Accounting Fundamentals: Chart of Accounts

But why does it matter?

As a business owner, you need a basic understanding of your financials. You need to know this to:

• Communicate it better with your advisors, bankers, etc.
• To better understand and communicate what your needs are for your business.
• To know which metrics and KPIs are important to watch in your business.

There are a few main buckets that make up the chart of accounts:

• The income statement, where you can measure your revenue, cost to deliver on your revenue promise, and overhead costs. This resets every year.
• The balance sheet, where you can see your assets (such as inventory, cash, and accounts receivable), liabilities (such as accounts payable, sales tax payable, and loans), and equity (what you as the business owner have as far as the business’ financial value). This is cumulative and represents a snapshot of our business since inception.

Accounting Fundamentals: Balance Sheet

It includes:

• Assets – what you own
• Liabilities – what you owe
• Equity – the difference between the two (hopefully, a positive number!)

Assets include two distinct areas:

• Current assets, which are liquid (easily convertible to cash). For example: cash, accounts receivable, inventory, other cash equivalents.
• Non-current assets, which are more long term over at least a year. For example: investments, property, plant equipment, office furniture, computers, goodwill.

Liabilities include two distinct areas as well:

• Current liabilities, which are one year or less. For example: accounts payable.
• Non-current liabilities, which are longer term in nature. For example: debt, like a mortgage or vehicle loan.

Equity breaks down into:

• Capital – what you paid into the business
• Retained earnings – profits retained into the business over time
• Owner distributions – a reduction in your equity

Accounting Fundamentals: Income Statement

Why?

Because it includes those vanity numbers, like top line revenue/sales.

The income statement breaks down into a few different buckets:

• Revenue – sales of your product or service
• Cost of sales / cost of goods sold – the direct cost to deliver on your revenue promise
• Gross profit – revenue minus the direct cost of sales.

Gross profit is the engine that prints money and generates that cash flow. This number needs to cover your overhead costs (such as administrative expenses, utilities, rent overhead, marketing expenses, R&D, general expenses), cash flow items, debt payments, charitable contributions, etc.

A monthly income statement, set up to measure against a budget, will help you have your controls in place and understand what your numbers are actually communicating. With a budgeted income statement and an income statement for this period versus a prior period, you can understand progress and where to make adjustments.