Financial Record Keeping Kit

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This Financial Record Keeping Kit provides background and guidelines for understanding basic accounting and bookkeeping principles. This kit will assist a business owner to understand the record keeping process. This form is ready for instant download.

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Countless small businesses fail because their owners do not understand the complex accounting processes and systems used in modern business. This Financial Record Keeping Kit is designed to assist a business owner in understanding the record keeping process and contains easy to read and understand guides and forms.

This Financial Record Keeping Kit includes the following:
  • Understanding Financial Record Keeping Guide
  • Current Balance Sheet Form
  • The Profit and Loss Statement Guide
  • Estimated Profit and Loss Statement Form
  • Accounting Methods Guide
  • Financial Record Keeping Checklist

Protect Yourself and Your Business by using our professionally prepared up-to-date forms.

This attorney-prepared packet contains:
  1. General Information
  2. Financial Record Keeping Kit
State Law Compliance: This form complies with the laws of all states
This is the content of the form and is provided for your convenience. It is not necessarily what the actual form looks like and does not include the information, instructions and other materials that come with the form you would purchase. An actual sample can also be viewed by clicking on the "Sample Form" near the top left of this page.












Financial Record Keeping Kit










This Packet Includes:
1. General Information
2. Understanding Financial Records Guide
3. Current Balance Sheet Form
4. Estimated Profit and Loss Statement Form
5. Financial Record Keeping Checklist






General Information
Financial Record Keeping - Kit

This kit provides the background and guidelines for understanding basic accounting and bookkeeping principles.

Each year, thousands of small businesses fail because their owners have lost control of their finances.  Many of these failures are brought on by the inability of the business owners to understand the complex accounting processes and systems that have become relatively standard in modern business.  Accounting and bookkeeping have, in most businesses, been removed from the direct control and, therefore, understanding of the business owners themselves.  If business owners cannot understand the financial situation of their own businesses, they have little chance of succeeding.



This kit is designed to aid you in understanding how to develop a concise and easily understood financial record keeping system, keep the books for a business, and, perhaps most importantly, actually understand those records.




DISCLAIMER:

FindLegalForms, Inc. (“FLF”) is not a law firm and does not provide legal advice.  The use of these materials is not a substitute for legal advice. Only an attorney can provide legal advice.  An attorney should be consulted for all serious legal matters.  No Attorney-Client relationship is created by use of these materials.  

THESE MATERIALS ARE PROVIDED “AS-IS.  FLF DOES NOT GIVE ANY EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY, SUITABILITY OR COMPLETENESS FOR ANY OF THE MATERIALS FOR YOUR PARTICULAR NEEDS.  THE MATERIALS ARE USED AT YOUR OWN RISK.  IN NO EVENT WILL:  I) FLF, ITS AGENTS, PARTNERS, OR AFFILIATES; OR II) THE PROVIDERS, AUTHORS OR PUBLISHERS OF ITS MATERIALS, BE RESPONSIBLE OR LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR CONSEQUENTIAL DAMAGES (INCLUDING, BUT NOT LIMITED TO, PROCUREMENT OF SUBSTITUTE GOODS OR SERVICES; LOSS OF USE, DATE OR PROFITS; OR BUSINESS INTERRUPTION) HOWEVER USED AND ON ANY THEORY OF LIABILITY, WHETHER IN CONTRACT, STRICT LIABILITY, OR TORT (INCLUDING NEGLIGENCE OR OTHERWISE) ARISING IN ANY WAY OUT OF THE USE OF THESE MATERIALS. 



Understanding Financial Record Keeping

The purpose of any business financial record keeping system is to provide a clear vision of the relative health of the business, both on a day-to-day basis and periodically.  Business owners themselves need to know whether they are making a profit, why they are making a profit, which parts of the business are profitable, and which is not.  This information is only available if the business owner has a clear and straightforward record keeping system.  

Business owners also need to be able to produce accurate financial statements for income tax purposes, for loan proposals, and for the purpose of selling the business.  Clear, understandable, and accurate business records are vital to the success of any small business.  In order to design a good record keeping system for a particular business, an understanding of certain fundamental ideas of accounting is necessary.  For those unfamiliar with the terms and concepts of accounting, grasping these basic ideas may be the most difficult part of accounting, even simplified accounting.

First, lets get some of the terminology clarified.  Accounting is the design of the record keeping system that a business uses and the preparation and interpretation of reports based on the information that is gathered and put into the system. Bookkeeping is the actual inputting of the financial information into the record keeping system. The purpose of any business record keeping system is to allow the business owner to easily understand and use the information gathered. Certain accounting principles and terms have been adopted as standard over the years to make it easier to understand a wide range of business transactions.  In order to understand what a record keeping system is trying to accomplish, it is necessary to define some of the standard ways of looking at a business.  There are two standard reports that are the main sources of business financial information: the balance sheet and the profit-and-loss statement.


