Recent studies

I've been updating my accounting knowledge recently. One of the many accounting courses I haven't had yet is a course in auditing. Here is a little of what I have picked up so far.

Auditing is a service accountants perform to assure readers of financial statements that the information they are reading is reliable for making investment decisions. Auditing also includes operational assurance and compliance assurance. An operational audit is to confirm that parts of a business' procedures are being run efficiently and effectively. It is possible to have one without the other. A compliance audit is to confirm that specific rules - GAAP, IRS or other guidelines - are being followed correctly.

When auditing financial statements provided by a client, an auditor is required to have adequately educated and informed personnel participating in an audit. The audit is to have a specific scope and enough evidence must be gathered to warrant the auditor giving an opinion on the information being audited. Once the audit is complete, an opinion of the results is issued by the auditor. The opinion, presented in a report in the format of a letter to the client, may be unqualified, unqualified with explanations or modifications to a format standardized by the AICPA, qualified or else adverse/disclaimer. The AICPA (American Institute of Certified Public Accountants) has specific requirements about what determines what level of opinion the auditor may issue. Once the opinion is issued, it is up to the reader of the audited financial statements to determine how much trust to put in the financial statements so the appropriate investment decision can be made.

That's enough for now. Have a good week.

Banking and cash management

In starting your business, be sure to begin with establishing a bank account designated purely for business purposes. This will make it simple to keep business activity - deposits and payments - separate from personal activity. It will allow you to find business transactions more easily. It will allow you to pay yourself and know more readily that a certain payment is not for business use. In addition, it becomes a tool to help in building a business relationship with a bank and its staff as your business develops. Another thing to keep in mind comes from conversation with a former employer. This person told me that a bank will work diligently to attract you as a new customer but after that, you are often "forgotten". On the banks side, the sale has been made. You have been brought in as a customer. The employer mentioned this to his banker and it was confirmed by the banker. Consequently, be open to moving from one bank to another - only as necessary - to get the best service, interest on your deposits and investments and to get the best financing rates you can. Remember: the goal is to do all you can to keep your bottom line as big as possible.

Other things to consider is the variety of services available from your bank. Multiple accounts. Bill payments. Investments. And, if necessary, loans. (I'm extremely big on avoiding debt at any cost!) Having a separate account for payroll and payroll taxes will be a smart move, adding cash on a regular basis to cover necessary net payroll, federal taxes - income & FICA and unemployment, state income and unemployment taxes, and local taxes. These tax payments come due mostly on a quarterly basis until your liabilities are large enough to require payments to help keep your cash flow - and the government's cash flow - running smoothly. Having a separate account for payroll will also allow you to keep a clearer picture of what you will need to consistently keep your vendors paid. This will help you maintain good relationships with vendors and will also give you leverage in negotiating better pricing, purchasing arrangements, and payment terms. All of these will contribute to keeping your bottom line larger. As you can guess, this will make room for you to make a better product, do better marketing and advertising, provide better benefits and pay for your employees, and take more home for yourself.

Last is the subject of financing. This goes back to relationship with your bank and its staff. As your business grows, it may be necessary and maybe even advantageous to borrow money to make payments. If you have been managing your money well, your bank will know you have sufficient assets and a good credit history. Using this to your advantage will mean borrowing money at a lower interest rate, saving you a lot of money which can then be used toward a downpayment for a location of your own instead of a rental. Or, maybe you can buy a piece of machinery that will make your operation more productive. In any event, handling your money carefully will give you greater control and lots of advantages to be as profitable as you can.

Have a good week.

More on the Chart of Accounts

Continuing on from my last entry, I would like to explain a little more about setting up your chart of accounts.

Usually, an accountant will have a preferred format for a "standardized" account list or chart of accounts. As I mentioned previously, a lot of accounting packages allow you to use account names without assigning numbers to the individual accounts. My personal preference is to use a numbering system that sets up your account list in the sequence of the accounting equation: Assets, Liabilities, Equities, Revenue and Expenses. There are numerous ways of doing this. Often the easiest route is to simply use a three- or four-digit system until your records require something more sophisticated. I like to have lots of room, so I will use a four-digit system, establishing Assets as beginning with 1, Liabilities beginning with 2, Equities with 3, Income with 4 and Expenses with 5. It is common for "Other Income" and "Other Expenses" to begin with 9, segregating them significantly from the remainder of the categories. Some people prefer a simpler structure, using only three digits. An accounting firm will likely use a simpler system since they may be providing only the information required for the tax return, resulting in putting several of the accounts you use into one larger, single bucket.

As you develop your list, you will want to look ahead at areas that you will anticipate having more accounts that other areas. You may have a lot of fixed asset accounts or inventory accounts, so you will likely want to give those groups a greater range of numbers than your cash or receivables accounts. If you only have one or a few cash accounts, you can get away with accounts 1001, 1005 and 1010, leaving room to add more in between at a later date, if necessary. On the other hand, you may have a variety of types of receivables and use all of the 1100's to keep them together. I think you get the idea. This will work with Equities, also. Rather than using all of the 3xxx account numbers, you may only want to use the 2900's for these accounts. Similarly, the Revenue accounts might be all of the .xxx's or 4xxx's. The next accounts might be the "Cost of Goods" accounts, assigned the 5xxx's, after the revenue accounts have been assigned the 4's.

Once you get into your departmental structuring, you can go down the line, using 6xxx, 7xxx, 8xxx groupings for each department. If you have several parts of a department making all of one parent department, the 7xxx's may be all of the, so you could use the 7's for Sales & Marketing and then break it down to 71xx for Sales, 72xx for Marketing, 73xx for Advertising, etc.

In any event, it's your chart of accounts. Make it easy for others, like your banker or your accountant, to understand and for you to know where to find certain things on your financial statements. Set it up to follow the KISS method: Keep It Simple, Stupid.

Expense analysis

Analyzing your expenses will be the tool you use to see where you're spending money. This is done through a review of the figures on the month-end income statement. As mentioned before, the income statement is the list of the revenues and expenses of your business. This is prepared monthly, often with a comparison to the budget figures you developed so far.

All of the income categories are totaled and represented as 100%. From here, expenses are calculated as a percentage of total income. Naturally, there will be certain expenses that are significantly large in comparison to other expenses. This will be identifiable in dollar figures and by percentage of total income. Watching the percentage will help you to see peaks and valleys if the item has regular fluctuations. An example would be labor. In construction, labor will be high during the summer, building up during the spring and then falling until winter. This would compare to high labor costs during the Christmas season and lower labor costs during the remainder of the winter for a retail store. If your labor is consistently steady, you will expect similar dollar amounts and percentages throughout the year. If this changes, you should catch it as a problem and identify what caused the change and then make any necessary corrections.

Over the course of time, you will prepare your budget according to expected highs and lows in all areas and be able to aim for specific income, expense and profit levels each month and as a cumulative figure at the end of the year. As years pass, you will see recurring percentages for expenses and be able to know if there is a problem or weakness in a particular. This will trigger corrective actions as variances arise.

In the end, you should have set up your budget to anticipate all the highs and lows you can and expect to have profits at a certain level. There should be a percentage target for your profit. As you control this, you will be continuously searching for ways to reduce total expenses and increase profit - the goal of any business.

