The Small Business Bookkeeping Bible for 20 Years KEEPING THE BOOKS 2008 Book 7th Edition e Basic Recordkeeping and Accounting and Up-toDate Tax Information for the Successful Small Business Linda Pinson
Table of Contents Dedication & Acknowledgements.... i About the Author (Linda Pinson). ii Automate Your Business Plan 2007... vi (companion software to our book, Anatomy of a Business Plan) Preface...viii Chapter 1 Recordkeeping Basics..... 1 Functions of Recordkeeping... 1 When Does Recordkeeping Begin?... 3 Chapter 2 Income & Expenses........ 5 Income (or Revenue) 5 Expenses 5 What are Deductible Expenses?. 6 Common Deductible Expenses... 7 Chapter 3 Cash Accounting Vs. Accrual Accounting....... 9 Cash and Accrual Accounting Defined 9 Which Method Will You Be Required To Use? 11 Pros and Cons of the Two Methods. 11 Can You Change Methods from Year to Year?. 12 Chapter 4 Essential Records For Small Business.... 13 Single and Double Entry Systems... 14 Chart of Accounts... 16 Debits and Credits... 18 An Overview of Four Accounting Tasks Using QuickBooks Pro. 20 Summary: Accounting Software... 24 Revenue & Expense Journal... 26 Petty Cash Record... 30 Inventory Record... 32 Fixed Assets Log... 38 Accounts Receivable... 40 Accounts Payable... 42 Payroll Records... 44 Independent Contractors... 47 iii
Travel, Transportation, and Entertainment Expenses... 50 Customer Information Records... 56 Business Checkbook... 58 Receipt Files... 60 Chapter 5 Financial Statements..... 61 What are Financial Statements?... 61 Balance Sheet... 63 Profit & Loss (Income) Statement or Income Statement... 66 Business Financial History... 70 Personal Financial Statement... 74 Pro Forma Cash Flow Statement or Budget... 76 Preparing your Cash Flow Statement... 77 Completing your Pro Forma Cash Flow Statement... 84 Quarterly Budget Analysis... 86 Three-Year Income Projection... 88 Break-Even Analysis... 90 Chapter 6 Financial Statement Analysis... 93 Financial Statements... 93 Liquidity Analysis... 96 Profitability Analysis... 98 Debt Measures 100 Investment Measures 101 Vertical Financial Statement Analysis 102 Horizontal Financial Statement Analysis 104 Summary 105 Chapter 7 Taxes and Bookeeping. 107 Basic Understanding of the U.S. Tax System... 107 Federal Taxes for Which You May be Liable... 109 Income Tax (for Sole Proprietors) 114 Home Office Deduction. 117 Income Tax (Partnerships)... 119 Income Tax (S Corporations). 122 Income Tax (Corporations)... 124 Estimated Tax (for Sole Proprietor, Individual Who is a Partner, or S Corporation Shareholder) 127 Estimated Tax (Corporations).. 130 Self-Employment Tax (for Sole Proprietor, Individual Who Is a Partner, or an S Corporation Shareholder) 132 Social Security (FICA) Tax and Withholding of Income Tax 135 Federal Unemployment (FUTA) Tax 142 Payment to Nonemployees for Services Rendered 145 Taxpayer Identification Number (EIN)... 148 Free Tax Publications Available From the IRS... 149 Summary 152 iv
Chapter 8 Recordkeeping and Tax Reporting Schedules... 153 Organizing Your Recordkeeping.. 154 Building Your System. 154 Recordkeeping Schedule.. 156 Tax Reporting Schedule 158 Chapter 9 Preparing for Uncle Sam... 161 What to Give Your Accountant. 162 The Last Chore. 163 Appendix I: Independent Contractors: Facts Versus Myths.... 165-172 Appendix II: Worksheets. 173-195 Small Business Resources... 197-198 Glossary. 199-206 Index... 207-210 v
CHAPTER Recordkeeping Basics 1 The keeping of accurate records is imperative if you are going to succeed at business. From time to time, I have had students in my small business classes who have wonderful ideas for products or services, but who do not want to be bothered with the details of recordkeeping. Their businesses are already doomed to failure. This book was written with the assumption that you are starting from scratch and know nothing about the recordkeeping process. I have tried to solve the puzzle for you. By the time you have finished applying the principles in the book, I hope that you will understand how all of the pieces fit together to develop a simple, but accurate set of books. Functions of Recordkeeping The first, and most important, function is to provide you with information that will help you to see the trends that are taking place within your operation. You will see, as you study this book, that a complete and simple set of records will make it possible to tell at a glance what is happening with your business -- which areas are productive and cost-effective and which will require the implementation of changes. The second function of recordkeeping is to provide you with income tax information that can be easily retrieved and verified. Who Should Do Your Recordkeeping? You, the business owner, should be personally involved rather than delegating this job to an outsider. Keeping your own books and records will make you doubly aware of what is going on in your business and it will also save you money that can be used to benefit your business in other areas. For example, you may now be able to afford a piece of effective advertising that will generate more sales. Even if time will not allow you to keep your own records and you assign the task to someone else, it will be a major benefit to you to make every attempt to understand how your records are organized and to learn how to read and use them to make decisions in your business.