The Balance SheetThe Balance Sheet

The purpose of the balance sheet is to look at what the business owns and owes on a specific date.  By seeing what a business owns and owes, anyone looking at a balance sheet can tell the relative financial position of the business at that point in time.  If the business owns more than it owes, it is in good shape financially.  On the other hand, if it owes more than it owns, the business may be in trouble.  The balance sheet is the universal financial document used to view this aspect of a business.  It provides this information by laying out the value of the assets and the liabilities of a business.  One of the most critical financial tasks that a small business owner must confront is keeping track of what the business owns and owes.  Before the business buys or sells anything or makes a profit or loss, the business must have some assets.

The assets of a business are anything that the business owns.  These can be cash on hand or in a bank account; they can be personal property, like office equipment, vehicles, tools, or supplies; they can be inventory, or material that will be sold to customers; they can be real estate, buildings, and land; and they can be money that is owed to the business.  Money that is owed to a business is called its accounts receivable, basically the money that the business hopes to eventually receive.  The total of all of these things that a business owns are the businesss assets.

The liabilities of a business are anything that the business owes to others.  These consist of long-term debts, such as a mortgage on real estate or a long-term loan.  They also consist of any short-term debts, such as money owed for supplies or taxes.  Money that a business owes to others is called its accounts payable, basically the money that the business hopes to eventually pay.  In addition to money owed to others, the equity of a business is also considered a liability.  The equity of a business is the value of the ownership of the business.  It is the value that would be left over if all of the debts of the business were paid off.  If it is a partnership or a sole proprietorship, the business equity is referred to as the net worth of the business.  If the business is a corporation, the owners equity is called the capital surplus or retained capital.  All of the debts of a business and its equity are together referred to as the business liabilities.

The basic relationship between assets and liabilities can be shown in a simple equation:


Assets = Liabilities

This simple equation is the basis of business accounting.  When the books of a business are said to balance, it is this equation that is in balance: the assets of a business must equal the liabilities of a business.  Since the liabilities of a business consist of both equity and debts, the equation can be expanded to read:


Assets = Debts + Equity

Rearranging the equation can provide a simple explanation of how to arrive at the value of a business to the owner, or its equity:


Equity = Assets - Debts

A basic tenet of record keeping is that both sides of this financial equation must always be equal.  The formal statement of the assets and liabilities of a specific business on a specific date is called a balance sheet.  A balance sheet is usually prepared on the last day of a month, quarter, or year.  A balance sheet simply lists the amounts of the businesss assets and liabilities in a standardized format.

On a balance sheet, the assets of a business are generally broken down into two groups: current assets and fixed assets.  Current assets consist of cash, accounts receivable (remember, money that the business intends to receive; basically, bills owed to the business), and inventory. Current assets are generally considered anything that could be converted into cash within one year. Fixed assets are more permanent-type assets and include vehicles, equipment, machinery, land, and buildings owned by the business.

The liabilities of a business are broken down into three groups: current liabilities, long-term liabilities, and owners equity.  Current liabilities are short-term debts, generally those that a business must pay off within one year.  This includes accounts payable (remember, money that the business intends to pay; basically, bills the business owes), and taxes that are due.  Long-term liabilities are long-term debts such as mortgages or long-term business loans.  Owners equity is whatever is left after debts are deducted from assets.  Thus, the owners equity is what the owner would have left after all of the debts of the business were paid off.  Owners equity is the figure that is adjusted to make the equation of assets and liabilities balance.

Lets look at a simple example: a basic sales business.

Smiths Gourmet Foods has the following assets: Smith has $500 in a bank account, is owed $70.00 by customers who pay for their food monthly, has $200 worth of food supplies, and owns food preparation equipment worth $1,300.

These are the assets of Smiths Gourmet Foods and they are shown on a balance sheet as follows:

Cash   $   500.00
+   Accounts owed to it   $   70.00
+   Inventory   $   200.00
+   Equipment   $     1,300.00
=   Total Assets   $   2,070.00

Smith also has the following debts: $100 owed to the supplier of the food, $200 owed to the person from whom she bought the food equipment, and $100 owed to the state for sales taxes that have been collected on food sales.  Thus, the debts of Smiths Gourmet Foods are shown as follows:

Accounts it owes   $   100.00
+   Loans it owes   $   200.00
+   Taxes it owes   $        100.00
=   Total Debts   $    400.00

To find what Smiths equity in this business is, we need to subtract the amount of the debts from the amount of the assets.  Remember: assets - debts = equity.  Thus, the owners equity in Smiths Gourmet Foods is as follows:

Total Assets   $   2,070.00
-   Total Debts   $        400.00
=   Owners Equity   $   1,670.00

Thats it.  The business of Smiths Gourmet Foods has a net worth of $1,670.  If Smith paid off all of the debts of the business, there would be $1,670 left.  This basic method is used to determine the net worth of businesses worldwide, from the smallest to the largest: assets = debts + equity or assets - debts = equity.  Remember, both sides of the equation always have to be equal.