The Chart of Accounts

Something not previously covered is the chart of accounts that make up your general ledger in your accounting software. The concept is plenty simple and has plenty of room for you to make it fit your way of thinking and working. The accounts will follow the accounting equation: Assets, Liabilities, Equity (or Capital), Income and Expenses. I prefer to set up my chart of accounts numerically but it isn't a requirement. Most accounting software will allow you to add accounts "on the fly", identifying them by category as you enter them. The thing that is a problem with this method is that it's easy to duplicate accounts and not know it. This can occur with a numerical system too.

In setting up the chart of accounts, it's typical to follow a common pattern. Here is a generalized sample. As your business develops, you will add accounts within these groups. I hope it's not too confusing.

ASSETS
***Current Assets
***Long term Assets
***Property (Land)
***Plant (the building(s))
***Inventory

LIABILITIES
***Current Liabilities
(ex.: payables, payroll, payroll taxes, current portion of long-term loans)
***Long term Liabilities
Portions of loans due more that one year out

EQUITIES
***Owner's Equity / Capital
***Less: Owner's drawing
***Net Equity or Retained Earnings.

REVENUE
***All sales accounts

EXPENSES
***Segregated by department


The software will put these accounts and any sub-accounts you create into the above categories as you set up the accounts. It will also do the math based on your financial setup.

That's all for tonight. Catch you next time.

Budgeting

Budgeting can be an involved process, especially the first time through. As you work through your numbers, you are sometimes shooting in the dark because you don't have enough historical information to work with. That's OK. With your first budget, you are building your foundation and each year you add another layer of brick and mortar and build your insight to how your business functions and where you can make adjustments to increase or decrease costs.

I think the best place to start is with your expenses, particularly if you are working on your first budget. If you already have some figures from previous months or the preceding year's activity, you are at a nice starting point. Look at these figures and study what is higher and lower than you expected. Then look at what percentage each expense is of the total of the expenses. From seeing this information, you can get a feel for where you need to plan your amounts for the next year. It will be good to look at the items that have caused a particular expense to be unusually high. It may turn out that something got put into account A instead of account B. Correcting these errors will give you a new picture and a better view of where your costs really are. In the future, you will be watching the performance of your actual expenses vs. your budgeted amounts and make the corrections throughout the year so you don't have a lot of fixing up to do at the last minute.

Now that you have your corrected figures, you can look again at where your highs and lows are. Decide from this information if you spent too much in a particular area. You may have been too frivolous or you may have room to negotiate lower prices. You can also decide to actually spend more in one area or another. Remember that this is alright. In spending more, you are putting emphasis on items that may help you generate more income. The key to this is to still get the best prices so you get as much out of your dollar as you can, spending the savings on something else that you may need as well....even if it's money in your pocket (profit) to help you pay your bills at home more easily.

Before I go too far with the expense side of the picture, we have to remember to plan expenses so they remain within the income you will earn. If you plan your expenses well enough, it will be easier for you to set sales targets AND profit targets. If you budget your expenses to increase by 50% but you will only be able to plan on an increase of 30% in sales, you will have a problem. This will be the trigger to get you to re-evaluate your expense budget for realistic figures. Having a budget will eventually allow you to set aggressive sales goals and plan for expenses and profit that will match.

More on this to come. Let me know if you have any questions or comments.

Sales Tax and Use Tax and exemptions

The Pennsylvania Sales Tax has intricacies that require a lot of study to be sure of adhering to the laws while still avoiding paying unnecessary taxes. Let's start with Sales Tax....

To begin with, a lot of customers hold a Sales Tax license and believe that gives them exemption from any sales tax liability on their purchases. If they run a gym and a window breaks, the glass used to replace the broken pane is not exempt. It is part of an expense to maintain their facility, not something for resale. Other businesses do similar things. From a financial standpoint, the business is saving money. If a PA Sales Tax auditor catches this a couple of years later, the tax will be due, along with interest and penalty. Naturally, one purchase isn't a big deal. If this is a habitual practice, the results of an audit can add up quickly.

When a customer claims exemption from Sales Tax on a specific purchase, you as the collector are required to have an executed exemption form for that purchase. If the customer is a regular customer, particularly purchasing items from you for resale, having a single form in the customer's file will, from my experiences, satisfy an auditor.

As a business collecting Sales Tax, there are rules within PA of what is and what is not taxable. You need to know what items you are selling that are taxable and what are not. An orange or grapefruit isn't taxable. It's food. But...the meal you get at a restaurant is taxable. It's a prepared meal. A shirt is exempt from sales tax. An accessory, possibly a purse or bracelet, would be taxable.

A quick bit on Use Tax. Use Tax is due on anything taxable purchased without tax charged. This often occurs in construction and with interstate or international purchases. I've been told that if you order something from another state and no tax is charged, you don't owe the tax. This is flat out FALSE! If the item purchased from another state and will be used by your business, not for resale, The PA Sales Tax is due.

That's all for now. See you next time.

Unemployment taxes

Part of the fun of payroll is having to pay taxes in case you have to lay someone off from their position. That way they can still be paid even though they aren't working. These taxes are called, believe it or not, unemployment taxes. The federal and PA governments assess these taxes based on the beginning earnings each year. The federal portion is calculated and on the first $7,000 of earnings. The base rate is 6% but credit is allowed at 5.2% for a net payment of .8%. So, for each employee, you pay .8% on the first $7,000 they earn each year. Obviously, this will take several pays before they reach the $7K limit.

PA Unemployment is similar but it is calculated at a rate assessed or adjusted each year, before the 31st of March, based on previous years' records. If you have a lot of turnover or a lot of layoffs, you will have a higher rate or multiplier to calculate the tax. The PA figure is based on the first $8,000 for each employee.

Be sure to allow for these payments after the close of each quarter to make sure you avoid penalties and to keep your cash flow smooth. The nice thing about these taxes is that although they are significant the first quarter or two each year, they drop off significantly for the remainder of the year. One other point to make about these is that as you acquire new employees throughout the year, the tax starts all over again for them. Even if they earned the base of $7k or $8k working for a previous employer, you still pay the tax on their first $7 or $8k as your employee. If they happen to have two jobs at the same time, the tax is paid by each employer. The IRS and your state revenue department make some serious tax money from people changing jobs during the year or picking up a second job.

Have a good weekend!

The Federal form 941

The Federal form 941 is the most intricate payroll tax form I've completed. You can see a sample of it at: http://www.irs.gov/pub/irs-pdf/f941.pdf?portlet=3

This form is used to reconcile payment of income and FICA taxes withheld from employees each quarter. Once you have been issued your FID #, you will start receiving a number of things from the IRS to help you make your tax payments. Often, when your tax liability is low at the end of the quarter, you can complete the 941 and remit payment at that time. More than likely, you will have to make payments every other week (bi-weekly) via the coupon booklet you receive from the IRS. This coupon booklet is nothing more than a packet of forms #8109-B which you complete and take to the bank with your payment. The bank receives your payment and coupon and deposits it into the Federal Reserve Account for you, using the information off the coupon. An example of the coupon can be found at http://www.irs.gov/pub/irs-pdf/f8109b.pdf. It should be pretty self-explanatory.

