Radical Accounting

Excerpt of Chapter 4, and Table of Contents from the book:

Radical Accounting A Way Out of the Dark and into the Profit With a few QuickBooks™ Accounting Software Tips & Tricks

By Madeline Bailey

www.radicalaccounting.com

“Devoured your eBook over several sittings yesterday, finished up this morning. I was actually voluntarily sitting at my desk at 6:45 a.m. on a Sunday morning, reading about BOOKKEEPING, of all things!! Am taking a break from setting up my first Chart of Accounts to send you this email. A quick read of your eBook has tremendously raised my comfort level with managing our family and small business bookkeeping tasks, and I wanted to share my appreciation." Stephanie Roberts, Lotus Pond Press, www.FastFengShui.com

"I am so excited about Madeline's book, Radical Accounting. I've read it cover to cover twice, marking it up with stickies and margin notes, and had it open on my lap when I sat down in front of a brand new QB account to create my Chart of Accounts from scratch. The day it all clicked - when I finally got it - when the P&L became clear and it all made sense - I was jumping up and down. I've been self employed for 8 years and until I read her book I thought my Chart of Accounts was just something I kept for my tax preparer so she'd know how much to deduct from my Schedule C. I wanted to understand more about how the finances affect my businesses, but I didn't know where to go to learn. Now I recommend it to everyone who runs his or her own business. It's concise, to the point, and puts all the pieces together. THANK YOU for such an awesome resource and for explaining it so clearly.” Lara Eve Feltin, Partner, Biznik, www.biznik.com

“Of all the accounting textbooks. or educational literature I've read, or been subject to, this one may be the easiest to understand and apply in the real world. I think this book should be required reading for all entrepreneurs thinking of starting their own business, or those who continuously have trouble communicating effectively with that highly paid accountant they use." Scott D. Hayes, Controller, Oregon Dept. of Fish & Wildlife. Previously: Business Manager, OR State Data Center, Internal Auditor, OR Dept. of Transportation, Controller, Oregon Dept. of Commerce

4: Accounting Basics Made Fun (Of) “Money frees you from doing things you dislike. Since I dislike doing nearly everything, money is handy.” Groucho Marx, Comedian1

There is only one business bookkeeping system—the double-entry system. Luca Pacioli published the first textbook of double-entry bookkeeping in 1494. Believe it or not, there has been virtually no change since then. His system of debits and credits is so confusing that no one can figure it out, let alone improve upon it, so it remains intact. (Just kidding, Pacioli.) The real reason that we’re still using double-entry bookkeeping is because it works, produces balanced books, and has become an ingrained standard. Double-entry bookkeeping is what they teach in accounting school. Fledgling accountants learn to enter a bookkeeping transaction using a journal entry. A journal entry has two or more line items (entries) that balance debits and credits.  One entry is considered primary; the other offsetting.  One entry will be a debit; the other a credit.  One entry shows what account the money is going to; the other what account the money is coming from. Luckily for you, popular accounting software insulates you from having to learn the rules of double-entry bookkeeping. However, you might not want to use your software as directed. If you get stuck or want to do something tricky, a journal entry is the way to go. You can do anything, change anything, or manipulate anything with a journal entry. One trick to making a journal entry is learning when to use a debit and when to use a credit. Here’s a Journal Entry Debit / Credit Chart to help. Post this “cheat sheet” near your computer, so that it’ll always be handy.

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Journal Entry Debit / Credit Chart Account Type

Debits

Credits

Income

Decrease

Increase

Expense

Increase

Decrease

Equity

Decrease

Increase

Asset

Increase

Decrease

Liability

Decrease

Increase

With time, you’ll memorize some basics…like your bank account is an asset account so when you want to increase it, you debit it. Here’s a journal entry for a bank deposit from the sale of a product: Account Name

Account Type

Debit

Bank Account

Asset

$99.95

Product Sales

Income

Credit $99.95

See how the credits and debits balance? See how you’re becoming empowered? Don’t see it yet? Just for fun, let’s say you remember that when your bank account is increased, it’s debited. The first time you hear about a “debit card” your empowered mind will go “red flag—possible money trick.” You know that using your debit card decreases your bank account. So why is it called a debit card? (The answer comes later in the book.) Not certain of debits and credits? There’s always the trial-and-error method: try it one way, check your financial report to see if you’re correct, and if not, change it to the opposite way. If you make a mistake, relax. Depending on your software, you can either correct your mistake by reversing the entry or make an adjusting entry. Trust me, your accounting software package offers you a way to fix mistakes. Accounting really is one part doing the work and one part auditing it.