Attached below is a sample Balance Sheet that you can use to determine your businesss Owners Equity.

CURRENT BALANCE SHEET
As of:    
ASSETS
Current Assets
Cash in Bank

Cash on Hand

Accounts Receivable

Inventory

Prepaid Expenses

Total Current Assets

Fixed Assets
Equipment (cost)

Autos and Trucks (cost)

Buildings (cost)

Total

(Less Depreciation)

Net Total

Add Land (cost)

Total Fixed Assets

Total Miscellaneous Assets

Total Assets

LIABILITIES
Current Liabilities
Accounts Payable

Miscellaneous Payable

Total Current Liabilities

Fixed Liabilities
Loans Payable (long-term)

Total Fixed Liabilities

Total Liabilities

Owners Equity
Net Worth or Capital Surplus + Stock Value

The Profit and Loss Statement
The Profit and Loss Statement
The other main business report is the profit and loss statement.  This report is a summary of the income and expenses of the business during a certain period.  Profit and loss statements are sometimes referred to as income statements or as operating statements.  You may choose to prepare a profit and loss statement monthly, quarterly, or annually, depending on your particular needs.  You will, at a minimum, need to have an annual profit and loss statement in order to streamline your tax return preparation.

A profit and loss statement, however, provides much more than assistance in easing your tax preparation burdens.  It allows you to clearly view the performance of your business over a particular time period.  As you begin to collect a series of profit and loss statements, you will be able to conduct various analyses of your business.  For example, you will be able to compare monthly performances over a single year to determine which month was the best or worst for your business.  Quarterly results will also be able to be contrasted.  The comparison of several annual expense and revenue figures will allow you to judge the growth or shrinkage of your business over time.  Numerous other comparisons are possible, depending on your particular business.  How have sales been influenced by advertising expenses?  Are production costs higher this quarter than last?  Do seasons have an impact on sales?  Are certain expenses becoming a burden on the business?  The profit and loss statement is one of the key financial statements for the analysis of your business.

Generally, income for a business is any money that it has received or will receive during a certain period.  Expenses are any money that it has paid or will pay out during a certain period.  Simply put, if the business has more income than expenses during a certain period, it has made a profit.  If it has more expenses than income, then the business has a loss for that period of time.

Income can be broken down into two basic types: service income and sales income.  The difference between the two types of income lies in the need to consider inventory costs.  Service income is income derived from performing a service for someone (cutting hair, for example).  Sales income is revenue derived from selling a product of some type.  With service income, the profit can be determined simply by deducting the expenses that are associated with making the income.  With sales income, however, in addition to deducting the expenses of making the income, the cost of the product that was sold must also be taken into account.  This is done through inventory costs.  Thus, for sales income, the income from selling a product is actually the sales income minus the cost of the product to the seller.  This inventory cost is referred to as the cost of goods sold.

A profit and loss statement begins with a sale. Back to the food business.  Smith had the following transactions during the month of July:  $250 worth of food was sold, the wholesale cost of the food that was sold was $50.00, the cost of napkins, condiments, other supplies, and rent amounted to $100, and interest payments on the equipment loan were $50.00.  Thus, Smiths profit and loss statement would be prepared as follows:

Gross sales income   $   250.00
-   Cost of food   $       50.00
=   Net sales income   $   200.00

Operating Expenses   $   100.00
+   Interest payments   $       50.00
=   Net expenses   $   150.00

Thus, for the month of July, Smiths business performed as follows:

Net sales income   $   200.00
-   Net expenses   $     150.00
=   Net profit   $   50.00

Again, this simple setup reflects the basics of profit and loss statements for all types of businesses, no matter their size.  For a pure service business, with no inventory of any type sold to customers: income - expenses = net profit. For a sales-type business or a sales/service combined business: income - cost of goods sold - expenses = profit.

These two types of summary reports, the balance sheet and the profit and loss statement, are the basic tools for understanding the financial health of any business.  The figures on them can be used for many purposes to understand the operations of a business.  The balance sheet shows what proportions of a business assets are actually owned by the business owner and what proportion is owned or owed to someone else.

Looking at Smiths balance sheet, we can see that the owners equity is $1,670 of assets of $2,070.  Thus, we can see that the owner has more than 80 percent ownership of the business, a very healthy situation.  There are numerous ways to analyze the figures on these two financial statements.  Understanding what these figures mean and how they represent the health of a business are keys to keeping control of the finances of any business.

Attached below is a sample Estimated Profit and Loss Statement.