The coupon book should have your business information already printed on each form. You have to complete the information the IRS won't automatically have and take the completed coupon to the bank as a mentioned above. I have been away from this task for a while, so this can probably all be done by a draft by the bank from your account, online, without having to make the extra trip to the bank. The payment you are making with this coupon is calculated on gross wages your employees have earned and Federal income tax withheld. When you hire employees, they must fill out a form W-4 which specifies how much Federal income tax you are to withhold from their earnings. Once you have this completed form, the amount to be withheld can be found in a booklet you should receive from the IRS called the Circular E. There is a table in this booklet that you can use to find out how much to withhold for each employee's gross earnings. The FICA taxes withheld are two separate figures. One is for Social Security, calculated at 6.2% of gross wages. The other is for Medicare, calculated at 1.45% of gross wages. The total you pay with the coupon is a combination of all income tax withheld, FICA tax withheld AND a matching amount of FICA taxes. If $100.00 is withheld for FICA from employees, the employer also pays $100.00 as an expense. This should be included in how much will be needed for payroll taxes each week or pay period.

At the end of the quarter, you have a month to complete the 941 and submit it to the IRS by mail. The form summarizes the wages your employees RECEIVED (by check, cash or direct deposit) within the quarter. The total wages for all employees and the Federal income taxes withheld are shown and the gross wages are multiplied by the FICA percentages and listed also. There is a separate section for the monthly totals of the payments you have taken to the bank. If there is a difference, this must be paid, refunded or applied to future quarters. If there is a balance you have to pay, you must submit it with the form 941-V - payment voucher. There are additional items included on this form, such as EIC (Earned Income Credit) and similar items. Your accountant can give you more information about these. Once all of this is reconciled and the form is completed, it gets signed, dated and mailed to the IRS at an address specific for your state.

This got pretty lengthy. Write back and I'll reply to your questions.

Have a great weekend.

Back to blogging

Hello, again.

Coming back to this blog, I have been trying to decide what to write about. I'll start off with something I added today. There is a link to Entrepreneur.com. I think you'll find a lot of articles here that can give you extra information that you can put to good use. I hope it comes in handy. You'll see it at the right under "Useful links".

The next thing to address, I suppose, is a continuation of having employees. You've decided to hire employees so you need to prepare for what this will require. First is going to be getting a Federal ID number. As I mentioned in a previous entry, this has a variety of names: FID, EIN, FEIN, tax ID, etc. Ultimately, it's a number assigned to your business so the government knows you may be paying employees for their work. This number is obtained by filing a form SS-4. You can see it and also fill it out and print it for mailing at: http://www.irs.gov/pub/irs-pdf/fss4.pdf?portlet=3 . You can get to this form by going to another link I have on the right called "IRS web site - great for forms". Once you complete this form and send it to the SSA office in the instructions, you will receive notice within a few days or couple of weeks, telling you what your number is. You will also need to contact any state and local authorities to advise them of your need to pay income taxes withheld from employees.

Each authority will require you to complete a form and return it to their office with payment of the taxes withheld for the time period they require. Usually this will be quarterly, but often, it will be monthly. The form will most likely require you to indicate the amount of wages paid, tax withheld and possibly the tax liability if it's different from the amount withheld. When you return this form, you will need to submit payment at the same time.

On the cash side of this, you will want to plan your payments around your payroll requirements so you can be sure you have the money available for these taxes. If you have $3,000 in gross payroll each week, (hours worked times rates paid), and your tax rate is 3%, you should to plan on saving $90.00 each week until it is time to pay your taxes. Then you can pay on time and not have to wonder how you will come up with the money. The nice thing about this is that using the gross payroll figure will allow you to cover this figure. To be more specific, if you have gross payroll of $3,000 but the actual amount of your paychecks is $2,400, you know to set $600.00 aside for payments when you have to file your monthly or quarterly taxes.

That's all for today. Next entry: the Federal form 941...a little more involved.

Gary

Employees - deciding to hire

Having employees adds a whole new piece to the business puzzle. From the cash needed each week or each two weeks to taxes and benefits and even legal issues, becoming an employer instead of self-employed can be demanding, but it is key to growth and to helping the national economy.

Beginning the hiring process may sound intimidating. The kind of business you're running will help you decide what kind of help you will hire. If you have a lot of contact with your customers, you will likely start with someone to handle your office duties so you can be out of the office, generating your contacts and making your sales. On the other hand, you may remain in the office, generating bids or quotes with little time needed away from the office. Until you have so much activity that you can't get it all done, you will be able to stave off the hiring process until you generate quite a bit of business. If you are a hands-on business owner, you may be out in the field hammering, digging, welding, cutting, etc. and get to where your projects take more than a single person, it will be time to get a helper so you can do more work in the same amount of time. The technicalities of interviewing and the legalities of what you can and cannot discuss, as well as hiring and firing issues are something to address via another source, like a book on the subject, a willing HR manager, possibly a placement service or maybe even an attorney.

To start the hiring process, you can get a pad of employment applications from the nearest business supply house, put an ad in the papers for the specifics you need and begin the interviewing process. The most difficult hiring will be for positions you are unfamiliar with. Knowing how to write proposals or repair engines may be your expertise, but how to hire an office helper may be out of your comfort zone. Begin by looking at what you aren't able or interested in handling and seek people with interests and experience in those areas. You may be good at working the numbers side of your business, but not too good at writing the letters and completing necessary forms. Measuring pistons and spark plugs to the thousandth of an inch might keep your interest, but filling out the invoices and filing tax forms is nothing but drudgery. Office help to take care of incoming customers will ease your work load and keep things running smooth.

When you have finally hired someone, you entered into the world of income taxes...and maybe unemployment taxes. In addition, you will be required to have workers' compensation insurance. More forms for your office help to fill out. Here are some you will need to have filled out: Starting with the Federal government, there is the 941, 940, 8109, and W-2. The state will have its own income tax and unemployment tax forms. Some states also allow their local municipalities to collect income tax, so there will be forms from them as well. What I have seen...only working in Pennsylvania...is quarterly reports throughout the year and then a summary or reconciliation at the end of the year for both state and local taxes. Both are similar to the Federal forms. The 941 is quarterly and the W-2 summarizes the activity throughout the year.

Have a great weekend. More to come on tax forms later.

Gary

From accounting into the real

OK. I guess you've had enough accounting for a while. What about actually running the business? How do you get the most bang for your business buck?

Let's start with the shop or main office part of your business. We'll take the example of a business making something for resale. We've talked about setting up the paperwork side of the business, now it's time for the hands-on part. You know you have to buy the materials and equipment. Think about the layout of the space and the workflow itself. What equipment has to be at the beginning of the process? I like cabinetry, so I have a shop set up. It's small, so location of everything is critical! The lumber comes in and will flow around and across the shop as the pieces are cut, sanded, assembled, finished and prepared for shipping.

If you're running a service, whether it's drywall finishing, insurance sales, or consulting, you will want to set up your primary work space with a work flow. The drywall finisher will store the necessary tools that will go out on the jobs in an accessible location to the area where they will be taken in and out for use. The insurance agent will plan a front-end customer service area, separate from the administrative area where business planning & record keeping is done. A consultant will have to take similar considerations, depending on the kind of consulting involved.

What do you need to operate? In the case of cabinetry, the key item is, of course, the lumber. Shopping around for the best prices for the quality you need is important. Quantity buying, payment terms and discounts are important. If your customers typically will be paying with delays, delaying your payment terms may be useful. Otherwise, you'll be expected to pay your bills within thirty days but you won't collect your money for maybe sixty days. That makes it tough to take discounts on invoices from your material suppliers. If you can't get extended payment terms, see what other concessions the vendor might be willing to make. As you learn options in dealing with a few of your biggest suppliers, see what you can use in approaching other suppliers as your business grows.

