in mind the ‘float’ time inherent in the ‘flow’ of events outlined above, let’s get back to our check book register. According to your check register, you spent the $75.00 on Monday and the rest of the above paragraph is magic. What your monthly statement shows is the detail of what your bank eventually became aware of as of the closing date for the statement. From your bank’s point of view, what you and the power company’s bank do is just as much magic.
When you reconcile your check book against the monthly statement what you are doing is the ‘mathematical’ proof matching your register to the bank’s records.
This involves comparing your current register balance, minus any activity that is in the ‘float’ state, and the bank statement’s ending balance. Again that is a deceptively simply statement. It assumes that you have entered all transactions and carried the balance forward. If a variance exists between the two, it likely means a transaction was not recorded or an arithmetic mistake was made. It then is necessary to review the detail of your check register against the bank statement detail to determine where the discrepancy is.
This process can be a real pain! Figuring out the ‘how’ and ‘why’ of variances can be very frustrating. All I can say is that it is worth the effort in a great many ways.
Accounting is about keeping track. The more diligent you are, the less it impacts your life. Many people get into trouble when putting off this task, causing the problems to pile up. Once that happens, the problem becomes a ‘project’ and that means time and motivation become increasingly difficult. Also, by staying current, you are more likely to remember details that might help you resolve any issues, like that forgotten $40.00 from the ATM the night you were out with friends.
The truth is that the ‘math’ involved in ‘Accounting’ is simple addition and subtraction. Arithmetic is actually a more descriptive word for it. The hard part is keeping up with it.
Software to run your business
It has a nice ring, doesn’t it? In many ways software is the holy grail of all businesses today.
Easily said, commonly misunderstood…
Begin with the key concept that a business is nothing more than information. The products, services, customers, inventory, capital assets, liabilities, etc. are all items that need to be tracked. At the most basic level this information is used to complete a tax return. If that is your accounting goal (tax returns), the choices are easy. Most current accounting software packages will provide a way to track financial transactions with enough detail to satisfy the government’s reporting requirements. But most businesses are more than just financial balance sheets. While it is certainly true that maintaining a list of customers for billing seems elementary, how can that list also increase your revenue?
All that build up was designed to “set the stage” for the following question:
What does your business need from its software? In other words, what information do you need, as the ‘owner’ of the business, in order to make the decisions to run and hopefully grow your business?
Once you have answered that question, a second question immediately requires an answer: What is the value of that information? How much money are you willing to invest in collecting and reporting the information you consider important?
Let’s look at those costs a little more closely…
First we’ll examine traditional (aka obsolete) paper accounting systems. At the most rudimentary level we have a shoebox. All financial information is thrown into said shoebox including a carbon copy of the Invoice/Bill that was written up for the customer in exchange for payment. Overhead is low. The shoebox was free with that last pair of ‘kicks’ you just bought; depending on your accountant, the shoes may be a tax deduction - the shoe box is an integral part of your IT solution! (That was a joke! If you decide that ‘suggestion’ was a good idea and wind up in front of a tax auditor for your troubles, we don’t want to know about it.)
So your investment is the paper and carbon paper used to create Invoice/Bill/Receipts for your customers and the time to throw all that stuff into the shoebox. Or is it? What about the time needed to turn that mess of information into a tax return? Whether you do the work yourself or you pay someone to do it is a decision you’ll have to make, but either way there is a cost involved.
The next step up is the old faithful double entry paper accounting system that has been used successfully for centuries. Number one, assuming that you inherited the work needed to setup a paper system in the first place, there is cost associated with maintaining it. Depending on your volume of business, that cost can equal at least the wages of a part time job. That brings us to our next question: How useful is that information? If completing your tax return is your only worry, the information is probably enough. However, if you want to make any management decisions, data needs filtering to extract the information that provides specific detail needed to make decisions. Something simple as determining you have sufficient cash on hand to make payroll becomes a much larger task. Thinking back to the hay day of paper accounting systems bombards one with images of Bob Cratchit-like clerks maintaining accounts and ledgers so that Mr. Scrooge could ‘know his position’. Oh, how old Ebenezer Scrooge would have loved today’s computerized software systems! The ability to look at various reports detailing assorted aspects of the financial picture via the click of a mouse would certainly have warmed the old codgers’ heart.
Obviously in this computerized age, the thought of using a paper accounting system seems ridiculous to many people. However many small businesses today still use that old ‘shoe box’ accounting system. Why? Because the business owner is more focused on the parts of the business they know (production, marketing, distribution) as opposed to the financial tracking of the business required by law. With very few exceptions people start businesses because they see an opportunity not because they want to spend their time tracking information.