ESTIMATED PROFIT AND LOSS STATEMENT
For the period of:    

ESTIMATED INCOME
Estimated Gross Sales Income

Less Estimated Cost of Goods Sold

Estimated Net Sales Income Total

Estimated Service Income Total

Estimated Miscellaneous Income Total

Estimated Total Income

ESTIMATED EXPENSES
Advertising expenses

Auto expenses

Cleaning and maintenance expenses

Charitable contributions

Dues and publications

Office equipment expenses

Freight and shipping expenses

Business insurance expenses

Business interest expenses

Legal and accounting expenses

Business meals and lodging

Miscellaneous expenses

Postage expenses

Office rent/mortgage expenses

Repair expenses

Office supplies

Sales taxes

Federal unemployment taxes

State unemployment taxes

Telephone/Internet expenses

Utility expenses

Wages and commissions

Estimated General Expenses Total

Estimated Miscellaneous Expenses

Estimated Total Expenses


Estimated Pre-Tax Profit (Income less Expenses)


Accounting MethodsAccounting Methods

There are a few more items that must be understood regarding financial record keeping.  First is the method for recording the records.  There are two basic methods for measuring transactions: the cash method and the accrual method.  Cash method accounting is a system into which income is recorded when it is received and expenses are recorded when they are paid.  With cash accounting, there is no effective method to accurately reflect inventory costs.  Thus, Internal Revenue Service regulations require that the cash method of accounting may only be used by those few businesses that are solely service businesses and do not sell any materials to their customers at all, even a few spare parts.  If a business sells any type of product or material whatsoever, it must use the accrual method of accounting.

The accrual method of accounting counts income and expenses when they are due to the business.  Income is recorded when the business has a right to receive the income.  In other words, accounts receivable (bills owed to the business) is considered as income that has already been received by the business.  Expenses are considered and recorded when they are due, even if they are not yet paid.  In other words, accounts payable (bills owed by the business) is considered expenses to the business when they are received, not when they are actually paid.  The vast majority of businesses will wish to use the accrual method of accounting.  A business must choose to keep its records either on the accrual basis or on the cash basis.  Once this decision is made, approval from the Internal Revenue Service must be obtained before the method can be changed.  After you select the type of accounting you will use, please consult a tax professional if a change in the system must be made.


Accounting SystemsAccounting Systems

In addition, there are two basic types of record keeping systems: single-entry and double-entry.  Both types are able to be used to keep accurate records, although the double entry system has more ways available to double-check calculations.  Double-entry record keeping is, however, much more difficult to master, in that each and every transaction must be entered in two separate places in the records.  The benefits of ease of use of a single-entry system far outweigh the disadvantages of this system.  The Internal Revenue Service recommends single-entry records for beginning small businesses, and states that this type of system can be “relatively simple…used effectively…and is adequate for income tax purposes.”  Many accountants will disagree with this and insist that only double-entry accounting is acceptable.  For the small business owner who wishes to understand his or her own companys finances, the advantages of single-entry accounting far outweigh the disadvantages.
Accounting PeriodsAccounting Periods

A final item to consider is the accounting period for your business.  A business is allowed to choose between a fiscal year accounting period and a calendar year period.  A fiscal year consists of 12 consecutive months that do not end on December 31st.  A calendar year consists of 12 consecutive months that do end on December 31st.  There are complex rules relating to the choice of fiscal year accounting.  Partnerships and S corporations may generally choose to report on a fiscal year basis only if there is a valid business purpose that supports the use of a fiscal year.  This generally complicates the reporting of income and should be avoided unless there is an important reason to choose a fiscal year accounting period.  If a fiscal year period is considered necessary, please consult a tax or accounting professional as there are complicated rules to comply with.

For the majority of small businesses, the choice of a calendar year period is perfectly adequate and, in most cases, will simplify the tax reporting and accounting record keeping.  In the year in which a business is either started or ended, the business year for reporting may not be a full year.  Thus, even for those who choose to use a calendar year, the first year may actually start on a date other than January 1st.

The simplified small business accounting system that is explained in this kit is a modified single-entry accounting system.  It is presented as a system for accrual-basis accounting for small businesses.  The records are designed to be used on a calendar year basis.  Within these basic parameters, the system can be individually tailored to meet the needs of most small businesses.

The backbone of the record keeping system is the chart of accounts for your business.  A chart of accounts will list each of the income, expense, asset, or debt categories that you wish to keep track of.  Every business transaction that you make and every financial record that you create will fit into one of these four main categories.  Your transactions will either be money coming in (income) or money going out (expenses).  Your records will also track either things the business owns (assets) or things the business owes (debts).

Note that it is important to take the time to carefully analyze your business in light of its record keeping needs.  No two businesses will have identical financial record keeping requirements.  You must determine which financial facts and figures will be most important in the successful operation of your individual business.  Keep in mind that as your business grows, your needs may change.  In addition, as you become more familiar with your record keeping, you may decide that you need additional methods of tracking certain aspects of your operations.  You may decide that some of the information that you are collecting is unnecessary in your particular type of business.  Dont be afraid to alter your record keeping system as your business changes.  Your system is only valuable to you if it fits your own needs.



