A Tale of Two Businesses

by Beth Rifkin

6 min read

In honour of Financial Literacy month, here are two stories about non-accountants learning to record their business transactions in a way that let them make good decisions and tell their story to others.

1. Out to Launch with Dolly

Peter had a job drafting technical documents, but he dreamed about owning his own business.  In his spare time he raced Laser sailboats and he had designed a new dolly that would allow someone to singlehandedly get their boat into the water. He and his wife were going to sell them at regattas. He had bought QuickBooks so his wife could also do the books. The only problem was that she had never worked in accounting and didn’t know where to start.

Peter told me, “I understand the words, like Revenues, Expenses, Assets and Liabilities, but I don’t know how they work together. QuickBooks comes with a template, but I don’t know which accounts to use.” So, the three of us sat down one evening to set up his business.

Inventory – We started with his product, the dolly. He proudly showed me his design. At the bottom of the drawing was a components list, which detailed everything, right down to the last screw. “This list is your inventory. Your design calls for 12 screws, but you will buy them in the hundreds, so you will always have a supply of screws waiting to be made into dollies. That, and the other components you have on hand are your inventory.” He thought about that for a minute and said that there were other things he needed, like packing materials and cardboard. I added them to the list.

Cost of Goods Sold – “Every time you make and sell a dolly, you will take those 12 screws from inventory, along with the aluminum tubes, rubber tires and packing materials. In QuickBooks, we will create a memorized entry that takes all those items out of inventory and adds them to an account that tracks the cost of each dolly you sell. That’s the cost of Goods Sold account.”

Margin – “At the same time, we will record the sale to your customer as well as the funds you received from their credit card. You sell the dolly for $200, but the parts only cost you $75, so the profit, or margin, you make on each sale is $125.“ Peter looked confused. “Didn’t I already record the cost of the parts when I bought them?

Assets vs. Expenses – “Yes, that’s right. You could look at all the costs of running the business as expenses you pay every year. But let’s say that you get a really good deal on aluminum, only you have to buy three years’ worth in order to get the deal. If you treated the cost of aluminum as an expense, you would have a very low margin in the first year and a higher one in the next two years. That doesn’t make sense, so we set up the inventory as an asset, meaning that it has a future value to you. It only becomes an expense, in this case Cost of Goods Sold, when it is used up in a dolly.”

Depreciation – Peter said, “I need to buy some equipment for the business. Won’t that affect my profit as well?” I answered, “Yes, it will, but not all in one year. Let’s say you think the equipment will last for five years. We will spread the cost over that period, so that the expense, called depreciation, is 20% of the cost in any one year. Now, the tax authorities have special rules about how much depreciation you can claim, so I’ll work with you on that, but you get the idea.”

With that, we sat down to set up his books.

2. For a Good Cause

The new Executive Director of a local charity called me excited that she was going to bring her association into the 20th century by computerizing the green ledger pages with all the columns of numbers patiently maintained by her predecessor. “Great, Jan!” I said, “What accounting package did you buy?” “Excel,” she answered.

That started a conversation about the differences between a spreadsheet and an accounting system, talking about audit trail, the ability to create multiple reports, as well as handling payroll and printing cheques. “Don’t worry,” I said. “QuickBooks isn’t expensive. We can fit it into your budget.”

Then came the real reason Jan had called me. She didn’t know what to set up. She had had complaints from the Board of Directors that the annual financial statements that came from the green cash sheets were too general, as well as arriving so long after the end of the year.

Accounts and Subaccounts – “Look at the columns in your cash sheet (or the lines on your financial statements), starting with the revenues, like Membership Dues, Conference Fees, and Seminar Registration, and the expenses, like Staff Costs, Rent, Travel, Speaker Fees, Professional Fees and Bank Charges. Those all become your accounts. If you want more detail in any one area, you create subaccounts.

“For example, all of your employee related expenses are grouped in the Staff Costs line. If you want to break that down into Salaries, Statutory Deductions and Employee Benefits, you create a subaccount for each of those categories.”

Classes and Subclasses – One problem Jan had was that the Chair of the Annual Conference had to create his own report showing how much the association made on its Annual Conference.  “Can’t the accounting system do that?” she asked. “If you look at the whole Association as a business, then the Annual Conference is like a business within a business. That’s what departments, or as QuickBooks calls them, “Classes,” are for. You set up each separate area of the association, such as Education, Advocacy and the Annual Conference as its own class.”

“But what if I want to know what happened with each Seminar?”

“Then you set up each seminar as a subclass of the Education class. That way you can have both the detail of each event and the results of Education as a whole.”

Summary vs. Detail – Jan’s final challenge was figuring out how much detail the Board wanted in their reports, so we decided to send an email to each Board member asking what they wanted to see. Most of them were happy with the current financial statements. They just wanted to see them at each quarterly meeting. But one Board Member sent a detailed list of the expense break down he wanted. It was perfect! So, we kept the financial statement lines as Accounts and made the more detailed list into subaccounts. That way, we could produce both summary financial statements and detail financial statements that would be consistent, meaning that the totals on the detail statement would equal the lines on the summary statement.

A few months later I checked in with Jan about how the accounting system was working. She said that the Board was happy with the financial statements. As an added bonus, the Board Member who wanted the detail, now understands the running of the association better and was much more supportive of Jan’s initiatives. It was a happy ending for all.

Bill Kennedy is an Ontario Chartered Professional Accountant who works with companies and charities to make their financial systems and results more effective and understandable.  See more of his articles at http://EnergizedAccounting.ca

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