2 Keeping the Books Do You Need an Accountant? I do not advocate the elimination of an accounting professional. In fact, end-of-theyear tax accounting requires special expertise and will best be handled by an accountant who can maximize your tax benefits. You will have to decide whether to use a Certified Public Accountant (CPA), Enrolled Agent (tax accountant), or noncertified bookkeeper/tax preparer. The first two are empowered to represent you at an IRS audit. All accounting professionals are dependent on the financial information that you provide. To ensure the most profitable results for your business, you will need to set up and maintain general records as the source of financial data. You should also work with the accountant to establish a good line of communication and a smooth flow of that data. Depending on the size and scope of your business, you will have to decide which of the recordkeeping chores you can handle and which ones should be delegated to an expert. For instance, you may be able to do all of your accounting except for payroll, which is very exacting and will probably be more effectively handled by your accountant. You may also decide that you would like to use an accountant at the end of the month to generate your financial statements. In fact, if the scope of your business becomes very large, it may become necessary to turn over your entire accounting operation to an expert. If so, it will still be imperative that you understand the process, so you will be able to use your financial information to make sound business decisions. Accounting Software One of the most frequently asked questions is about which accounting software programs will make the process easy. There are many programs on the market today that will adequately take care of your needs. However, if you do not understand the recordkeeping basics, you will not know how to tailor the program to your business or feed in the proper information. You may best be served by beginning with a manual system. You can always translate it into a computer application as the need arises. At that time, if you are working with an accountant, it will probably be best to use a software program that he or she suggests and one that will easily interface with what is currently being used in that office. Coordinating with your tax accountant may even enable you to work together via Internet transmissions. Every Business Is Unique The system you use must be tailored to your individual needs. Obviously a service-oriented business will not use the same records as a retail operation. Because no two businesses will have exactly the same concerns, it is imperative that you develop your own system. You will have to consider any information that will be used by your particular venture and set up your records according to those needs.
Chapter 1, Recordkeeping Basics 3 When Does Recordkeeping Begin? Your business commences as soon as you begin to refine your idea. You do not have to wait until you have a license and are open for business to start with your recordkeeping. In fact, you will do yourself a great disservice if you are not keeping records at this very moment. Many of your initial expenses are deductible if you have begun to actively pursue your business. A good way to begin is as follows: Deductible Expenses The first thing you should do is familiarize yourself with the expenses that are commonly deductible for a business. When you are doing things that relate to your business begin to think of the costs involved and record them for future use. (See Chapter 2, Income and Expenses. ) Diary Buy yourself a hardbound journal at your local stationers. Keep a diary of your thoughts and actions related to your new business. Number the pages, write in pen, and initial any corrections you make. Your journal will serve to protect your idea as well as provide you with a record of your contacts and the information you gather for the future. You can also list any expenses incurred and file away your receipts. Be sure to date all entries. Beginning Journal I like to utilize the last few pages of the journal to keep a record of income and expenses during the planning stages of a business. It need not be complicated. You can set it up like the sample Beginning Journal provided on page 4. Simplicity is the key Simplicity is the key to small business accounting. Your records must be complete, but not so complicated that they cannot be read and interpreted. It will be the function of this book to not only introduce you to the terminology and forms necessary to set up a recordkeeping system for your business, but to enable you to actually set up records that will give you the information you need to satisfy tax requirements, examine trends, make decisions, and implement changes that will make your business venture more profitable and rewarding.
4 Keeping the Books Beginning Journal for ABC Company Date 1. Check # 2. Cash 3. C/Card Paid To or Received From Explanation of Income or Expense Income Expense 1/7/07 Pers. Check 1475 Coastline Community College Registration for Small Business Start-Up 65 00 1/09/07 Cash Tam s Stationers Office Supplies 25 63 1/17/07 Cash Ace Hardware Tools 71 80 2/03/07 VISA A-1 Computer Pentium Computer 1821 34 2/04/07 Pers. Check 1493 AT&T January Telephone Business Calls 52 00 Remember: All expenses relating to our new business endeavors should be recorded. A few examples are as follows: 1. Conference, seminar and workshop fees 2. Mileage to and from business pursuits 3. Meals related to business (see tax rulings) 4. Books, tapes, videos, etc. purchased for business 5. Office supplies (notebooks, journals, pens, etc.) 6. Telephone calls relating to business 7. Professional organizations (dues, fees, etc.) 8. Materials used for developing your product 9. Tools or equipment purchased for your business There are many other business expenses, including those mentioned under the pages on Common Deductible Expenses. A good rule of thumb is that when a purchase or activity seems to have any possible bearing on your business, journalize it, keep receipts, look up tax rulings, and then utilize the information accordingly.