Financial Record Keeping Checklist

?   Set up your business chart of accounts

?   Open a business checking account

?   Prepare a check register

?   Set up a business petty cash fund

?   Prepare a petty cash register

?   Set up asset accounts

?   Prepare current asset account records

?   Prepare fixed asset account records

?   Set up expense account records

?   Set up income account records

?   Set up payroll system

?   Prepare payroll time sheets

?   Prepare payroll depository records

?   Determine proper tax forms for use in business
Number of Pages13
DimensionsDesigned for Letter Size (8.5" x 11")
EditableYes (.doc, .wpd and .rtf)
UsageUnlimited number of prints
Product number#27192
This is the content of the form and is provided for your convenience. It is not necessarily what the actual form looks like and does not include the information, instructions and other materials that come with the form you would purchase. An actual sample can also be viewed by clicking on the "Sample Form" near the top left of this page.












Financial Record Keeping Kit










This Packet Includes:
1. General Information
2. Understanding Financial Records Guide
3. Current Balance Sheet Form
4. Estimated Profit and Loss Statement Form
5. Financial Record Keeping Checklist






General Information
Financial Record Keeping - Kit

This kit provides the background and guidelines for understanding basic accounting and bookkeeping principles.

Each year, thousands of small businesses fail because their owners have lost control of their finances.  Many of these failures are brought on by the inability of the business owners to understand the complex accounting processes and systems that have become relatively standard in modern business.  Accounting and bookkeeping have, in most businesses, been removed from the direct control and, therefore, understanding of the business owners themselves.  If business owners cannot understand the financial situation of their own businesses, they have little chance of succeeding.



This kit is designed to aid you in understanding how to develop a concise and easily understood financial record keeping system, keep the books for a business, and, perhaps most importantly, actually understand those records.




DISCLAIMER:

FindLegalForms, Inc. (“FLF”) is not a law firm and does not provide legal advice.  The use of these materials is not a substitute for legal advice. Only an attorney can provide legal advice.  An attorney should be consulted for all serious legal matters.  No Attorney-Client relationship is created by use of these materials.  

THESE MATERIALS ARE PROVIDED “AS-IS.  FLF DOES NOT GIVE ANY EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY, SUITABILITY OR COMPLETENESS FOR ANY OF THE MATERIALS FOR YOUR PARTICULAR NEEDS.  THE MATERIALS ARE USED AT YOUR OWN RISK.  IN NO EVENT WILL:  I) FLF, ITS AGENTS, PARTNERS, OR AFFILIATES; OR II) THE PROVIDERS, AUTHORS OR PUBLISHERS OF ITS MATERIALS, BE RESPONSIBLE OR LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR CONSEQUENTIAL DAMAGES (INCLUDING, BUT NOT LIMITED TO, PROCUREMENT OF SUBSTITUTE GOODS OR SERVICES; LOSS OF USE, DATE OR PROFITS; OR BUSINESS INTERRUPTION) HOWEVER USED AND ON ANY THEORY OF LIABILITY, WHETHER IN CONTRACT, STRICT LIABILITY, OR TORT (INCLUDING NEGLIGENCE OR OTHERWISE) ARISING IN ANY WAY OUT OF THE USE OF THESE MATERIALS. 



Understanding Financial Record Keeping

The purpose of any business financial record keeping system is to provide a clear vision of the relative health of the business, both on a day-to-day basis and periodically.  Business owners themselves need to know whether they are making a profit, why they are making a profit, which parts of the business are profitable, and which is not.  This information is only available if the business owner has a clear and straightforward record keeping system.  

Business owners also need to be able to produce accurate financial statements for income tax purposes, for loan proposals, and for the purpose of selling the business.  Clear, understandable, and accurate business records are vital to the success of any small business.  In order to design a good record keeping system for a particular business, an understanding of certain fundamental ideas of accounting is necessary.  For those unfamiliar with the terms and concepts of accounting, grasping these basic ideas may be the most difficult part of accounting, even simplified accounting.

First, lets get some of the terminology clarified.  Accounting is the design of the record keeping system that a business uses and the preparation and interpretation of reports based on the information that is gathered and put into the system. Bookkeeping is the actual inputting of the financial information into the record keeping system. The purpose of any business record keeping system is to allow the business owner to easily understand and use the information gathered. Certain accounting principles and terms have been adopted as standard over the years to make it easier to understand a wide range of business transactions.  In order to understand what a record keeping system is trying to accomplish, it is necessary to define some of the standard ways of looking at a business.  There are two standard reports that are the main sources of business financial information: the balance sheet and the profit-and-loss statement.


The Balance SheetThe Balance Sheet

The purpose of the balance sheet is to look at what the business owns and owes on a specific date.  By seeing what a business owns and owes, anyone looking at a balance sheet can tell the relative financial position of the business at that point in time.  If the business owns more than it owes, it is in good shape financially.  On the other hand, if it owes more than it owns, the business may be in trouble.  The balance sheet is the universal financial document used to view this aspect of a business.  It provides this information by laying out the value of the assets and the liabilities of a business.  One of the most critical financial tasks that a small business owner must confront is keeping track of what the business owns and owes.  Before the business buys or sells anything or makes a profit or loss, the business must have some assets.

