We’re at the beginning of a new year, and I’m getting contacted by lots of small business owners whose New Year’s Resolution appears to be “get bookkeeping straightened out.” Usually this is because it’s tax time and they either a) realize they have no idea how to do taxes for their business or b) their tax preparer told them they need to get their bookkeeping straightened out.
Often, these folks are busy running their day-to-day business, following their passion, taking care of customers, paying bills. They’ve rarely, if ever, looked at their financial statements, and if they did, they looked at the Profit and Loss but never at the Balance Sheet. If they did look at the Balance Sheet, they couldn’t make heads or tails of it, either because it’s wildly inaccurate or because they don’t know the purpose of the balance sheet and what the numbers mean.
The main reasons for keeping a solid set of books are a) tax compliance and b) getting information to help make solid financial decisions when running your business.
Tax compliance has a few areas. One is completing the income tax return. Another is tracking payroll expenses and making sure tax payments are made and forms are submitted timely. The same goes for sales tax. It’s also likely that a business needs to file and send out Form 1099s at the end of the year to vendors.
Using the data in reports generated by the accounting system requires a certain amount of financial literacy. Most business owners know the profit and loss statement, but don’t know if it’s accurate or what metrics they should be looking at.
The balance sheet is a mystery to many business owners but it needs to be looked at. The balance sheet is a snapshot (meaning it is looking at balances at one point in time, rather than showing results over a period of time like the profit and loss) of the balance sheet accounts: 1) assets, 2) liabilities and 3) equity. The simplest definitions are that assets are what you own (bank accounts, equipment, accounts receivable), liabilities are what you owe (credit cards, accounts payable, loans) and equity is the difference between the two, or your company’s net worth. The balance sheet accounts should always be reconciled to make sure the balances are accurate. If the balance sheet is off, you can bet your profit and loss is off as well.
The first thing I do when taking on a new client who is scratching their head over their profit and loss, sure it is incorrect but having no idea why, is look at the balance sheet. Obviously incorrect balances are a good clue of where to start looking.
In future posts, I’ll go over some common balance sheet problems and how they affect the profit and loss.