What will it take to have employees? Remember this: The payroll taxes have to be paid!!! Better to use the money to pay the taxes on time than to have to pay tax, penalty and interest later....especially when the penalty may not be deductible for tax purposes. The payroll will take a big bite out of what you were taking home when you were only paying yourself. You have less money, but it is a legitimate business expense - as well as the payroll taxes. If you have someone working for you at $10 per hour, you will need $400 plus Social Security and Unemployment taxes. With few employees, you can pay your payroll taxes quarterly. That means it will be easy to use that money for day-to-day activity and then not have it when it's time to pay the taxes you've withheld and the additional employer's share of payroll taxes.

More to come on this later. Keep in touch.

Gary

Equities: What you're worth

Equity - or capital - is the "big picture" of why you're working. When you finish your work and close the books, you want to see your equity bigger and better than you started.

In a sole proprietorship or partnership, it's simply seeing the total equity increase. If you're the owner, it's all yours. As a partner, usually there is, or at least, should be a partnership agreement that spells out the terms of which partner gets what portion of the business. Often, a 50/50 split is often difficult, for obvious reasons. Determining how to structure this will take advice from people you can trust and with plenty of experience with partnership relationships.

In the event you decide to incorporate, the equity of the business is represented in shares, or parts of ownership, of the company. A privately held company (as I recall from years ago) consists of 15 shareholders or less. If your goal is to develop your business into a company whose shares are traded on a stock exchange, you will get to the point of watching the value of your shares grow. The profits of a company are sometimes distributed to the shareholders. These distributions are called dividends. Any profits not distributed are referred to as retained earnings. By this point, you, as the owner, will more than likely be an employee. Consequently, the retained earnings aren't as significant for you personally. Instead, they will be important for your shareholders. Although you want to be able to issue dividends to them, you also want to be able to keep a portion of the profits in the company to keep the value of the stock itself high.

When an investor looks at the earnings of a business, he (or she) wants to see a good price-to-earnings ratio. I'm starting to get out of my area of expertise here, but other things an investor wants to see are a good dividend payment and a good return on investment. When a company pays dividends consistently and when it also has growth in its equities, the investor knows there is a good return on investment because the dividends are similar to interest earnings on a bank account and the increase in retained earnings adds to the value of the shares of stock the investor owns.

Grow the value of the business and you and your partners or investors will be happy.

Have a great weekend.

Gary

Equity: The goal and purpose of business

The third and final part of the balance sheet is the equities, or capital, section. This will look different, depending on the structure of your business. Like I've mentioned before, The equities are the net result of everything else that occurs in your business during a period of activity, whether it's monthly, quarterly or yearly. As you generate sales, incur expenses and pay or get paid for these activities, the results impact your equity. Part of the closing of your books takes the net of income and expenses and moves it into equity. Some of the money you receive will pay down loans or accounts payable, buy assets or maybe get put into an asset. Maybe your sales went up but they were all charge sales. So...your receivables go up, an increase to assets. Maybe you didn't have to pay your 6-month insurance premium, so you still have some money in your bank account. When all of this activity is finalized for whatever reporting period you're looking at, the end result hits equity.

Remember the reason for the name "Balance Sheet". Assets must equal, or balance with, liabilities and equity. So, to follow a little bit of algebra (using an equation), Assets minus Liabilities must equal equities. Sometimes you will take money out of your business by way of the drawing account. This gets counted against equity. The final answer to all of these ups and downs throughout the month gets finalized to a "net equity" figure. This is how much your business is worth after everything else is wrapped up. The point to running a business is to see this figure grow. The result is that your net worth, or your partners' or your shareholders' stake in the business. In a sole proprietorship, this is called owner's equity. A corporation has shareholders' equity and retained earnings. Partners' shares are also separated by each partner's stake in the business. As any owner's or shareholder's value of the business grows, it is a return on investment.

This is the world of capitalism. The capital of a business is expected to grow. This is the reward for taking the risk of running a business or placing your money into it to help it grow. My commentary: The growth of capital is not only to benefit you, but also to be used for the good of others. When the U.S. uses its capitalist profits around the world for the good of those in need, it has done the right thing.

Go be a capitalist. Have a great weekend.

Gary

Liabilities: owing to someone else.

Liabilities are grouped like assets. Those you can easily pay - or be demanded to pay - are called current (or short-term) liabilities. The most usual current liabilities are Accounts Payable - like the local office supply store, materials dealer for your type of business, etc. Equally as common are payroll and payroll tax liabilities. These are followed by notes or loans payable. Like with assets, these are usually scheduled for payoff within the coming year.

The next group of liabilities are long-term liabilities. Things like mortgages, extended term loans and similar things. One particular note about loans is that they are often separated into short-term and long-term parts. If $1,000 of a $10,000 loan will be paid off within the coming year, that $1,000 will be classified as short-term. The remainder will be shown in the long-term part of the liabilities. As the loan progresses, the short-term and long-term balances are adjusted to show realistic claims against your business. This may be done annually, quarterly or even monthly. The larger and more heavily you rely on financing for business operations, the more important it will be for these figures to be kept accurate. I am opposed to any more debt than necessary. Who do you want having a claim on your business? You or someone else you may not even know?

The last part of liabilities is the unusual or irregular items. In the case of a business that owes another business, transactions may be run through a "suspense account". This is an account that holds amounts due to or from one internal businsess to or from another internal business. Other uses for a suspense account would be items you owe somebody but are not "encumberances" to your business. For example, I issued a check to someone recently and the individual lost the check. Consequently, when I voided the check for re-issue, I increased my cash and a suspense account in the liabilities until I would replace the check. The new check would then reduce cash and the offsetting "other side of the entry" would reduce the suspense account as well. Suspense accounts can be asset or liability accounts. You can make that determination based on what you will be putting into that account as a general rule.

When you're starting a business, some of these things will be unnecessary. If you have questions about them, let me know & I can go into them in greater depth.

Until then, have a great day.

Gary

Assets: The first part of the Balance Sheet

Assets are the things you can identify as yours. These are the usual things like your cash account, things you buy and hold onto for later re-sale, buildings, furniture, tools, vehicles, etc. These assets are categorized as current, long-term or fixed assets. In addition to tangible things like these, there are intangible things like accounts receivable, notes or loans receivable, copyrights, goodwill (which may come with the purchase of a business), prepaid items like rent or insurance. Let's take a look at these in greater depth.

Current assest - assets that can easily be converted into cash - are also referred to as liquid assets. These usually are expected to have a life of six months or maybe up to a year. Checking and savings accounts, petty cash, accounts receivable, inventory, prepaid rent, prepaid insurances, investments, such as CD's or annuities, notes/loans receivable that will mature within the terms of a current asset and inventory are considered current assets.

Long-term assets are expected to have an extended life. If you loan a large sum of money to someone and give them several years to pay it off, the part that will be due beyond the current terms is considered long term. Goodwill, property such as artwork or maybe a valuable stamp or coin bought as an investment to be held for an extended amount of time, CD's or annuities with a maturity several years out, are considered long-term assets.

Fixed assets, sometimes known as plant assets, would be items that are part of your day-to-day functions. These will be the office furnishings, tools, vehicles, fixtures, A/C units, cars or trucks, computers, production machinery, construction equipment, etc. These are depreciated (reduced in value due to wear and tear) and assigned a new value. This is how it works. If you buy a desk for $1,000 and expect it to last five years, one fifth of the $1,000 is written off as an expense - reducing your taxable income. The expense is a debit, as we have seen previously, and the credit goes into what is called a "contra-asset" account on the balance sheet, called "Accumulated Depreciation". The combined total of the debit balance in the fixed asset account and the credit in the accumulated depreciation account combine to provide a net figure, demonstrating the net value of the assets you own. To complicate things, but to give you tax advantages, the IRS has multiple methods of calculating depreciation of various kinds of assets. These can be discussed at length with your bookkeeper, CPA or internal accountant.