The assets of a business are anything that the business owns.  These can be cash on hand or in a bank account; they can be personal property, like office equipment, vehicles, tools, or supplies; they can be inventory, or material that will be sold to customers; they can be real estate, buildings, and land; and they can be money that is owed to the business.  Money that is owed to a business is called its accounts receivable, basically the money that the business hopes to eventually receive.  The total of all of these things that a business owns are the businesss assets.

The liabilities of a business are anything that the business owes to others.  These consist of long-term debts, such as a mortgage on real estate or a long-term loan.  They also consist of any short-term debts, such as money owed for supplies or taxes.  Money that a business owes to others is called its accounts payable, basically the money that the business hopes to eventually pay.  In addition to money owed to others, the equity of a business is also considered a liability.  The equity of a business is the value of the ownership of the business.  It is the value that would be left over if all of the debts of the business were paid off.  If it is a partnership or a sole proprietorship, the business equity is referred to as the net worth of the business.  If the business is a corporation, the owners equity is called the capital surplus or retained capital.  All of the debts of a business and its equity are together referred to as the business liabilities.

The basic relationship between assets and liabilities can be shown in a simple equation:


Assets = Liabilities

This simple equation is the basis of business accounting.  When the books of a business are said to balance, it is this equation that is in balance: the assets of a business must equal the liabilities of a business.  Since the liabilities of a business consist of both equity and debts, the equation can be expanded to read:


Assets = Debts + Equity

Rearranging the equation can provide a simple explanation of how to arrive at the value of a business to the owner, or its equity:


Equity = Assets - Debts

A basic tenet of record keeping is that both sides of this financial equation must always be equal.  The formal statement of the assets and liabilities of a specific business on a specific date is called a balance sheet.  A balance sheet is usually prepared on the last day of a month, quarter, or year.  A balance sheet simply lists the amounts of the businesss assets and liabilities in a standardized format.

On a balance sheet, the assets of a business are generally broken down into two groups: current assets and fixed assets.  Current assets consist of cash, accounts receivable (remember, money that the business intends to receive; basically, bills owed to the business), and inventory. Current assets are generally considered anything that could be converted into cash within one year. Fixed assets are more permanent-type assets and include vehicles, equipment, machinery, land, and buildings owned by the business.

The liabilities of a business are broken down into three groups: current liabilities, long-term liabilities, and owners equity.  Current liabilities are short-term debts, generally those that a business must pay off within one year.  This includes accounts payable (remember, money that the business intends to pay; basically, bills the business owes), and taxes that are due.  Long-term liabilities are long-term debts such as mortgages or long-term business loans.  Owners equity is whatever is left after debts are deducted from assets.  Thus, the owners equity is what the owner would have left after all of the debts of the business were paid off.  Owners equity is the figure that is adjusted to make the equation of assets and liabilities balance.

Lets look at a simple example: a basic sales business.

Smiths Gourmet Foods has the following assets: Smith has $500 in a bank account, is owed $70.00 by customers who pay for their food monthly, has $200 worth of food supplies, and owns food preparation equipment worth $1,300.

These are the assets of Smiths Gourmet Foods and they are shown on a balance sheet as follows:

Cash   $   500.00
+   Accounts owed to it   $   70.00
+   Inventory   $   200.00
+   Equipment   $     1,300.00
=   Total Assets   $   2,070.00

Smith also has the following debts: $100 owed to the supplier of the food, $200 owed to the person from whom she bought the food equipment, and $100 owed to the state for sales taxes that have been collected on food sales.  Thus, the debts of Smiths Gourmet Foods are shown as follows:

Accounts it owes   $   100.00
+   Loans it owes   $   200.00
+   Taxes it owes   $        100.00
=   Total Debts   $    400.00

To find what Smiths equity in this business is, we need to subtract the amount of the debts from the amount of the assets.  Remember: assets - debts = equity.  Thus, the owners equity in Smiths Gourmet Foods is as follows:

Total Assets   $   2,070.00
-   Total Debts   $        400.00
=   Owners Equity   $   1,670.00

Thats it.  The business of Smiths Gourmet Foods has a net worth of $1,670.  If Smith paid off all of the debts of the business, there would be $1,670 left.  This basic method is used to determine the net worth of businesses worldwide, from the smallest to the largest: assets = debts + equity or assets - debts = equity.  Remember, both sides of the equation always have to be equal.

Attached below is a sample Balance Sheet that you can use to determine your businesss Owners Equity.

