You do not keep your books for the IRS or your accountants. You record your transactions because they are the best tool you have to monitor the success of your business.
Business owners too often view bookkeeping as a necessary evil. They enter the transactions, do bank reconciliations, print statements and turn them over to their accountant—but many do not analyze the books themselves.
Some business owners do look at the numbers, but more often than not they are only focusing on singular lines like sales or profit. Whether or not enough of those increased sales are resulting in a desired level of profit is often under analyzed.
Ever watch Shark Tank? What do the sharks tell potential entrepreneurs over and over again? Know your numbers.
What are your sales? How do they compare with prior periods? What costs are associated with producing that product or servicing that customer? What are your fixed costs (including monthly general and administrative costs, such as rent, which remain more or less the same each month regardless of the volume of sales)? What is your breakeven point or the level of sales you need to achieve to cover those fixed costs?
The answers to these and many other questions should be easily available by looking at your books—but only if you set them up to tell you what you want to know.
Too often companies utilize a basic chart of accounts produced by the bookkeeping program. The program likely allows the addition of new accounts or subaccounts, but no effort is made to tailor the chart of accounts to your business’s individual needs.
You can never have too many accounts or categories. It’s simple to combine similar or related accounts on the tax return or financial statement, but much more time consuming to break down “catch-all” types of categories into their component parts after the fact, such as miscellaneous, office expenses or product costs.
Defining expense categories
As a general rule of thumb, do not combine cost of goods sold (CGS) expense categories with general and administrative (G&A) expense categories. The CGS expenses are variable in nature, due to the level of sales. Subtracting these costs from sales will give you your gross profit and dividing this gross profit by your sales will give you your gross profit percentage. Examples of CGS would be product costs, sales commissions or professional staff in a service business.
G&A expenses, by contrast, are fixed in nature. This would include items like rent, office salaries, insurance, office supplies, telephone, utilities, professional fees, web costs, computer maintenance, etc. Making enough gross profit to cover these costs is what allows you to break even. Making more than these fixed costs is when you start to be profitable.
Including fixed costs within CGS will distort your gross profit & gross profit percentage. Including some variable costs within G&A will distort your breakeven analysis. That is why it is so important to identify which costs are variable versus fixed. There may be some mixed categories so where possible, split them up. Separate CGS salaries from G&A salaries, freight/shipping from postage, etc.
Monitoring expense categories
Even within CGS or G&A, you may want more details to monitor how your money is being spent. Separate marketing postage from other administrative postage—or computer maintenance and repair from computer consumable supplies.
Travel and entertainment should always be separately identified, as the IRS treats entertainment very differently than travel. The category of sales might be too broad. Create subcategories of sales by types of products or services—or sales through your website versus direct sales.
The GPS of your business
Basically, you need to step back and figure out what details you need to know in order to run your business effectively and then track those details accordingly. Again, the primary reason for your books should be to guide you and monitor when you are heading off-track—so you can quickly make corrections.
Think of your books as the GPS of your business. To get to California, you could drive west—and you would eventually get there—but not as effectively and efficiently as you would if you had used a GPS and corrected yourself whenever you got off course. Your records are for you, not just your accountant or the IRS.
Alyssa Lebovic, CPA is a partner at Keller & Lebovic, CPA’s in Fair Lawn, New Jersey. The firm specializes in “Helping You Keep More of What You Make” by providing profitability consulting, in addition to tax planning and preparation services. Find them at www.kellerandlebovic.com or call (201) 797-1966.