One more thing...often a business owner or company will determine that many of the things that can be considered fixed assets will wear out well before a useful life is met. These items are often expensed immediately. Frequently, this company will determine a dollar value as a threshold to determine if an item will be considered a fixed asset or an expendable item. Depending on what you use in your business, you may want to do the same, setting the limint at $250, $500 or even $1,000.00. That way you won't have an excessive number of small value assets being depreciated over an extended life. This keeps your asset list - which should be relatively specific in its descriptions - smaller and saves substantial work when these small items have to be disposed of early.

Write back with questions. I'll look forward to hearing from you.

Gary

Looking at tax issues

As you can guess, there are plenty of things to know about the IRS's requirements and limitiations when it comes to self employment. The Schedule C is the sole proprietors business tax return. Your first adventure into filing your income taxes for your business will be daunting. This is the reason for so much planning when you prepare to start a business and as you run your business.


Most of what goes onto a Schedule C will be fed by the income and expense accounts you've set up based on some of my other posts. If you choose to prepare your own tax returns, it will be a good idea to check out the form for the most recent year so you can get a look ahead at what you will need to prepare to complete the form as smoothly as possible. The web site for the IRS will have the form you'll need. They come up with them; they ought to have them!!!


Two other items that will be important when you prepare your business tax return - sole proprietorship, partnership, corporation or whatever. One is depreciation. This is for calculating the devaluation of your fixed assets based on wear and tear, using a "useful life" in number of years. Don't miss this expense! When you have equipment or other property that wears out, depreciation will let you take advantage of this loss of value and you don't spend money for it. It also reduces your tax liability when it has been included.


The other thing to make sure to take advantage of is business use of your personal vehicle. If you can't afford a new vehicle right off the bat, using your personal car for business purposes is legitimate and will help you save some tax money. The annoying thing about this for a lot of people is due to the hassle of writing down the starting and ending mileage on your odometer so you can claim mileage expense. This is expense is a great benefit because the IRS allows you to claim 48 1/2 cents per mile for every business mile you use your personal car. 100 miles means $48.50 in expenses, reducing your taxable income. That makes it worth doing the paperwork!!


One warning: Keep your records of this expense. The IRS wants you to be able to prove your claims for use of your personal vehicle for busines purposes. The IRS Form 2106 & Form 4562 are used for depreciation and mileage expenses.


Well, the day is over. I have to quit for now. Keep in touch. Have a good weekend!


Gary

Expenses: How are you spending?

Expenses are where you spend your money. But, as with income, a lot of times you incur expenses without using cash. Now for another accounting term. Accrual. The accrual method of accounting is the tool that deals with these kinds of transactions. If you buy something at the local supply store and don't have to pay for it for 30 days or six months (same as cash!!), the expense (debit/increase) is recorded in your books for the day you bought it and then is put on "accounts payable" (credit/increase). When you finally do send your check to pay for the thing you bought, you will credit (decrease) cash and credit (decrease) accounts payable. This closes the circle leaving you with the expense of the item you bought and the payment from your cash account. Accounts payable was merely the means of keeping track of what you owed until you paid it. Accounts receivable and sales work the same way but the debits and credits are reversed.

Now we come to the rest of the expense picture. Expenses are accumulated until the end of the month and the totals are listed on the income statement or profit and loss statement (P&L). To manage your profitability and have better control of your spending, the P&L is broken into smaller segments. The first piece is your cost of operations. A great example is a construction company. The contract income earned is listed, naturally, at the top of the P&L. Next is the various expenses directly for the fabrication and installation of the project, whether it's an air conditioning unit for an office building or a back-up generator for a manufacturing facility. When I worked for a mechanical contractor, construction costs were grouped into equipment, materials, labor, subcontract, and other direct costs. The individual totals of these categories are added together and that figure is subtracted from total sales. The result is gross profit. The gross profit has to be enough to cover your administrative or overhead costs. Some businesses may have a large gross profit and a lot of overhead and administrative expenses. The mechanical contractor I worked for aimed for 15% as the gross profit target. From here, the goal was to cover overhead with 10% and have 5% remaining for net profit. This means that out of every $1.00 of income, only 5 cents were left for the business to buy new, more or better equipment. On $10 million, $500,000 was available for future projects or other future plans.

When the expenses are studied, it may be found that more cost-conscious buying in operating costs can yield a higher gross profit percentage. Then, tighter controls on overhead expenses could take net profit to 7%. Guess what!!! Now you have money for an enhanced marketing plan in the first half of the year, generating more sales in the second half of the year. Now you've grown your business, improved profitability and maybe started a profit sharing program for your employees.

One more step. This will come well before you hit $10 million in sales. As you evaluate your overhead expenses, you may find you have so much going into one big bucket that you don't know what it all means. This is the time to consider establishing separate departments. One thing not to do, though, is to have so many departments there is too much separation of duties. Something else is to avoid is changing your structure so often you and everyone else can't keep up with the unending change. Plan a structure that will have unique responsibilities by department and that will need to be changed only as your business grows. A simple example is not to start an IT department until you need to pass off the duties to an individual or group of individuals that can handle the duties without your intense supervision.

That's enough for today. Have a good one.

Gary

Income ....and income tax

You're up and running and bringing in money and spending it. How does all of this work with profit, my money and income taxes?

Income, as mentioned in other posts, is the money you earn from running your business. There is "regular income" and there is "other income". Regular income is the result of the routine activities of your business. Whether you're a car dealer, home builder, lawyer, garbage collector or software writer, the earnings from the core activities of your business are your regular income. Many times, you will have several things directly related to what you do. These will all fall under regular income. Other income is the result of out-of-the-ordinary activities. If you are a painter and, on rare occasion, you install some electrical wiring for someone, the electrical work would be other income. If you have some of the business money invested in a CD or longer term investment for later use, the interest earnings are other income. If you're in an accident with your business-owned car and it gets totalled, the insurance proceeds are other income.

So, I billed someone for 100 widgets but haven't gotten paid yet. What do I do? Unless you choose the cash basis of accounting (I prefer to avoid this) the sale is your income but, instead of having the money in your bank account, the money goes into accounts receivable. Accounts receivable are kept separately by customer. The total of all unpaid customer balances becomes the accounts receivable figure on your balance sheet. If you sold the widgets for $2.00 each, you will have $200 on accounts receivable (as a debit) and $200 in sales (as a credit). When you get paid the $200 by your customer, you reduce your accounts receivable (credit - offsetting the original debit, for an end result of zero on accounts receivable for that customer) and increase your cash account (debit) when you take the check to the bank for deposit.

One question that may come to mind is "What is the difference between revenue, income, sales and receipts?" The first three: sales, income and revenue, are pretty interchangeable, all representing your business earnings. Sales are the revenues/income directly from regular business activity or operations. Other items, like those I mentioned earlier, are still income or revenue, but since you didn't specifically try to earn them, they don't get classified as sales. Receipts are the payments you receive. Usually, they are for the sales you've made, but if you have income from other sources, those qualify as receipts as well.

