Learning how to keep your records is a prerequisite to learning how to make money. If you fail on the aforementioned, not even all the money in the world will help you. There will come a time when you wish you had kept better financial records. You won’t know what happened to your business during a five-year period, or how much money you made from various activities, or where the money went. And it could be very hard to find out. My accountant recently asked if I had any idea how much time he saves me. I have the same question about the doctor, the dentist, and my mechanic.
Ask yourself whether you are paying for convenience or for expertise. Convenience is fine, but you also need someone who actually knows what they are doing.
If you have a business, this is a good time to set up a double-entry bookkeeping system or upgrade to a computerized system if you already have one. This does not imply that you will one day have a comprehensive record of everything that happened during those five years—though that will be nice—but because keeping good financial records is like taking care of yourself, if you do it as part of your daily routine, it doesn’t seem like such a chore.
Your business will have to keep many records, and you are legally responsible for making, keeping, and filing them. I’m not a lawyer, so I can’t give you legal advice about whether your particular business structure requires you to do anything besides pay taxes. But chances are that you’ll need to keep at least these records:
- Receipts for the income you’ve received for your own protection as well as potential tax liability.
- A record of all your expenses. Expense records are important because even if your income is low this year, you may not be able to deduct any losses from it next year; you may only deduct them from the income of the prior year. So keep good records of your expenses this year, or else save your receipts and invoices for next year.
- A record of all money paid out; money coming in; money spent on operating expenses; and money spent on capital investments (including depreciation).
Many businesses also need to keep more specialized records: accounts receivable (money that customers owe you), accounts payable (money that you owe suppliers), inventory (the things you’re storing for sale), fixed assets (things like furniture and equipment), intangible assets (goodwill), liabilities (debts), etc
Accounting is a language, and it has its own kind of logic. If you can understand the language, and follow a few simple rules, you will be able to read your financial records and follow your business’s progress. This is not as hard as it might sound.
In effect, accounting boils down to two things: recording what money comes in, and recording what money goes out. The first of these is called “revenue” (or “sales”), and the second is called “expenses.” Revenue minus expenses is profit.
The basic principle of accounting is that revenue should equal expenses. If it doesn’t, you have made a mistake somewhere; either you recorded an expense for something that didn’t cost anything (a “bad expense”) or a receipt for something that didn’t bring in any money (“a bad receipt”). Any time you make a mistake like that, the difference between the mistake and reality is an error.
The problem with accounting is that, when you do something wrong early on, it can blow the whole thing up.
Suppose your business buys a truck for $30,000. You put down $3,000 and finance the remaining $27,000 at 4% over ten years. Your monthly payment is $269. The total cost of the loan is $21,917.
You just made a mistake: you should have put down 10% and financed 90%. This is because if you had done that, your payment would have been only $217 a month, and the total cost of the loan would have been only $18,511.
So why did you make this mistake? Well, maybe because your business had recently lost money and you were feeling pinched; maybe because you were more optimistic about your business’s prospects than you had any right to be; or maybe because you were foolishly confident in yourself. Or maybe for some other reason altogether.
Whatever the reason was, here’s what happens next: your business makes money and does well and eventually repays its loan in full. And then someday— if not today and not tomorrow and not next week or even next year — someday some accountant is going to see that last loan payment.
Accounting is where you put down what you have, what you do with it, and what you got out of it.
The most practical use of accounting is that, if it’s done right, it forces you to confront exactly these questions. You can’t avoid thinking about them. You can only put them off.
Facing up to the problems is hard enough when your business is small. But if you are planning for growth, ignoring them will make your future harder to predict, and lowers your odds of success.
What are you going to do with your time? How are you going to spend it? How much time will each project or task or relationship consume? And how will the sum total of these decisions affect the state of your life?