Enter the concept of computerized accounting systems with a promise to free you from all that drudgery. That’s nice. But now, you have substituted one set of hurdles with another. For instance, every accounting system starts with a ‘Chart of Accounts’ that define the categories (accounts) that transactions will be recorded under. The ‘Chart of Accounts’ (at its core) is used to ‘map’ business transactions to a tax return, a sort of ‘road map’ to the tax return. Expenses categorized as ‘Payroll’ will appear as one line items on the return. Transactions categorized as ‘Income’ will appear as another line item, etc. Where you record a particular transaction will in part determine how much tax you will be liable for. Creative categorization of those transactions could possibly lead to IRS problems, so it is a really good idea to consult with a certified professional before setting up the initial ‘Chart of Accounts’. That is more than just a strong suggestion it is an entreaty. If you are not a tax professional do not set up your ‘Chart of Accounts’ yourself.
Okay, so now you have a basic ‘Chart of Accounts’ that will satisfy the need to complete your tax return. But is that information enough to make the business decisions you find yourself faced with? If so - great! If not, then you might want to consider some additions to the basic ‘Chart of Accounts’ that will assist in the decision making process. Is it necessary to mention that you will want to run your changes by the tax professional that helped you with the ‘Chart of Accounts’ in the first place?
With your modified ‘Chart of Accounts’ in hand you are ready to consider software. One fundamental question to ask: Does the software you are considering provide you with the features you need? For instance a service business may have no need for an inventory module. A ‘manufacturers rep’ firm may need to collect sales tax on every purchase, while a manufacturer may need to inventory ‘raw materials’ separately from ‘finished goods’. It is possible that your customer base insists on transacting business via ‘EDI’ (Electronic Document Interchange) which is an electronic means of issuing purchase orders and invoices, status updates, and even payments. These issues and many more should be considered when selecting an accounting package. Is your tax professional more familiar with one accounting package or another? If so that may weigh heavily into your decision making process. Another aspect to consider is the level of help required for the software (e.g. technical support line), where to find that help, and the cost associated with that help.
Accounting software falls into two basic categories: The ‘light weight’ single entry accounting, where you issue a payment or invoice and you’re done. The reports etc. then extract the information needed to perform the rest of the accounting functions. On the other end of the spectrum is the traditional double entry accounting , developed to make certain that paper accounting systems did not get ‘out of balance’. At the heart of a double-entry accounting system is the principle that for every action there is an equal and opposite reaction. In other words, if you write a check you are ‘relieving’ (taking money out of) your checking account for a specified sum, in exchange for goods, services or liabilities like insurance, repayment of a loan or taxes. So in addition to the money leaving your checking account there is an equal ‘balancing’ entry that will increase/decrease an asset or liability account by the amount of the check. Simply, if you purchase an ‘asset’ the Asset value goes up by the amount that your checking account goes down.
Of course once the software is installed and configured to fit your needs you will start entering your transactions into the system. Time and effort has been invested into getting yourself to this point. So now let’s take a quick minute to talk about protecting that investment. Fact: Every computer ever created will fail. Period. The amount of pain experienced as a result of that event is the only thing you can affect. The particulars of the plan will be guided by the answers to such questions as: How long can my accounting system be down before the negative impact to my business becomes critical. At minimum, a working backup of the data you have entered into the system is essential. Of course simply having the ability to backup your system is not enough. That ability must be used in order for it to be useful. Many people choose scheduled automatic backup strategies for metal comfort while others prefer the assurance of ‘knowing’ the backup was completed by running them manually. No matter what your approach is, we strongly recommended that you test restore your data from the backup. Please don’t assume that just because you have executed the backup process that the result is actually usable! Instead try it, make certain that you can recover your information from created backups.. The need for this verification cannot be stressed strongly enough. The ‘penalty’ for failing to do so starts with having to re-enter all that information and escalates to the loss of important one-of-a-kind data that can never be recovered!
To help you on your journey, the list below contains software packages that are so-called ‘open source’. These packages are free to download, modify, and use. A note of caution: While the initial investment may appeal, support may be expensive or very difficult to obtain. A steep learning curve may exist for those not familiar with accounting software or open source packages. Remember, due diligence before selecting an accounting product!
Accounting Software Packages – Open Source
http://www.roseindia.net/opensource/open-source-accounting-software.shtml
http://www.gnucash.org/
http://www.turbocashuk.com/
http://www.grisbi.org/
