Make your accounting system more useful (Part 1 of 2)
If your accounting system is just there to collect data for your accountant to file your taxes you have missed the point.
Yes, we all have to file taxes and yes, we need a system for doing that. However, your accounting system should do more than help you file your taxes.
Having worked one-on-one with contractors for more than 30 years, I have noticed a few things about accounting systems. Below are a few thoughts that might help you turn your tax data-collecting system into a more useful tool to help run your business more efficiently and profitably.
Create useful categories
In order for an accounting system to benefit income, expenses and cost of goods, it needs to split costs out into simple, but understandable categories. Don’t just list “utilities;” have a heading that says utilities with subcategories for gas, electricity, water, etc. The same goes for “Insurance.” Create subcategories for life insurance, vehicles, workman’s comp and so on.
Similarly, break out your income by departments. If you only do service and installation, two departments or categories are sufficient. However, if you also do commercial work and/or new construction, those departments’ incomes need to be split out as well.
Also, create an income category for maintenance agreements, if you offer them. There are a lot of reasons to track maintenance-agreement income separately and I will touch on them in another article.
Your accountant may tell you this amount of detail is unnecessary. If you are the one filing taxes, then that may be true. However, if you are the company owner, you need to know where every dime comes from and where it went, laid out in a language you understand.
Know what ‘other’ means
The vast majority of contractors use QuickBooks. When categories and subcategories are created it’s not unusual to view a P/L statement and notice a subcategory, that you did not create, called “Other.”
What that means is the person entering the data put the information in the main header category rather than one of the subcategories. When that happens, QuickBooks automatically creates a new subcategory called “Other” and sticks it in there. If that happens, simply double-click that folder on your P/L statement; it will bring up the details and allow you to reclassify it into the correct category or subcategory.
Develop a budget
Once you have a year’s worth of detailed data in your accounting system, it’s time to create a budget for the coming year.
To my knowledge, every accounting system (large or small) has a place the owner can create a budget by month. QuickBooks has one by clicking Company/Planning and Budgeting/Set Up Budgets. Since you already have all the proper categories developed within your system, creating next year’s budget is pretty straightforward.
To create a budget, simply review the past 12 months’ actual income and expenses, and ask yourself, “Will this income or expense go up, down or stay the same next year?” Then ask: “When do you expect to pay it; what month or months?”
Placing income and expenses in the proper months begins the process of creating the cash-flow part of your budget.
Review budget vs. actual, each month
Creating a budget is of little value if you don’t use it. It’s kind of like buying a brand-new car but never taking it out of the garage. You feel great because you own it, but it has no practical value.
Each month review your budget vs. actual report. The objective is to find out how close your actual figures are to your budgeted figures. Note any significant differences, asking yourself why it’s different and what, if anything, can you do about it.
You now are beginning the process of managing your business. Keep in mind the ultimate goal of budgeting is to develop proper pricing by department. Having accurate cost information is the foundation stone for setting profitable hourly rates.
Next month — in our online exclusive — I am going to walk you through breaking materials out by department and budgeting your salary. I will also discuss a couple things that will never show up in a standard P/L statement, but have the potential of putting you out of business. Lastly, I will discuss finding the “right” accountant to review your numbers with each month.
Check out Tips for making your accounting system more useful (Part 2 of 2)