Which Accounting Software? Business accounting software, such as QuickBooks® and Peachtree®, are designed as double-entry systems. Underneath the seemingly innocent check is a journal entry. Personal accounting software, such as Quicken® and Money®, are called single-entry systems. Underneath the check is a checkbook entry.

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Calendar or Fiscal Year? The tax period for most small businesses is the calendar year. You close out your books on December 31st and open them for the new tax year on January 1st. On one hand, does it really make sense to do your biggest bookkeeping chore of the year when you’re high on sugar cookies and hung over from eggnog? The U.S. government doesn’t think so, so their fiscal year starts Oct 1st. The State of California doesn’t think so either, so their fiscal year starts on July 1st. A fiscal year is any 12-month accounting period. On the other hand, payroll requires the calendar year. So unless you have a good reason to buck the herd, keep it simple and use the calendar year, eggnog or not. On yet a third hand, you might consider switching to another fiscal year if you have a seasonal business. No matter how many hands you have, don’t stack up your paperwork for the slow season. By then you’ll have a real mess on your collective hands. Do the bookkeeping as you go along and cycle other tasks for the slow season.

Cash or Accrual Basis? Despite opinions to the contrary the “cash vs. accrual” basis does not refer to something that happens after dark in the privacy of your own home. Sure, cash vs. accrual is for adults only but it’s not as confusing as it may seem at first. For cash accounting your income consists of what you actually received during the tax period, and your expenses consist of what you actually paid out. If you use the accrual basis your income is made up of all the invoices your business issued during the year, even if you have not received payment. You also deduct your bills even if you have not paid them yet. So if bills exceed invoices, or if you have an agreement with your vendors whereby they’re financing you with trade credit, consider using the accrual basis. If your business stocks inventory then the IRS requires the accrual basis. Corporations tend to use the accrual basis; private business owners tend to use the cash basis. To decide whether cash or accrual would be best for your business, ask you tax advisor. You can also run your P&L Report, first using the cash basis and then the accrual basis, to see which is to your advantage tax-wise. Whatever decision you make…you won’t be groping in the dark.

What are Account Types? Accounting is structured around account types. You’re already familiar with account types but you probably don’t use that terminology and may not be familiar with their 4

nuances of use. “Bank Account” is one account type you’re familiar with; “Credit Card” is another. While all account types are found in the chart of accounts, some end up on the P&L Report and some end up on the Balance Sheet. Account types maintain standards in accounting. Financial reports are universally formatted with a standard “look and feel” that doesn’t deviate from software to software, or business to business. Once you understand how to read your own financial reports, it’ll be that much easier to read financial reports from another business. Each account type has a specific location on the financial report. The locations are set in stone! Check out the tablets:

Profit and Loss Report Format The Profit and Loss Report is a report of money coming in, money going out, and how much your business made (profit) or lost, for any given time period. Income - Cost of Goods = Gross Profit - Expenses = Net Profit (also called Income for Operations) + Other Income - Other Expense = Profit

Profit and Loss Report Account Types Chart Account Type Income Cost of Goods Sold Expense Other Income Other Expense

Functionality Money received from primary business activities. Money spent to purchase goods or services that will be directly resold to customers. Money spent for primary business activities. Money received from secondary income. Money spent for secondary expenses.

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Balance Sheet Statement Format The Balance Sheet is a report of how much your business owns, owes, and how much it’s worth, as of a specific date. Assets + Bank Account + Accounts Receivable + Inventory + Fixed Assets + Other Assets = Total Assets Liabilities & Equities Accounts Payable + Credit Card + Other Current Liabilities + Long Term Liabilities = Total Liabilities + Equity + Retained Earnings = Total Liabilities & Equity The formula is: Assets = Liabilities + Equities. The two sides of the equation balance. Get it? It’s a Balance Sheet.

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Balance Sheet Statement Account Types Chart Account Type

Functionality

Bank Account Checking, money market, petty cash, etc. Also called a Current Asset account type. Accounts Receivable

Invoices, or other money owed by customers. A/R for short. Also called an Other Current Asset.

Inventory

Raw materials, work in progress, and stock of goods on hand.2 Also called an Other Current Asset.

Fixed Asset

Property used in the production of goods and services, such as machines and oil wells.

Other Asset

Something of value that could be sold for cash, like a stock portfolio or gold.

Accounts Payable

Bills or other money owed to vendors. Abbreviated as A/P. Also called a Current Liability.

Credit Card

Plastic card with a credit limit. Also called a Current Liability.

