Millions of small business owners and startup entrepreneurs are masters at creating great products and services, building awesome teams and winning over customers. Many of them, however, would probably flunk basic bookkeeping. But if you – the business owner – don’t understand the different types of “accounts” your bookkeeper uses to organize your finances, measuring the success (or failure) of your efforts will be futile. Being deft at digital marketing, for example, isn’t enough if you don’t have a clear financial picture of your business and run headlong into cash flow problems. What do your accounts receivable look like? Are you constantly paying your own bills late? Not sweating the small stuff like understanding your own books is trouble in the making, says Lita Epstein, who designs online courses about reading financial reports and is the author of Bookkeeping Kit for Dummies (Wiley, 2012). Here are basics of the 10 most common types of bookkeeping accounts for a small business that you should know:
- Cash. It doesn’t get more basic than this. All of your business transactions pass through the Cash account, which is so important that often bookkeepers actually use two journals — Cash Receipts and Cash Disbursements — to track the activity.
- Accounts Receivable. If your company sells products or services and doesn’t collect payment immediately you have “receivables” and you must track Accounts Receivable. This is money due from customers, and keeping it up to date is critical to be sure that you send timely and accurate bills or invoices.
- Inventory. Products you have in stock to sell are like money sitting on a shelf and must be carefully accounted for and tracked. The numbers you have in your books should be periodically tested by doing physical counts of inventory on hand.
- Accounts Payable. No one likes to send money out of the business. But it’s a little less painful if you have a clear view of everything via your Accounts Payable. Good bookkeeping helps assure timely payments and – importantly – that you don’t pay anyone twice. Paying bills early can also qualify your business for discounts.
- Loans Payable. If you’ve borrowed money to buy equipment, vehicles, furniture or other items for your business, this is the account that tracks what’s owed and what’s due.
- Sales. The Sales account is where you track all incoming revenue from what you sell. Recording sales in a timely and accurate manner is critical to knowing where your business stands.
- Purchases. The Purchases Account is where you track any raw materials or finished goods that you buy for your business. It’s a key component of calculating “Cost of Goods Sold” (COGS), which you subtract from Sales to find your company’s gross profit.
- Payroll Expenses. This is the biggest cost of all for many businesses. No matter how much you beg, few people want to work for nothing. Keeping this account accurate and up to date is essential for meeting tax and other government reporting requirements. Shirking those responsibilities will put you in serious hot water.
- Owners’ Equity. This account has a nice ring to it. Basically, it tracks the amount each owner puts into the business. “Many small businesses are owned by one person or a group of partners; they’re not incorporated, so no stock shares exist to divide up ownership,” says Epstein. “Instead, money put into the business is tracked in Capital accounts, and any money taken out appears in Drawing accounts. In order to be fair to all owners, your books must carefully record all Owners’ Equity accounts.
- Retained Earnings. The Retained Earnings account tracks any of your company’s profits that are reinvested in the business and are not paid out to the owners. Retained earnings are cumulative, which means they appear as a running total of money that has been retained since the company started. Managing this account doesn’t take a lot of time and is important to investors and lenders who want to track how well the company has done over time.
Many business owners think of bookkeeping as an unwelcome chore. But if you understand and make effective use of the data your bookkeeper collects, bookkeeping can be your best buddy, helping you run your business more effectively.