A colorful guide to catching up the books in 4 easy steps.
Let us get real, creating a budget is as hard as it gets, right? Now we are throwing in data entry and bookkeeping into the mix, and this is where most small-business owners check out. Before you go, please let me give it a try. I want to show you how to create the profit statement and balance sheet in 3 easy steps. If you can create this statement, then you will have completed most of the work required by your tax preparer after the end of the year.
What are “the books,” and Why Does it Matter?
When we say “the books” we mean the organized ledger of income minus expenses, in addition to any equity transactions, that provide us the final, magic number: the net income. The net income is what your tax preparer requires to determine your projected and actual tax liability. The net income is what you can bring home as the owner. The net income is the magic number that gives your business value, and therefore we have to climb the mountain we call “the books” to touch the sun! Okay, for those of us that are convinced we are ready to get rocking and rolling.
How to do the books in 4 colorful steps
1. Create a template
The foundation for every good cake is the recipe. Am I right? So, we need to set up the canvas on which we are going to perform our paint by numbers. You can use notebook paper or excel.
- At the top of either, you can type in a heading: Income. If you need more lines for income transactions, you can simply add a piece of paper or select “insert” on your excel sheet.
- On the next sheet or a few lines below if using excel, create the heading: expenses. Now, under the expenses heading we are going to create the following sub-headings: cost of goods sold, gross employee wages, meals, interest expense, other expenses. Yes, there are other expense categories on the tax return, however, these are extremely important.
- Finally, on the next piece of paper, or a few lines below if using excel, write personal distributions.
There you have it, your simplistic foundation is created, and now it is time to gather the data.
2. Gather the data.
The data must be legitimate, of course. So, the absolute easiest place to gather your transactions is the bank statements. For the digitally handicapped you can request your bank statements from your bank via mail. If you are up to speed with online banking features, then you can download the statements from your portal.
For those of us that want to step it up, you can download the monthly bank statements into a .CSV file. From here you copy and paste your transactions when we get to the next step.
3. Organize the transactions = coloring time
Keep this simple by using the format of the bank statement and your 3 favorite colors of highlighters.
- Highlight the income transactions: The top of the statement gives you the total value of the deposits and the expense separately. If your only deposits into this account are revenues of the business, then you simply transfer this value over to the income section of your books. Otherwise, you need to look down the deposits column and highlight the transactions that are considered revenue to your business.
- Highlight the expense transactions: Next, do the same for the expense column. Now, this is where you need to separate the expenses into categories. Feel free to add additional categories into your sheet, however that does complete the process if time is an issue. Also, correlate the new categories with new colors of highlighter ink for easy identification. Once you are finished highlighting your bank statement then move all the corresponding transactions to their section of the expenses sheet.
- Finally, all deposit and expense transactions that were either personal or distributions to you as the owner, need to be placed under the personal distributions section. Highlight these transactions with your last remaining color and then transfer them to the books. Place a simple comment or memo beside each transaction so that your tax preparer will know exactly why it occurred. For example, was it owner’s pay, a contribution to the company to keep it afloat, or loan from the bank? This is important so make sure that these types of transactions are separated from expenses.
4. Finally: Compute the Net Income
The final step sounds easy, right? Let us make sure we are on the same page. You need to sum up all the income first. Then, sum up all individual categories of expenses. Then sum up all categories of expenses into one large expense in total. Finally, subtract the total value of expenses from the value of income to arrive at net income.
Do not forget about the distribution section. Why did I even have you separate that? Well, these are special transactions that could be considered capital in nature. This means they need to go elsewhere on your tax return and do not affect the net income of your business, in terms of financial accounting. I will throw a few tips about the owner’s salary versus distributions in the Tips and Reminders section below.
Tips and Reminders for “the books.”
This bookkeeping guide is simple because it is meant to be. Unfortunately, this guide is not meant for any business owner who would like to see financial trends of their sales and revenues, or expenses and distributions. These numbers will help you to put together a quick and easy set of numbers for your tax preparer come next January, or it can give you the final net income number as a business owner.
The owner’s salary versus the owner’s distributions. These are terms that get used incorrectly quite often so we need to break them down. If your business is operated as a sole proprietor or a partnership/ LLC, then you do not pay yourself a salary as far as the IRS is concerned. The owner’s salary is the same thing as net income to the business, regardless of if you distributed the money to yourself or left it in the business bank account for future growth. What you paid yourself was an owner’s distribution. I am learning that most owners just transfer money out of their business income into their account using their smartphone. This is the type of transaction I am talking about. Therefore, all money paid to you during the year can go in the distribution category above. If you are taxed as a C-Corp or S-Corp, then you need to pay yourself a salary throughout the year. The remaining net income will come to you as a dividend, or sometimes called an owner’s distribution in the case of an S-Corp. This salary will need its category on your expense sheet, Owner’s Salary so that your tax preparer can create the proper tax liability for you.
Be honest, was that too hard? Time-consuming, yes, and probably even a little annoying for most of us. However, this is the name of the game. It is the price we pay as entrepreneurs so that we can be free and carve our own path. Also, you can sign up to receive a PDF that will organize your income and expense categories specifically for your tax preparation. I wish you all the best, and as always, do not hesitate to email or comment with your questions.
Have a question? Please comment below! Have a suggestion for the improvement of a step above? The community and I are always listening. Do not forget to sign up for the upcoming blogs that will finish out the final 3 “DO NOTS” of the year-end process.