Other Current Liability

A loan you’ll pay back in one year or less, like a loan from a friend.

Long Term Liability

A loan you’ll pay back over a long period of time, like a loan from a parent, or bank.

Equity

Owners, partners, and investors money.

Setup Account Names By Account Types You’ll design your chart of accounts by choosing account names that are meaningful to you, account type by account type. Before you get started choosing account names, let’s

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look at the guiding principal behind designing your chart of accounts—your business model!

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Table of Contents 1: Why Accounting?................................................................................................... Who Are You? ................................................................................................................................. A Book is Born.................................................................................................................................

2: Find Your Motivation ............................................................................................ Witnessing........................................................................................................................................ Abundance....................................................................................................................................... Wealth............................................................................................................................................... Epiphany .......................................................................................................................................... A Way Out of the Dark and Into the Profit .................................................................................

3: Managing Bookkeepers and Financial Advisors ................................................ Bookeeping = Yuck! ........................................................................................................................ Liberation from Chaos.................................................................................................................... Comparative Advantage................................................................................................................ Finding Trustworthy Help ............................................................................................................ See the Shadow................................................................................................................................ See the Light.....................................................................................................................................

4: Accounting Basics Made Fun (Of) .....................................................................2 Calendar or Fiscal Year?............................................................................................................... 4 Cash or Accrual Basis? ................................................................................................................. 4 What are Account Types? ............................................................................................................ 4 Profit and Loss Report Format.................................................................................................... 5 Balance Sheet Statement Format................................................................................................. 6 Setup Account Names By Account Types................................................................................. 7

5: Define Your Business Model ................................................................................. Consider Other Interested Parties ................................................................................................ Refer to the IRS Schedules ............................................................................................................. A “Business of One” ....................................................................................................................... Systems for Your Business Model ................................................................................................ 1: Just Business ................................................................................................................................ 2: Business and Personal Commingled........................................................................................ 3: Just Personal ................................................................................................................................ 4: Moonlighting ............................................................................................................................... Help. It’s Confusing!.......................................................................................................................

6: Design Rules!.......................................................................................................... Use Account Numbers? ................................................................................................................. Account Numbers Schema ............................................................................................................ Excellent Account Names .............................................................................................................. Group Accounts by Areas of Business Management................................................................. 9

Alphabetical Order ......................................................................................................................... Keep it Simple.................................................................................................................................. Close the Chart of Accounts .......................................................................................................... Ready. Set. Go!.................................................................................................................................

7: Bank Account ......................................................................................................... Bank Account Names ..................................................................................................................... Reconcile your Bank Statement..................................................................................................... Petty Cash Spending....................................................................................................................... Petty Cash Deposits ........................................................................................................................ Transferring Money........................................................................................................................

8: Credit Card ............................................................................................................ Credit Card Account Names ......................................................................................................... Credit Card Statement Reconciliation.......................................................................................... Staff Reimbursed Expenses ........................................................................................................... Compulsive Debt ............................................................................................................................ The Debit Card ................................................................................................................................

9: Your Filing System................................................................................................. Paperwork = Boring!....................................................................................................................... From Disaster to Organization in One Day Flat......................................................................... Brand New Filing System .............................................................................................................. Design Your Filing System ............................................................................................................ Organizational Tips ........................................................................................................................ Paperwork Reduction Acts............................................................................................................

10: Profit and Loss Accounts..................................................................................... P&L Report Format......................................................................................................................... Profits or Prophets? ........................................................................................................................ Don’t Use Proper Names on Your P&L .......................................................................................

11: Income................................................................................................................... Income Account Names ................................................................................................................. Tracking Sales Tax .......................................................................................................................... Q&A: What Counts as Income? .................................................................................................... Reimbursed Expenses as Income.................................................................................................. Income By Location ........................................................................................................................

12: Cost of Goods ....................................................................................................... P&L Report Format......................................................................................................................... Cost of Goods Account Names ..................................................................................................... Income and Cost of Goods............................................................................................................. Labor Costs ...................................................................................................................................... Case Study: General Contractor.................................................................................................... How Important is Cost of Goods?................................................................................................

13: Expense ................................................................................................................. P&L Report Format......................................................................................................................... Tax Deductible Expenses ............................................................................................................... 10

Initial Setup For Expense Account Names.................................................................................. Additional Expense Account Names ........................................................................................... Operating & General Expenses ..................................................................................................... Expense Account: Sub Account Names....................................................................................... Insurance Account Names............................................................................................................. Medical Account Names................................................................................................................ Travel and Entertainment Account Names................................................................................. Payroll Account Names ................................................................................................................. In-House Payroll Account Names ................................................................................................ Payroll for Only One Employee.................................................................................................... Professional Services Account Names ......................................................................................... Miscellaneous & Uncategorized ................................................................................................... Closing Out the Year ...................................................................................................................... Tithing ..............................................................................................................................................

