FW1 - Mental Imagery
FW2 - Visioning
FW3 - Creativity
FW4 - Micro economy
FW5 - Macro economy
FW6 - Globalization
FW7 - Real world
FW8 - Country rating
FW9 - Global trends
FW10 - Sector rating
FW11 - Business idea
FW12 - First sketch
FW13 - Consumer analysis
FW14 - Supplier analysis
FW15 - Marketing mix
FW16 - Operations
FW17 - Organization
FW18 - Accounting
1. Current accounts operations
2. First balance sheet
3. Specific operations
4. Organization and audits
5. Cost accounting
6. Do it yourself
7. Author
FW19 - Financial statements
FW20 - Financial analysis
FW21 - Cash flow
FW22 - Business name
FW23 - Decision making process
FW24 - Check up point
FW25 - Communication
FW26 - Negotiation
FW27 - Raising money
FW28 - Project management
FW29 - Management
FW30 - Strategy

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F18-SMALL BUSINESS ACCOUNTING

YOUR POSITION

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MAP

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

INTRODUCTION

Without accounting, you can’t lead a company in an effective way. It's just like traveling in a foreign country without any map!

What is more, without some accounting knowledge's, you should be quite unable to deal with the figures of costs and receipts that are coming from the previous lessons. It means that accounting is a must for you.

Nevertheless, many executives do not know the basics of accounting. As a result they must rely on their staff to explain any financial statements to their stakeholders! What is more, people show some arrogance towards accounts.

Real life example:

Few years ago in France, an "intellectual" socialist woman was appointed as Minister of "Social Affairs". As the Social Security (health, unemployment, pensions) was in the red, some people asked her how will she plan to put right the situation.

She just answered with a disdainful smile "I do not intend to be the Minister of Accounts". As a result, things were rapidly going bad and she was fired by the President Mitterrand.

It illustrates the contempt for accounting among some people.

Duration

Lesson: 4 hours

External readings and quiz: 5 hours

Do it yourself: 1 hour

Total: 10 hours

Objectives

Our objectives are:

-To enable you to open accounts and to post them with simple operations.

-To show you how to use the trial balance and how the balance sheet and the income statement are coming from the trial balance

-To enable you to make a choice between the different methods regarding accounting on inventories and depreciation of fixed assets.

-To describe the minimum organization that you can set up and to give you some tips about the crucial checking's.

By the end you will not become a CPA but you should be able to understand the Accounting basics.

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

1-CURRENT ACCOUNTS OPERATIONS

Accounting is said to be complicated. In fact, it's not true: The basics are quite simple. I shall propose you an easy way to get it.

11-Opening accounts

111-The cash register

Most people and companies keep a cash register. Suppose that your safe contains $10,000 at the beginning of the year. During the year, all inflow and outflow of cash will be written down in your book, and these writings will explain why your initial amount has increased or decreased at the end of the year.

You will find the following information in your cash account:

With an accounting like that, you can’t have a global view of your situation. It's just a chronological journal. Of course you need it but it's not sufficient.

For example, the bank loan will certainly increase your funds with $7000, but in this journal there is no mention of your debt towards the bank!

The amounts in parentheses do not correspond to an inflow or an outflow in your cash register, yet the credit purchases and sales will have a real influence on your situation at the end of the year.

That is why a real accounting system must be established.

112-The accounts

First step is to open accounts.

This is what an account looks like (for instance the cash register):

The first column on the left shows the debit, the second the credit and the third and fourth column shows the debit and credit balances.

For the moment don’t try to understand what debit and credit mean. Simply notice that your initial 10 000 $ is written in the debit column and that the exit of 3 000 $ for cash purchase of goods is written in the credit column. This gives us a debit balance of 7 000 $:

10 000 — 3 000 = 7 000

12-Entering operations

We must always make two entries to register all kind of transactions on an account, regardless if it’s an inflow or outflow of cash.

In our example, we will first use the Cash register account and the second account correspond to the operation’s nature (purchase, sale etc.). That is why we say that book keeping is a double entry system. Let’s take a look at the first four operations and see how to register them:

1. $10 000 is registered in the company’s cash register. Even if this is your money, we must distinguish between what goes into the company and where it comes from. This money is the result of your savings, that means your capital. It must therefore be entered into two different accounts, the Cash Register, as we know already, and the Equity account.

Note what is common for all kind of account operations:

When an amount is entered in the debit column of one account, the same amount must be entered in the credit column of another account.

2. We are buying goods for $3 000 in cash. This means an outflow of money that must be entered in the credit column of our cash register because all outflows is registered in the credit column.

We are now using a new account called Purchase. Since the Cash register has been credited $3 000, the Purchase must be debited for the same amount, $3 000 .

3. We are selling goods for $5 000 in cash. This is an inflow of money, so the transaction must be registered in the debit column of our Cash register:

4. We borrow $7 000 from the bank and enter this amount in our Cash register. The Cash register will then be debited, but we must also register our debt in the Bank account, which will be credited.

