By Bruce Peterka, Peak Advisers LLC
As a young person growing up in a household with a father who was an IRS agent I heard many discussions about accounting between his colleges and friends next to the backyard grill. I did not understand any of the fancy language, but I knew it was a career of respect. People would stop my Dad to ask him questions and seek his advice. When it was time to begin refining my life goals, aspirations and select a career path there was only one direction…I will be an Accountant.
Today, I work with many business owners, entrepreneurs, technicians with a vision of providing services and products to others for a value. If this is you, you’re not an Accountant. That is ok. What is it that Accountants are doing? What is this Accountant language? Let’s look at this language in a different way.
What’s the purpose and why is this important?
Archeologists first discovered a method of tracking things around 727 B.C. This method was fundamentally listing things and who owns those things and was probably a list of sheep, goats, chicken, wine, stored grasses, etc. Most of these things may be owned by the farmer but others were not. The sheep may be owned by another farmer who was placing the animal in the care of another for a fee or fleece at the end of the season.
The point here is that the farmer needed to track things and who owned those things. If one expresses this in a simple equation you get: things = who owns things.
Tracking things – Accountants call it a Balance Sheet
Materials, products, cars, trailers, hay, livestock, furniture, buildings, land and cash are all things. Tracking these things and who owns them is accounting. When you provide services or products to someone and there is promise from that other person to compensate you for those service or products, you have an open receivable.
If things are owned, they must be owned by either “You/Me” or “Other People”. The Accounting equation for this is Assets (Things) = Liabilities (Other People) + Equity (Me).
Cash in your bank account that you deposit there is yours.
$1,000 Cash = $1000 Equity
Now suppose the bank loans you $10,000 cash.
$11,000 cash = $10,000 loan (other peoples money) + $1,000 Equity (me).
This is overly simple but the principle is the same as it was in 727 B.C. You can breakdown the tracking of anything this way and you now understand what a Balance Sheet is: It is a list of things and who owns the things organized on a report in a specific order.
What things do we not track?
Accounting for things can quickly become very complicated as money and objects move and flow between parties. Your Balance Sheet is a list of things now and is a snap shot in time.
An example of things that are not on the Balance Sheet is something that is too small or too numerous to count. Inventory is part of the Balance Sheet. Let’s say you are a manufacturer of Go-Carts. You have 100 fully functioning Go-Carts and a whole lot of parts. Some of the parts are so small that you have tens of thousands of little nuts and washers. Your ability to count the nuts and washers is limited, therefore, we do not track these on the Balance Sheet…they are expensed on the Profit and Loss.
How does the Profit & Loss fit into this?
As our tracking becomes more detailed or complicated we need to create new terms for the activities and movements of things. The next tracking needed is the in & out of things. This tracking method is called a Profit and Loss Statement. As we track what we bring in we call the activity income/sales or revenue.
As we track what we spend on things we call it an expense. The spending of our cash can be an exchange – I exchange my cash for a office supplies. I exchange my cash for a bucket of nuts and bolts.
If we are tracking all of the ins and outs we can build a report listing this activity over a period of time. This report is called a Profit and Loss Statement and is your key to keeping a pulse on the health of your business.
Income – Expense = Net Income
As your business becomes more complicated, we start building on the report:
Income – Cost of Goods Sold – Expense = Net Income.
At the end of the day, it's important to keep a pulse on your financials. Achieving this shouldn’t be a hindrance, but rather a catalyst for improving your business and your bottom line. Seeking the help of a trusted accountant is a great step to understanding where you are and achieving your goals.
About the Author
Peak Advisers LLC is a future focused Intuit Premier Reseller owned by Advanced Certified ProAdvisors that deliver Business Solutions to QuickBooks users across the United States. For more information on how they can help small businesses, visit them online.