14: Other Income........................................................................................................ P&L Report Format......................................................................................................................... Other Income Account Names...................................................................................................... Passive Income ................................................................................................................................ Portfolio Income..............................................................................................................................

15: Other Expense...................................................................................................... Why Track Personal Expenses? .................................................................................................... Personal Expense Account Names ............................................................................................... College Account Names................................................................................................................. Household Account Names........................................................................................................... Job-Related Account Names.......................................................................................................... Medical Account Names................................................................................................................ Property Account Names............................................................................................................... Home Office Deduction ................................................................................................................. Why being a Saver Works.............................................................................................................. Why being a Miser doesn’t Work .................................................................................................

16: Profit and Loss Report ........................................................................................ The Meaning of Money .................................................................................................................. Audit Your P&L Report ................................................................................................................. Sample P&L Detailed Report ........................................................................................................ Sample P&L Summary Report ...................................................................................................... Monthly Analysis............................................................................................................................ Yearly Analysis................................................................................................................................ Income Taxes ................................................................................................................................... The Role of Tax Experts ................................................................................................................. Preventative Auditing .................................................................................................................... Profit flows to Balance Sheet ......................................................................................................... Balance is Profitable........................................................................................................................ Planning for the Future .................................................................................................................. 11

17: Balance Sheet Accounts....................................................................................... Balance Sheet Format...................................................................................................................... Use Proper Names .......................................................................................................................... Balance Sheet Data Entry ...............................................................................................................

18: Accounts Receivable ............................................................................................ Analysis of Accounts Receivable .................................................................................................. Collecting Accounts Receivable....................................................................................................

19: Inventory .............................................................................................................. Balance Sheet Format for Assets ................................................................................................... Case Study: Cafe ............................................................................................................................. Inventory or Cost of Goods? ......................................................................................................... Inventory Account Names.............................................................................................................

20: Fixed Asset............................................................................................................ Fixed Assets Account Names........................................................................................................ Fixed Asset Account: Sub Account Names ................................................................................. Depreciation..................................................................................................................................... Cars & Taxes .................................................................................................................................... Houses & Taxes ............................................................................................................................... Are Computers Fixed Assets? ....................................................................................................... New Asset Acquisition................................................................................................................... Value of Existing Fixed Assets ......................................................................................................

21: Other Asset ........................................................................................................... Other Asset Account Names ......................................................................................................... Loans Given ..................................................................................................................................... Portfolio Account Names............................................................................................................... Retirement Savings Account Names............................................................................................ Art & Collectibles............................................................................................................................ Turning Assets into Income........................................................................................................... Leaving Your Assets.......................................................................................................................

22: Accounts Payable ................................................................................................. Maximize Cash Flow and Pay Bills ..............................................................................................

23: Liability................................................................................................................. Balance Sheet Format for Liabilities & Equities.......................................................................... Leveraging ....................................................................................................................................... Other Current Liability Account Names ..................................................................................... Long Term Liability Account Names........................................................................................... Retainers........................................................................................................................................... Credit Line Account Names .......................................................................................................... Student Loans ..................................................................................................................................

24: Equity.................................................................................................................... Equity Account Names .................................................................................................................. Equity Account: Sub Account Names.......................................................................................... 12

Owner’s Investment ....................................................................................................................... Personal Funds for Business Expenses ........................................................................................ Owner’s Draw ................................................................................................................................. Owner’s Earnings Per Hour .......................................................................................................... Opening Balance Equity................................................................................................................. Retained Earnings...........................................................................................................................

25: Balance Sheet Report .......................................................................................... Balance Sheet Format...................................................................................................................... Sample Balance Sheet ..................................................................................................................... Audit Your Balance Sheet .............................................................................................................. Statement of Net Worth (Personal Balance Sheet) ..................................................................... The Value of a Business.................................................................................................................. Balance Sheet Analysis................................................................................................................... Financial Planning .......................................................................................................................... Net Worth Flows to Profit.............................................................................................................. Information leads to Empowerment ............................................................................................

Thanks a Million ........................................................................................................ Definitions of Terms................................................................................................... Recommended Reading, Etc. ..................................................................................9 End Notes .................................................................................................................... 1 2

Groucho Marx, www.quotations-page.com Inventory, Barron’s Dictionary of Business Terms

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