How to Determine the Accounts your Small Business Needs
The most important question to be answered, in the process of determining your account listing need, is what type of business you operate. Professional and service industries generally use a completely different set of accounts, to say, a manufacturing or retail sales business.
All account listings however, share some general characteristics. They are divided according to the account type, asset, liability, equity, income, and expense. In establishing your accounts, you may choose to work with your accountant, as the account listing represents a combining of accounting knowledge and business knowledge.
The asset accounts would be your accounts receivables, cash, savings, notes receivable, prepaid expenses, and property. Accumulated depreciation accounts are grouped with your asset accounts and usually directly behind the asset to which they apply. For instance, if you have an asset account entitled “Vehicles”, directly beneath that account you would find an account entitled “Accumulated Depreciation – Vehicles”.
The liability accounts would include accounts payable, sales tax payable, payroll taxes payable, accrued wages, notes payable and accrued income taxes. The liability accounts are generally some of the more difficult accounts to reconcile, simply because payroll transactions, income tax transactions, and sales tax transactions are quite complex, with many entries.
Capital, or equity, accounts are not many. There are only just a few ways to list owner equity, common stock, preferred stock, and retained earnings. In addition, the reconciliation of these accounts is usually quite simple because there may be only one or two transactions per month that affect these accounts.
The final two grouping of accounts are the accounts that are used to create the Income statement, or the Profit and Loss Statement. The Income and Expense account listings are directly affected by the type of business you operate, and the expenditures your business will have over the course of its operation. Some businesses will need an account entitled “gross sales”; other businesses that are service oriented will need an account entitled “fees earned”. Both accounts represent the income of the business operations, but due to a difference in the product marketed, the income is titled in a completely different way.
Expense accounts, again, will vary depending upon the nature of the business. Areas such as “cost of goods sold” and “contract labor fees” may refer to the money spent in the production of the items sold, or the services sold. They are however, categorized with completely different account titles. Some of the standard expenses for a facility that actually creates a viable, physical product will not be needed at all for a lawyer firm, or a doctor’s business.
Some of the more common, and generally shared accounts, would include utility expense, repairs, telephone, travel expenses, and wages.
If you’re a beginner with account setup, here’s a shortcut idea: Look at last month’s or last year’s financial statements. Use the account titles listed there to set up your own account listing. You will find those accounts to be the most useful in your business, and your accountant has already given you a list to work with.
How to Setup and Use Accounts
You’ve determined which accounts you need for your business. Now, how do you setup all this information, and bring the account totals up to current status?
Well, if you’re going to do this the old fashioned way and actually setup ledger books, all you really need is current book value information for equipment, cash account totals, and the monthly receipts not already provided to your accountant ( I am assuming at this point that an accountant has been previously providing this service). A copy of last year’s tax return will be necessary to establish previous depreciation totals and the method used to calculate deprecation. Accumulated depreciation will have to be manually calculated. Now, I would recommend that, if you are determined to do your own bookkeeping, you invest in a computer and some accounting software.
Setting up accounts, and entering accurate information can be time consuming. This can also be a daunting task, even for the computer literate person. Most accounting software on the market today, provide user friendly question and answer screens to help you determine what type of account you’re setting up, the opening balances, and to what tax line it is tied. Once you’ve setup a few accounts, you should be able to move through the rest rather quickly.
You will have to be knowledgeable about the type of account you are setting up. Asset accounts are divided into cash, accounts receivable, current asset, or fixed assets. When you set the account type on the computer, the software program will automatically set restrictions for what you can and cannot enter into the account. This is done to prevent careless, but costly errors. The same principles will apply when moving into liability, equity, income and expense categories. Setting up accounts, whether computerized or manual ledgers, you must know what type of accounts you’re working with, and how to label them.
I want to bring out some of the more overlooked accounts, that should always be included, but because they aren’t obvious and easy to categorize, business owners often fail to include them. The accounts include prepaid expenses, depreciation, inventory, and bad debts. These accounts are often overlooked because as business owners we are most concerned with the accounts that affect our daily information. The accounts listed above do not directly affect the daily operation of a business, and therefore often aren’t included in account setup. However, these four categories directly affect the bottom line at the end of the month or year.
Bad debts especially should be tracked and recorded for inclusion in year end tax computation. Inventory can become quite a large figure in the financial worth of a business. This is especially true if your business is manufacturing or retail sales. Both of these industries generally maintain large quantities of inventory, this equates to large quantities of equity, or retained earnings at the end of the month or year.
Depreciation erodes your stated net worth if your equipment is overstated in value, and depreciation hasn’t been transferred to the accumulated depreciation account. The book value you show for your equipment is incorrect if it hasn’t been tracked and updated for the last two or three years.
Without the inclusion of the correct and necessary accounts when you setup your account information, you cannot obtain financial reports that give you an accurate picture of the state of your business.