Keeping Your Accounts Straight
Understanding the Balance Sheet Accounts
Most small business owners are unfamiliar with accounting set up, and often get confused when setting up accounts. Learn what the different types of accounts are, and why
There are two basic classifications of accounts that are in any accounting system: balance sheet accounts and profit and loss (P&L) sheet accounts. The former accounts track the financial state of your business, basically how much it owes, what it owns, and its retained earnings. P&L sheet accounts track its current state of earnings – how much its revenue and expenses are. Each of these is important for different reasons, since you can’t get a complete picture of the business if you don’t know where it’s spending its money, and if you don’t know if it’s actually making money or not.
The Balance Sheet Accounts
In the balance sheet you will need basic items that track your assets, both current (short term (short term = less than one year life)) and long term. The first of these groups is your cash and its equivalents, including one account for each of your bank accounts, one for petty cash (if you have it) or your cash register, and one account fro each of your investments. You will also need one account to track what you owe people – this is the accounts payable. You should also keep an account for tracking any credit cards. Some accountants like to keep a separate account for each credit card. This is a good idea if you have no other way in your system to track the account balance of each card. Some computer systems will allow you to track each card by name, but keep all of the totals in one account. This keeps the ledger cleaner and smaller. But it can confuse those people who are unfamiliar with the system. You also need to track your other liabilities, such as government payroll and tax liabilities. It is a good idea to keep each liability in its own account, but not always necessary. Liabilities are clasified as current (short term, less than one year), and long term. Most of the above are current liabilities. Long term liabilities are usually larger loans and mortgages.
Other accounts include those that track your assets, including the amounts owed to you. These are called receivables are also classified current and long term. The first of these is your accounts receivable. You may also have prepaid expenses, which should be in their own account. There may also be loans from shareholders/owners and employees. These are usually long term. Track each class of these separately. This means that each type of loan can be kept in an account (for example, shareholder loans), and the individuals within can be tracked by name. There are also fixed assets, which are long-term assets. These are items like automobiles, computers, expensive tools (usually over $500 - check with your accountant or tax authority on these rules), and land and buildings.
Finally, there are equity accounts. In some instances you can classify shareholder loans as equity. Ask your advisor about this. Equity is basically the retained amount that your company has earned over the course of its business. Yes, this can be negative if there has been more money put into the business than it has earned over its life.
The balance sheet equation is Assets = Liabilities plus Equity. This is why it’s called a “balance sheet” – the top part is all of the assets, and they should total the liabilities and equity. An example of a simple balance sheet is herewith included.
Next... The Profit and Loss Statement...