• Now let’s combine the 5 accounts we have opened:

The arrows indicate the double entries for each amount.

However, the total of the debit and credit columns must be calculated for each account, as well as the total of the debit and credit balances.

For instance, the cash register’s debit column is calculated like this:

10 000 + 5 000 + 7 000 = 22 000

The total of its credit column is 3 000.

And the total of its debit balance is:

22 000 — 3 000 = 19 000

13-The trial balance

Let’s report these different totals to the following schedule:

What do we notice?

You can see that:

• the sum of the debit and the credit columns are the same,

• the sum of the debit balance column and the credit balance column are the same.

This double equality makes it possible to verify that all transactions have been correctly registered in the accounts.

14-Entering new operations

We shall proceed in the same way to open new accounts and to treat new operations.

To be able to enter the transactions from the following operations we must open new accounts:

1. We buy on credit a truck for $3 000 . The truck is now part of our equipment, but we also have a debt towards our supplier. Two accounts must be opened, one called Equipment who is debited, and one called Supplier who is credited:

2. On paying our debt towards the supplier, we debit our Supplier account because it has been credited in our previous operation. Then we credit our Cash register because it is a cash outflow.

3. We are now, buying raw materials for $2 000 in cash. We are selling them later on, but only after their transformation. The Cash register must be credited, and a new account called Stocks must be debited:

4. The 6/5/2000 we are buying raw materials for $3 000 , but this time on credit. Again it is our Stock that is debited, but it is our Supplier account who is credited and this because we owe him money:

5. Finally, we are making a sale on credit to a client for $5 000 . This means we must credit our Sales account for this amount. The debit will not be registered in the Cash register since no money is entering, but in the Client account because our client has a debt towards our company:

We shall now close all our operations. We note all Debit and Credit Balances for each account including our first 4 operations and the once we just did:

Right now, you understand the basic of the double entry system. It's quite simple. In fact as there are many daily operations and many accounts, it requires a lot of hard work. Of course you need to know the basics but you are not obliged to do all the job by yourself.

Down earth advice

Recall the economic module and the specialization chapter: Focus on your core business. Your aim is not to become a CPA but to start a biz. Of course you need basic accounting knowledge's but once you have gotten it, do not make by yourself all this paper work. I mean: Do not recruit and pay a lot of employees to do it in house. Profit from the productivity and expertise of accounting firms. Have a good contract with them and let them doing the job. Just check it. Do not do it.

I want to see you outside your office: You have to sell and to get money rather than to become an accounting expert !

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

2-FIRST BALANCE SHEET

We shall now close all our operations. We note all Debit and Credit Balances for each account including our first 4 operations and the once we just did:

First we have to make sure that the Debit and the Credit balances are equal. Then we must ask the following questions:

Amongst these balances, what is real and correspond either to cash money or to goods or equipment existing within the company?

The only accounts concerned are:

Secondly, how much is owed to us:

Now we can recapitulate what we possess and what is owed to us:

These accounts are assets

You may have noticed that the Purchase account is not mentioned. This is because we can’t physically observe purchases. Stocks on the other hand are real and can be observed.

Now the following question is to be asked: Amongst these balances, what is debt towards others and also towards ourselves (our equity)?

Those concerned are:

The Equity and the Liability accounts are accounts with a credit balance.

Sale is not mentioned because we can’t physically observe sales.

This is how we realize the stability between Credit and Debit in our balance sheet:

This schedule represents the Balance sheet at the end of exercise after allocation of our Income Statement result.

The benefits and the losses of the company appear on the Income Statement.

The debts and possessions of the company appear on the Balance sheet at the end of the exercise after imputation of results.

At the beginning of the exercise the Balance sheet appears like this:

At the end of the exercise this is what it would be like:

These 17 000 $ is the Net value. Compared to the 10 000 $ at the beginning of the exercise we notice that the company has a profit of 7 000 $.

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

3-SPECIFIC OPERATIONS

31-Inventories accounts

Prices are never stable: Suppose that we buy:

• In June: 200 empty bottles of 0,5 $ each = 100 $

• In August: 200 empty bottles of 1 $ each = 200 $

In December, we sell 200 bottles for 2 $ each, which makes 400 $. Which bottles do we sell? Those that we bought in August for 1 $ a bottle, or those that be bought in June for 0,5 $ a bottle? Depending on our choice, the profit is 200 or 300 $:

Down earth advice

We recommend to use a simple method: First in, first out (FIFO). According to this method, what is bought first is to be sold first. In our example, the 200 bottles at 0,5 $ each was the first ones to be purchased, and the profit will then be 300 and not 200 $.

This method allows to make a bigger profit. This is an advantage for new-coming companies.

But this method obliges you to support taxes on profit. That is why another method called LIFO (last in, first out) can be preferred. This means that we sell first what we acquired last.