Enough on money coming in. As you use this money, you reduce your profit. That's OK. I don't know of any business that is all sales with no costs. Not even gambling or robbing banks. You have to put money in to get money out. The profit is the part the IRS and state departments of revenue like. This is what is used to figure out your income tax. So, the challenge is to figure out how to keep your tax burden low while still having enough money at home for food, clothes & the mortgage. Expect to pay taxes. Plan for them and make the payments. BUT.....use every legal and practical opportunity to avoid paying taxes unnecessarily.

For a peek into another entry, here is an extra tool you will use to help you manage your business profits, expenses and taxes. When you setup your income statement, be sure to separate expenses directly related to how you earn your money (operating expenses) from your other expenses (overhead expenses). When you subtract your operating expenses from your sales, you are left with "gross profit". The amount - best measured as a percentage of sales - should be enough to cover your overhead expenses and still have enough profit to pay for you to live. The figure left after you have paid your overhead is your net profit which is where your "take home pay" comes from. Like I've said, when you take some profit home, be sure to plan some of it for paying your taxes.

That's all for today. Have a good weekend.

Gary

Financial Statements 2: The Balance Sheet

The Balance Sheet is where you see what your business is really worth. After you've finished recording all your activity for the month - income AND expenses - the leftovers, profit or loss, get carried to the equity section of the balance sheet. Remember the parts of the balance sheet: Assets, Liabilities and Equity (sometimes known as capital, other times known as net worth). When you incorporate, the money left in the business is referred to as retained earnings. We can look at that more later.

As I mentioned before, assets are the things you own. Start with your bank account and go all the way through "Property, Plant & Equipment" also known as fixed assets. Fixed assets are things that have an extended useful life. Assets are broken into levels of liquidity. Cash accounts, receivables - money you are due to be paid for things you have sold - , prepaid items like February rent paid in January, or insurance premiums for the coming 3, 6 or 12 months, investments in certificates of deposit, stocks, bonds and annuities and even inventory are considered liquid assets. It's easy to squeeze the useful money out of the people holding these things. These would be people like banks, customers, brokerage houses, etc. Fixed assets are things like filing cabinets, desks, power equipment, vehicles, production machines, billboards, construction equipment, sound systems, and of course, the building and land where your business is located (assuming you own it, rather than rent or lease it from someone).

Liabilities are things you are responsible to pay to someone else. I've mentioned buying office supplies on account from a local supply store. Other examples are your credit card, the oil company you use for heat, advertisers you use, payroll deductions - for payroll taxes withheld or for employee benefits. These are short-term, or current liabilities. You can easily pay them. Long-term liabilities are your mortgage, car loan, loans from individuals or companies that you will repay over several or even many years.

Finally, we get to equities or capital. After you close your monthly or yearly books, the profit or loss gets moved into the owner's or partners' equity or else into retained earnings. If your business is a sole-proprietorship or partnership, another account is closed into the equities as well. It's called a drawing account. If you or one of your partners takes money or materials of any sort out of the business for personal use, it gets recorded in that individual's drawing account. This is a "contra" account. Here's an example: If you, at the end of May, had equity of $10,000 and you needed $3,000.00 on June 10th to cover expenses at home, you can write yourself a check from the business and put it into your personal account. This check gets recorded in your drawing account in the business. At the end of June, you'll close your books and (not counting that month's profit or loss) end up with equity of only $7,000.00. This is how sole proprietorships pay their owners. In a new or slowly growing business, this is difficult to manage. Eventually, this will smooth out as your profit grows and the business becomes more self-funding. Then you will be able to plan how much you can regularly take out of the business to pay yourself without hurting the cash flow within the business.

After all this activity is netted together - Assets minus Liabilities, the remainder is the equity: the value of the business. even though you may not have a lot of cash, you can have a lot of equity because you may have used than money to buy new or better assets or to pay off loans. In any event, this is what you want to see grow. If you do keep your business equity low, you may be taking a lot of money home and building the value of your home.

That's a lot to digest. Study this and get it clear in your mind and you will have a good foundation to help you figure out how to keep your business developing and becoming something that not only provides for you, but can also benefit others - like employees. Or, if you run it well enough on your own, you can use the profits for charitable or philanthropic purposes.

Have a good one. Keep in touch and let me know if you have questions.

Gary

Financial statements: The income statement

The income statement is know by a couple of other names. The "Profit and Loss Statement", the P&L (from the previous name), or the "Operating Statement". This statement has two primary sections. First is the income section; second is the expenses. Let's take a look at each one. Then we'll hit one more - "Other Income & Expenses".

Income - also known as Sales or Revenue - consists of your earnings from your day-to-day activities. Depending on the kind of business you're running, you may several sources of income. A mechanical contractor's primary income may come from construction contracts. Additional sources may be equipment or parts sales, repair to people's equipment, system maintenance contracts. Each will be evaluated for its profitability as part of the business when the P&L is reviewed.

Expenses are the costs you incur as you buy things to run your business. Your operating expenses are the field labor, materials you buy to put into your products or projects, items you buy for resale, supplies you need to display what you're selling, etc. Overhead or administrative expenses are the costs of paper supplies, legal & accounting fees, phone service, depreciation, etc.

Once the income is totalled and the expenses are totalled, expenses are then subtracted from the income, with the answer being your profit or loss. This is called your "Net Operating Income".

As your business grows and changes, you'll analyze your expenses to determine if you're spending too much in one area or another. These managerial decisions to make changes will help you make more profit which can be used to build the business by making improvements or buying additional equipment or be taken home for a nicer vacation for the family. You'll likely develop departments to break the business down into more manageable pieces so you can see more easily where your money is going.

After your profit is figured, you may have income or expenses that aren't part of your regular business. An example of "Other Income" would be interest income or proceeds from an insurance settlement. "Other Expenses" might be income earned from crafts placed on consignment in your showroom.

These activities are handled the same way as your regular income and expenses, with the calculation of "Net Other Income (or loss)". "Other income or loss" is added to, or subtracted from, your regular income for a Net Income. This figure is what is used to calculate your income tax. The amount you take home is not a business expense, so it is part of the profit of your business. As a result, it is still taxed.

The thing about profit is that you juggle how much you are willing to have so you can balance how much tax you'll pay vs. how much you'll take home to live and how much you'll leave in the business to you can add value to the business and/or promote it to generate more revenue.

That's enough for tonight. Write back with questions or comments.

Gary

Who'll take care of the books?

One decision you'll find yourself faced with is if or when you should turn your bookkeeping over to someone more qualified. While the anticipation of self-employment has it's thrills, the "work" of keeping the books can frequently be intimidating unless you are already familiar with business operations and record keeping. Consequently, you'll want to try to assess whether you ought to do this on your own or pass (or should I say...delegate?) this to someone more equipped for this kind of work.

There are several routes you can go. Some require more digging than others. If you have an acquaintance who is comfortable with establishing and maintaining an accounting system, find out if they will be willing and able to handle your books for the kind of business you'll be running. Don't look for the cheapest person you can find. You might get what you pay for. This person has to be willing to put the time you need to understand your methods and also point you away from risky practices and habits. In addition, you will need to listen to this individual as an advisor, especially if he or she has a lot of expertise in accounting and business management.

Another source is an independent bookkeeper. This person, presumably, has been through enough clientele to be able to set up your books and report your income and expenses properly for tax purposes. While many of these people work out of their homes as a sideline income, others have their own offices and run a suitable practice to meet your needs quite well.