CURRENT BALANCE SHEET
As of:    
ASSETS
Current Assets
Cash in Bank

Cash on Hand

Accounts Receivable

Inventory

Prepaid Expenses

Total Current Assets

Fixed Assets
Equipment (cost)

Autos and Trucks (cost)

Buildings (cost)

Total

(Less Depreciation)

Net Total

Add Land (cost)

Total Fixed Assets

Total Miscellaneous Assets

Total Assets

LIABILITIES
Current Liabilities
Accounts Payable

Miscellaneous Payable

Total Current Liabilities

Fixed Liabilities
Loans Payable (long-term)

Total Fixed Liabilities

Total Liabilities

Owners Equity
Net Worth or Capital Surplus + Stock Value

The Profit and Loss Statement
The Profit and Loss Statement
The other main business report is the profit and loss statement.  This report is a summary of the income and expenses of the business during a certain period.  Profit and loss statements are sometimes referred to as income statements or as operating statements.  You may choose to prepare a profit and loss statement monthly, quarterly, or annually, depending on your particular needs.  You will, at a minimum, need to have an annual profit and loss statement in order to streamline your tax return preparation.

A profit and loss statement, however, provides much more than assistance in easing your tax preparation burdens.  It allows you to clearly view the performance of your business over a particular time period.  As you begin to collect a series of profit and loss statements, you will be able to conduct various analyses of your business.  For example, you will be able to compare monthly performances over a single year to determine which month was the best or worst for your business.  Quarterly results will also be able to be contrasted.  The comparison of several annual expense and revenue figures will allow you to judge the growth or shrinkage of your business over time.  Numerous other comparisons are possible, depending on your particular business.  How have sales been influenced by advertising expenses?  Are production costs higher this quarter than last?  Do seasons have an impact on sales?  Are certain expenses becoming a burden on the business?  The profit and loss statement is one of the key financial statements for the analysis of your business.

Generally, income for a business is any money that it has received or will receive during a certain period.  Expenses are any money that it has paid or will pay out during a certain period.  Simply put, if the business has more income than expenses during a certain period, it has made a profit.  If it has more expenses than income, then the business has a loss for that period of time.

Income can be broken down into two basic types: service income and sales income.  The difference between the two types of income lies in the need to consider inventory costs.  Service income is income derived from performing a service for someone (cutting hair, for example).  Sales income is revenue derived from selling a product of some type.  With service income, the profit can be determined simply by deducting the expenses that are associated with making the income.  With sales income, however, in addition to deducting the expenses of making the income, the cost of the product that was sold must also be taken into account.  This is done through inventory costs.  Thus, for sales income, the income from selling a product is actually the sales income minus the cost of the product to the seller.  This inventory cost is referred to as the cost of goods sold.

A profit and loss statement begins with a sale. Back to the food business.  Smith had the following transactions during the month of July:  $250 worth of food was sold, the wholesale cost of the food that was sold was $50.00, the cost of napkins, condiments, other supplies, and rent amounted to $100, and interest payments on the equipment loan were $50.00.  Thus, Smiths profit and loss statement would be prepared as follows:

Gross sales income   $   250.00
-   Cost of food   $       50.00
=   Net sales income   $   200.00

Operating Expenses   $   100.00
+   Interest payments   $       50.00
=   Net expenses   $   150.00

Thus, for the month of July, Smiths business performed as follows:

Net sales income   $   200.00
-   Net expenses   $     150.00
=   Net profit   $   50.00

Again, this simple setup reflects the basics of profit and loss statements for all types of businesses, no matter their size.  For a pure service business, with no inventory of any type sold to customers: income - expenses = net profit. For a sales-type business or a sales/service combined business: income - cost of goods sold - expenses = profit.

These two types of summary reports, the balance sheet and the profit and loss statement, are the basic tools for understanding the financial health of any business.  The figures on them can be used for many purposes to understand the operations of a business.  The balance sheet shows what proportions of a business assets are actually owned by the business owner and what proportion is owned or owed to someone else.

Looking at Smiths balance sheet, we can see that the owners equity is $1,670 of assets of $2,070.  Thus, we can see that the owner has more than 80 percent ownership of the business, a very healthy situation.  There are numerous ways to analyze the figures on these two financial statements.  Understanding what these figures mean and how they represent the health of a business are keys to keeping control of the finances of any business.

Attached below is a sample Estimated Profit and Loss Statement.

