Set up a good, easy to use bookkeeping system. It will eventually pay for itself many times over, and it’s a lot easier than trying to do everything by hand. Don’t worry too much about getting your accounting perfect while you’re small; it will be a lot easier when you’re bigger.
The best method I’ve found is Quicken. It’s fast and flexible, and it can get pretty complex without getting hard to use. For our purposes, the most important thing is that it automatically categorizes transactions into income or expense accounts, depending on which side of the transaction makes money. I like this feature because I don’t like doing the paperwork associated with tracking costs and income separately and then calculating profit and loss at the end of the month (or whatever). The conventional wisdom says that if you do things right you should be able to get away with not having to track your expenses too precisely—you’ll just add them up at the end of each month and compare them with your sales figures, and if they’re within 10% or so you’re doing OK.
A lot of people use accounting software, and this is a great idea, but it can actually be more work to set up at first. The problem with accounting software is that you have to figure out what you need before you can use it. And if your business is like most small businesses-you haven’t thought that far ahead-then the software won’t do what you need anyway.
I started out using an Excel spreadsheet, and I recommend the same approach. It requires a little more work up front, but you can get exactly the system you need without having to buy something expensive or figure out a way to make a free one do what you want. Setting up an Excel spreadsheet for bookkeeping is easy if you follow these instructions.
The main advantage of this system is that it’s simple and cheap, so there’s less of a chance that you’ll get stuck with it forever. In my opinion there’s no such thing as “good enough” in bookkeeping software; if keeping track of your books isn’t easy enough, then keeping track of your books becomes a pain in the neck, which leads to halfhearted bookkeeping, which leads to mistakes and worse problems down the road. So don’t get lazy about setting up your bookkeeping system.
If you are selling services, rather than goods, the first thing you need is an easy way to keep track of your time. You need to know how much time you spend on each client.
It’s not that these systems are more accurate; they’re just easier for you to use. You can forget about them once they’re set up. When you start out, some of the things you do will be hard to allocate time to. But as your business grows, more and more of your work will consist of long-term relationships with clients for whom it’s easy to keep track of the hours.
If possible, I would also recommend setting up a system for tracking expenses–at least if you’re billing by the hour. Find a program that will let you enter expenses automatically, so that when you get home from a business trip or transcribe an interview or whatever, all that’s left is adding up what you spent and entering the total into your accounting system.
It might seem like bookkeeping is something you do once, at the beginning, and then never again. But actually, bookkeeping is something you need to be doing all the time.
It doesn’t have to be difficult or time consuming or even boring. You can keep track of what you are spending by writing it on envelopes. You can keep track of your income by making a chart on the wall with thumbtacks. As long as you know how much money you have, and what needs to happen for more money to come in, then you are fine.
The point of bookkeeping is not to give yourself an excuse to obsess over numbers, but to give yourself comfort and flexibility. If you want to try some new idea for making money, you don’t want to have to worry about whether it will affect your taxes; with a system of bookkeeping in place, you can try new things without having to worry that they will put you behind on your taxes. And if something goes wrong – a flood in your basement or a burst pipe or a season where all the fruit trees die – then you will be able to look back over your records with a clearer understanding of where your money came from and how it got spent.
Have you ever wondered why there is so much fuss about keeping books when the numbers are so easy to fudge? The answer lies in the difference between “financial” and “economic” profit. Financial profit is what your accountant writes down for you, in your financial statements; it’s what you show to potential investors. It’s what you’re trying to maximize. Economic profit is what matters to your business, and it’s much harder to measure. It’s hard because it depends on factors like cash flow and inventory levels that don’t show up in your income statement.
It’s easy for accountants to make mistakes; they sit at computers all day, and when you sit at a computer all day, eventually you start doing dumb things like accidentally deleting all the data for the last six months when you were trying to trash some old spreadsheets. So accounting systems have checks built in: double entry bookkeeping, daily reconciliations, etc.
But checklists are no good if people don’t use them. We had a system that worked perfectly well–every month we did a reconciliation of our checking account against our bank statement. But I wasn’t paying attention during the reconciliations, so they didn’t do me any good.
If you’re reading this, you probably want to be rich. And if you want to be rich, you need to keep track of your money.
You should do this even if you have a good accountant and/or tax preparer: they can make mistakes; and even if they don’t, it’s good for you to know what’s going on.
Keeping track of your net worth is like keeping track of your weight: if someone else has to do it for you, there’s a good chance you’ll fudge the numbers.
Here’s an example: once I was in a restaurant with friends when the waiter brought the check and said something like “does anyone want change?” One of my friends said “I think we’re all set,” and put his credit card into the folder.
The waiter took out a calculator and added up all the charges: tax, tip, drinks, etc. He said “that’ll be $40.” My friend pulled his credit card out and said “actually, I think we’re a little short.” The waiter ran his finger down the column again and said “well, one of these charges isn’t right.” It turned out that my friend had been charged twice for one of his drinks.
The example of the English language can be instructive. The standard economic theory of language is that there are 300,000 words in English, but only about 2,000 are needed for daily conversation. Why don’t people just memorize these 2,000 words? Because it’s not easy to learn 300,000 words.
The solution is to create a language that has fewer words but still gets across whatever information needs to be conveyed. That way you can use smaller vocabularies and still get along.
It turns out that having an artificial language is very handy for dealing with computers. A computer program has instructions written in a programming language which is different from English or any other natural language. We don’t do much work directly in the programming language because it isn’t easy to learn and it’s hard to use when you’re trying to communicate with other humans. Instead we write in another language that is more like English or whatever human language we speak — Python for instance — and then translate the code into the programming language at the time it gets run.
So why not keep things simple by just using the programming language all the time? Because computers aren’t very good at dealing with natural languages like English or Spanish or French or German.