Option #3 would be to use a CPA or public accounting firm. If you know someone with these credentials who will offer you a bargain of a service, jump at it. My opinion is that if you are intent on a large start-up or are assured through your business planning that you will grow quickly, you should choose a CPA. If you expect to operate out of your garage or "second-rate" business space for several years before you think you'll really take off, save yourself some money early on and search out a capable friend, wife, neighbor or established bookkeeper and work with them until you are knowledgeable about what reporting requirements come up and how you will manage them as a business owner. Then you can progress to a more sophisticated bookkeeper.

One last possibility is to hire someone as an employee who can keep your books. This person will be a master of many skills until you have enough business to split some work off to another employee. You will want to check this individual's background so you can be sure they are able to handle numerous office tasks as well as your bookkeeping. If you aren't big on doing the paperwork, this person will be invaluable at keeping you organized. He or she must be able to handle your financial activity - for business and personal reasons - and report on how you are doing as time progresses.

You don't want to get to the end of the year and have to figure out how on earth you're going to sort through all your papers and do your tax return by the ominous April 15th. Anyone keeping your books must be able to prepare for this - even if it's you - to save stress, worry, interest and penalties.

Have a great day. Keep in touch.

Gary

Coming up: The parts of accounting

In series of new posts, you'll get to read more about the different key parts of the accounting system. Each will be addressed separately. Here's the primer, briefly re-visiting earlier material.

ASSETS: These are the things you own. They include cash, money people owe you value carried from a business purchase, investments, buildings, furnishings, tools, vehicles and more. There are also things called "contra-assets" that offset, or count against the value of certain assets.

LIABILITIES: This is the money or other things you owe to other people. Accounts payable - your regular vendors that let you buy things and send you a bill to pay later, taxes, withholdings from employees, loans, mortgages, etc.

EQUITIES: This is the "net value" of your company. Equity is also known as capital. This is where the term "capitalist economy". It is reflected as owners, partners' or stockholders' equity. When you get to this part of the financial statements, you see what's left after all other claims against the business have been taken into account.

REVENUE: This is any income your business receives as a result of trying to get paid for goods or services. Occasionally, a business receives payment for reasons outside of its normal activities. This is called "other income". Interest earned on a bank account is an example.

EXPENSES: These are what you pay for running your business. Expenses will run from pipe you use in a plumbing business to the coffee you use in your company kitchen. Like revenue, this has a classification of "other expenses".

Come back soon. Class will continue shortly.

Gary

Accounting basics

Debits and credits. These, and the five parts of the Chart of Accounts are the core of the accounting process. Here is how they operate. To go back to high school algebra, remember what Mr. Math Geek said so often you got tired of it: "What you do to one side of an equation you must do to the other." Here is what he is getting at. If you're not a numbers person, think this one through so you understand it.

If you have a simple equation of 2+3 = 4+1, you know both sides equal 5. Naturally, if you add 3 to the first side and not the second, you're saying 8=5. This isn't true. So, to make this a true statement, you also have to add 3 to the second side. 8=8. True statement! Mr. Geek would be proud. If both numbers effect the same side of the equation, the net of the two must equal zero. Using the same example: 2+3= 4+7-3-4+1. Combine your figures on each side of the = and you still have a true statement: 5=5. Now to accounting....

The accounting equation works off the same idea, using the five parts of the Chart of Accounts. It's set up like this:
Assets = Liabilities + Equity + Revenue + Expenses
To complicate things, Mr. Pacioli, the father of accounting, said we have to use debits and credits to make this work. What throws people off is that is some instances a debit increases an account and in other instances a debit decreases an account. In the diagram below, a + means an increase and a - means a decrease. Take a look!

The equation: Assets = Liabilities + Equities + Revenue-Expenses
Debits increase assets and expenses and they decrease liabilities, equities and revenue.
Credits to the exact opposite. The decrease assets and expenses and they increase liabilities and expenses.

This is the foundation for that familiar term "Double Entry Accounting. Every transaction has both sides - debit and credit - or your equation won't remain true. Here is an some example.

** You took $50 cash from the business out of your pocket and put gas into your car. This is an increase to your expenses and a decrease to your cash. The result: Debit expenses (increase) and Credit cash (decrease, since it's an asset). You have both sides of the entry and you effected both sides of the accounting equation with the same amount, keeping it in balance and keeping it a true statement. Often, if you can identify what one half of the entry, you can figure out the other half. Another example is buying something on account (charging it so you can pay for it later). You need copier paper, so your local supply store says "I'll send you a bill you can pay in 30 days." This purchase goes on your books as a debit (increase) to the expense (office supplies) and a credit (increase) to accounts payable. Later, you send the payment and credit (decrease) accounts payable) and credit (decrease) cash.

More to come later. Time to go to bed.

Quick review

Just a brief entry tonight. Let's go over what you've read so far.

You want to do something you know well and you want to do it for yourself. So you decide what type of entity you'll have: proprietorship, partnership, corporation, etc. You'll register a fictitious name, get a Sales Tax license, an employer ID (FID/EIN/FEIN/whatever) if you will be having employees in the near future, and open a bank account.

Plan your workday, week and month around how your industry operates. Plan on where you'll operate your business and plan the setup of your books or recordkeeping. Plan how much you'll charge to make enough money for the business AND to have enough to pay yourself. Plan how much revenue you'll need to make the profit you need to take home to cover the bills and feed the kids. Plan how much money you'll need to bring in to meet all your expenses and still be able to take some home.

Ready, set, ADVERTISE. Word of mouth is the best method, but, unless you have some great connections or friends with some connections, you'll have to build your reputation from the ground, up. Think about where people will look for what you sell or do and start shopping for the best advertising price to reach your audience. Once you build your customer base, word of mouth will help you out.


Until next time..........



Gary

Accounting - Ahhh! My home sweet home

It's time to start recording all your income and expenses. Good grief! Receipts! Checks! Invoices! Payments! Bills! Mileage! ENOUGH ALREADY!!! Yeah, it's time for administration and paperwork. What does "audit trail" really mean, anyway?


Hmmmm. This may take a few entries so you don't get lost in the details all at one time. Let's start with a chart of accounts. Before we do that, we'll need to hit a few accounting terms.


Your financial structure is made up of five parts. The first three make up the balance sheet. They are the ASSETS, LIABILITIES AND EQUITY (often referred to as CAPITAL). These things are the results of what your customers paid you for and the expenses you had to pay with what your customers paid you. The other two parts are the REVENUE (INCOME or SALES) and the EXPENSES. All of these are what go into your chart of accounts. Now, let's look at each of these, one at a time.


ASSETS: What you actually own. You own your cash, your "Accounts Receivable" (work you have done for people but not been paid for yet) your shop tools, your desk, copier, inventory, etc. There are a couple of things that get counted against these but they aren't important at the moment. An example, in case you are familiar with the term, is Accumulated Depreciation.


LIABILITIES: Remember that desk you use? Well, if you put it on a credit card, the amount you owe the credit card company is a liability. If you bought pens, pencils and copier paper from Smittie's Office Supply and he said you could pay for it later, that's a liability too. These are called "Accounts Payable". Did you buy a car under the name of the business? That's a liability as well. It's called a "Loan Payable".


EQUITY: Add up your Assets and make note of the total. Add up your Liabilities and make note of the total. Subtract the Liabilities from the Assest and the result is your Equity. A quick note about the equities... when you write a check to yourself for personal expenses, you take it out of cash. This gets listed in an account called "Owner's Drawing". This gets subtracted from the earlier equity figure. The result is your final equity figure.