ESTIMATED PROFIT AND LOSS STATEMENT
For the period of:    

ESTIMATED INCOME
Estimated Gross Sales Income

Less Estimated Cost of Goods Sold

Estimated Net Sales Income Total

Estimated Service Income Total

Estimated Miscellaneous Income Total

Estimated Total Income

ESTIMATED EXPENSES
Advertising expenses

Auto expenses

Cleaning and maintenance expenses

Charitable contributions

Dues and publications

Office equipment expenses

Freight and shipping expenses

Business insurance expenses

Business interest expenses

Legal and accounting expenses

Business meals and lodging

Miscellaneous expenses

Postage expenses

Office rent/mortgage expenses

Repair expenses

Office supplies

Sales taxes

Federal unemployment taxes

State unemployment taxes

Telephone/Internet expenses

Utility expenses

Wages and commissions

Estimated General Expenses Total

Estimated Miscellaneous Expenses

Estimated Total Expenses


Estimated Pre-Tax Profit (Income less Expenses)


Accounting MethodsAccounting Methods

There are a few more items that must be understood regarding financial record keeping.  First is the method for recording the records.  There are two basic methods for measuring transactions: the cash method and the accrual method.  Cash method accounting is a system into which income is recorded when it is received and expenses are recorded when they are paid.  With cash accounting, there is no effective method to accurately reflect inventory costs.  Thus, Internal Revenue Service regulations require that the cash method of accounting may only be used by those few businesses that are solely service businesses and do not sell any materials to their customers at all, even a few spare parts.  If a business sells any type of product or material whatsoever, it must use the accrual method of accounting.

The accrual method of accounting counts income and expenses when they are due to the business.  Income is recorded when the business has a right to receive the income.  In other words, accounts receivable (bills owed to the business) is considered as income that has already been received by the business.  Expenses are considered and recorded when they are due, even if they are not yet paid.  In other words, accounts payable (bills owed by the business) is considered expenses to the business when they are received, not when they are actually paid.  The vast majority of businesses will wish to use the accrual method of accounting.  A business must choose to keep its records either on the accrual basis or on the cash basis.  Once this decision is made, approval from the Internal Revenue Service must be obtained before the method can be changed.  After you select the type of accounting you will use, please consult a tax professional if a change in the system must be made.


Accounting SystemsAccounting Systems

In addition, there are two basic types of record keeping systems: single-entry and double-entry.  Both types are able to be used to keep accurate records, although the double entry system has more ways available to double-check calculations.  Double-entry record keeping is, however, much more difficult to master, in that each and every transaction must be entered in two separate places in the records.  The benefits of ease of use of a single-entry system far outweigh the disadvantages of this system.  The Internal Revenue Service recommends single-entry records for beginning small businesses, and states that this type of system can be “relatively simple…used effectively…and is adequate for income tax purposes.”  Many accountants will disagree with this and insist that only double-entry accounting is acceptable.  For the small business owner who wishes to understand his or her own companys finances, the advantages of single-entry accounting far outweigh the disadvantages.
Accounting PeriodsAccounting Periods

A final item to consider is the accounting period for your business.  A business is allowed to choose between a fiscal year accounting period and a calendar year period.  A fiscal year consists of 12 consecutive months that do not end on December 31st.  A calendar year consists of 12 consecutive months that do end on December 31st.  There are complex rules relating to the choice of fiscal year accounting.  Partnerships and S corporations may generally choose to report on a fiscal year basis only if there is a valid business purpose that supports the use of a fiscal year.  This generally complicates the reporting of income and should be avoided unless there is an important reason to choose a fiscal year accounting period.  If a fiscal year period is considered necessary, please consult a tax or accounting professional as there are complicated rules to comply with.

For the majority of small businesses, the choice of a calendar year period is perfectly adequate and, in most cases, will simplify the tax reporting and accounting record keeping.  In the year in which a business is either started or ended, the business year for reporting may not be a full year.  Thus, even for those who choose to use a calendar year, the first year may actually start on a date other than January 1st.

The simplified small business accounting system that is explained in this kit is a modified single-entry accounting system.  It is presented as a system for accrual-basis accounting for small businesses.  The records are designed to be used on a calendar year basis.  Within these basic parameters, the system can be individually tailored to meet the needs of most small businesses.

The backbone of the record keeping system is the chart of accounts for your business.  A chart of accounts will list each of the income, expense, asset, or debt categories that you wish to keep track of.  Every business transaction that you make and every financial record that you create will fit into one of these four main categories.  Your transactions will either be money coming in (income) or money going out (expenses).  Your records will also track either things the business owns (assets) or things the business owes (debts).

Note that it is important to take the time to carefully analyze your business in light of its record keeping needs.  No two businesses will have identical financial record keeping requirements.  You must determine which financial facts and figures will be most important in the successful operation of your individual business.  Keep in mind that as your business grows, your needs may change.  In addition, as you become more familiar with your record keeping, you may decide that you need additional methods of tracking certain aspects of your operations.  You may decide that some of the information that you are collecting is unnecessary in your particular type of business.  Dont be afraid to alter your record keeping system as your business changes.  Your system is only valuable to you if it fits your own needs.



Financial Record Keeping Checklist

?   Set up your business chart of accounts

?   Open a business checking account

?   Prepare a check register

?   Set up a business petty cash fund

?   Prepare a petty cash register

?   Set up asset accounts

?   Prepare current asset account records

?   Prepare fixed asset account records

?   Set up expense account records

?   Set up income account records

?   Set up payroll system

?   Prepare payroll time sheets

?   Prepare payroll depository records

?   Determine proper tax forms for use in business
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