REVENUE: This is all the money you have earned for your work or for the things you have sold. As your business gets larger, you will probably have several kinds of revenue.


EXPENSES: These are the different groups of things you have paid for to keep your business going. They might be things like gas and mower blades for a lawn care business. They could be paper and ink for a printing company. Both of these businesses will have administrative costs like paper supplies (business cards, bank fees, insurance) as well.


Add all of your revenue/income together and make note of the total. Add all of your expenses together and make note of the total. Subtract the total of the expenses from the total of the revenue and the answer is profit if the number is positive and loss if the number is negative.


Don't panic if the number is negative. At least you won't owe income tax on it.


The Chart of Accounts groups all of these different categories in the order I listed them. Some accounting packages use account numbers for a Chart of Accounts. Others are written to use only account names. Each account has a balance. All of the account balances in your Chart of Accounts make up your trial balance. That's for another accounting discussion. All of these balances are what make up the figures on your financial statements. If you decide to go to the bank to take out a business loan of any kind (like the car you bought), they will want to see your financial statements (sometimes referred to as "financials") so they can see if they are making a safe investment by loaning money to you and expecting to earn interest on what they loan you.


OK. Go take something to ease your headache and write back with questions.



Gary

Business planning

In preparing to start your own business, it's easy to jump in with minimal cash and say "I can do this!!!!" Been there, done that. It can work. It did for me. I didn't get rich in the process, but I learned a few things about myself in the process. Even so, there was some advance planning that helped me get where I was going. Since a quick start is often on a shoe-string budget, developing a business plan can seem pointless. Still, knowing a variety of parameters and goals will go a long way in helping you determine if "hanging out a shingle" is a smart idea.

Begin with knowing how much you want to make off of your venture. In one instance, I had been laid off and needed to replace the income I had lost. I brought home a certain amount and knew I had to net that much after business costs and income taxes. In addition, I wanted a measurable raise from what I had been making. I started with my hourly equivalent since that included the income taxes withheld from my paycheck. As a rough number, you can figure 25% of your gross earnings are held for income taxes (again, based on living in Pennsylvania). In addition, the Federal government makes you pay the second half of social security taxes if you make a profit as a sole proprietorship of more than $400.00 at the end of the year. That's an additional 7.65% you'll need to include in an hourly rate just to come out even.

Your operating costs - those caused directly by you doing your business... cutting grass, shining shoes or manufacturing widgets, you will charge to be reimbursed for, with a mark-up. Other costs, known as overhead and administrative costs, have to come out of the mark-up you include in your pricing, both for labor and for materials.

Once you know how much you need, you can start setting goals of how much revenue (sales or income) you need to target. This can be determined on a weekly, monthly or annual basis. From knowing your personal situation, you will be able to decide more easily if taking off on your own will be a workable idea. Even now I think about a lot of things I'd like to do. When I consider how much money I do or don't have, what my knowledge level is about the idea, what my family situation is, and how my personality fits the requirements of what I'd like to do, I can decide if it will work or not. Here's an easy example for me: I like using computers. It may be different kinds of software, different ways to develop spreadsheets, learning a different way of showing things in a spreadsheet. What I know I couldn't do for days on end is writing programs.

Getting back on track, though, there is another level to business planning. That level is much more sophisticated, detailed, time-consuming and thorough. It is called developing a formal (or written) business plan. There are quite a few of these on the internet. More than likely, if you will be financing the start-up - or a part of it - of your business, any rational bank or banker will want to see a business plan to assure themselves you are a safe investment for them to deposit their money for a safe return on their investment. This is a superb tool that will help you define your business, target market, market demographics, long- and short-term goals, financing structure, and more. The end result will help you prepare for a more structured, organized business. Be prepared for one thing. Many people who go into self-employment do so knowing what they do and loving it to the death. The caveat to that is to realize that there will be the drawback of having to do the paperwork and the administrative side of a business as well as the exciting part of plying your trade or practicing your profession.

That's all for this entry. Please write and ask questions. I'll be glad to answer questions and to use your questions for future posts.



Gary

OK! Now what?

So you decided to get your business going. Great! No more boss to answer to. No departmental conflicts and no supervisors wondering why you didn't get more done. You know what you want to do because you've done so much of it. How do you make it run?


Start with some structure. Decide what hours you need to work. When will your customers be available? What time will you need to get ready to work? To do this, you'll need to plan how your day will be spent. So much for getting ready for the day, then it's off to do the business. When the day's done, it'll be time for the paperwork. What facilities will you need to run your business? Your basement, den, back yard or garage? A new building? Rented shop space? Storefront in a location that will be available to plenty of customers?


More structure comes with budgeting. This is big because it impacts everything else. You'll determine where you work and how you build your business and how quickly you can expect it to grow. Remember: one important thing of building a business is to build value into the business which comes back to build value for you. When you budget, you don't limit yourself as is often the concern of a lot of people. Ideally, budgeting gives you a profit target to reach so you have money to take out of the business to live by and also to leave in the business to buy equipment or to use in other ways to enhance or expand the business. The trick to budgeting is figuring out realistic cost and sales projections so you can know ahead of time what profit you will end up with so you can feed your family and buy your own store instead of renting from someone else.

Many business owners aim for a sales target but don't know where their expenses are going to come in. As a result, they don't know if they will have extra money until after the end of the month.

Thanks for reading. Watch for the next entry.

Start-up thoughts to consider

When you're ready to start a business, it's typical to wonder just where to begin. There are, of course, lots of things you try to figure out. First, decide what form of business you'll run. The easiest to organize is the sole proprietorship. Others include partnership, corporation (S-corp, C-Corp) Limited Partnership or Not-for-profit. These all have various tax implications and advantages and more complicated steps to get started. These can be addressed at another time. Starting a business can be done simply by using your name. In Pennsylvania, if you choose to give your business a name, you will have to register the name as a "fictitious name" with the state. Once this is decided, open a separate bank account that will handle your business activity. The first question I see coming to mind is "How do I get my money out of the business to use for personal, day-to-day expenses like buying my groceries, etc.?". The ideal method is to write yourself a check from the business account to deposit into your personal account. In the recordkeeping for the business, this gets recorded into a ""Owner's drawing" account. You might take money out by using a debit card or check card. That will work the same way. This simplifies things for tax purposes and for being able to keep your accounting records easier to understand and to work with.

If you expect to have employees right away, apply for a Federal Identification Number. This is done with a form SS-4 which can be found be searching http://www.irs.gov/ . Complete this form and submit it to the address indicated in the instructions. You will get a response from the federal government telling you what number you've been assigned. The number is known by FID, FEIN, EIN, Tax Number and others. This number is not the same as your state's Sales Tax number. This is handled with a form from your state. It will probably come from your state's department of revenue.

Once you have these things in the works, plan on the ways you want to keep track of your expenses. I'll discuss these in more detail in another post. To begin, though, you'll use categories based on items directly related to how you'll actually be making money. These are called "operating expenses". The rest of your expenses will be related to "administrative costs". These are things like bank charges, office supplies, postage and others. Leave a reply and I will answer questions you might have about how to group expenses.

If you will be buying things to re-sell or that will become part of something you will be manufacturing, you will need to get a Sales & Use Tax license (in Pennsylvania) from the department of revenue. This is a subject for another post. Yup, I expect to be writing a lot!

That's all for today. Let me know if this is useful. I'll post as I come up with relevant topics and as I get questions coming in. Have a great venture!!!!