32-Depreciation on fixed assets

When a company acquires a truck, it is consider that its actual lifetime is let’s say 3 years. After this period it will be changed, and we must dispose money to buy a new one. If we have paid 3 000 $ for our truck, a depreciation of 1 000 $ per year is necessary (3 000 $ : 3 = 1 000 $).

During the first year, the value of the truck is 3 000 $ in our Assets.

The second year 2 000 $ (3 000 — 1 000)

The third year 1 000 $ (2 000 — 1 000)

And the fourth year 0 $ (1 000 — 1 000)

Mutually, the yearly amount of depreciation (1 000 $) will appear as a charge on the Income statement, even if there is no outflow of money. We shall see further that on the contrary, the amount of the depreciation must be added to the net result as an inflow of cash in the Cash flow statement.

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

4-ORGANIZATION AND AUDITS

41-Minimum organization

411-Records

Even, if you have an outside accountant , you have to provide him with some fundamental stuff. The stuffs are the records of all your operations: Order, invoices, checking accounts and receipts of any cash expenses or cash revenues.

It means that right now you have to keep all your records. For example, you buy a bus ticket to visit your chamber of commerce: You keep the ticket with its price and the date. All these elements are the fundamentals of any records that your accountant will need to be able to post the operations in the proper account.

What is more, in keeping your receipts, you avoid to pay the same bill twice and you can always prove that you have paid it.

As long you carefully keep these receipts, it's always possible to reconstitute your accounting and ledgers. Without these records, it becomes impossible and you can expect some trouble with your IRS controller!

Real life example:

Many years ago, I had to audit a State owned cooperative in Senegal. When I arrived on the place, a poor trembling guy said me: "Sir, when the chief accountant heard that you were coming, he threw all the ledgers into the closets and crossed the foreign border by night".

"No matter" I said "have you the records of sales and purchases?". Fortunately, we found these records under a pile of rice sacks through some swarms of weevils!

Studying the records and with the local bank agency help, I reconstituted all the accounting and discovered that the chief accountant and his State appointed Director had stolen two third of the poor farmers savings!

412-Ledgers

Any accounting organization is based on a chronological journal, some sub ledgers, a general ledger, and a charter of accounts.

-The charter of accounts includes all the accounts you need, identified by a specific number.

-The chronological journal registers the operations day by day. If you do your accounting by yourself, it takes a lot of time because you have to post each operation with its date, its amount and the proper debited and credited account with its identifying number.

What is more, it's wise to maintain a sub journal for each main account such as cash and bank. It means a lot of writings everyday.

-Finally the general ledger registers all your accounts and their credit debit balance. It is used to prepare the trial balance each month and the financial statements by the end of each year. As you can see we have followed the same cycle with our empirical explanation of accounting basics!

Anyway, accounting is not complicated but requires a lot of paper work: For example, let's suppose that today you realize only one operations: you make a deposit to your bank of $1000. Then you have to post this operation as follow:

The date. The title: deposit cash: the operation: cash account credited (1000) to bank account debited (1000)

There is only one line but let's suppose that you have one hundred operations and you can imagine the amount of job it represents in a day! In fact, computer spreadsheets have replaced the books and facilitated some calculations like additions but nevertheless, you should always have to enter each operation one by one.

There are on the market some popular automated accounting package but it represents nevertheless an hard work which could be better used in selling! For this reason, I recommend you to appoint an outside accountant.

413-Staff

Of course, you have not to do your accounting by yourself and you can delegate it to your staff. Then, you need some people with competencies and experience and it means money!

What is more, an Accounting Department always requires two different persons: one who drafts the checks, prepares the orders and invoices and one another who just registers in the accounts these operations.

Down earth advice:

To avoid fraud, it's a constant rule to have two different persons: The first who really does the operations and the second who just registers them in the accounts.

In supplement to the accounting staff, you will also need another employee to make the payroll and may be one another to check the physical inventories. Beware of the fixed costs!

42-Audits

In all case, you must exercise some regular and unexpected audits:

-Check every week the trial balance: it's very easy to check its accuracy as we have seen above. Recall that a difference of only one dollar can hide a fraud about thousand or millions dollars!

-Check every day the cash account and sometime without warning, check the money in the safety box. Of course its amount must be exactly equal to the figure of the cash account! Do not tolerate any difference or any "temporary receipts" instead of money!

-Always check the reconciliation between your bank account, the checking account coming from the bank and the drafted checks.

whatever, you have an outside accountant or an accounting staff, do these controls regularly. It's the best way to avoid fraud. When you discover a fraud, always complaint to the police.

Down earth advice

I shall give you a good tip: Along my career in banking and financial business, I have had often to change of company or to enter in new positions. When I took any office, I was accustomed to make clear for everybody that I was particularly experienced about accounting and I always began my office in doing some quick but hard audit.

Act in the same way with your staff and outside accountants. People must know that you have some basic knowledge's in accounting. Otherwise, it's too tempting to cheat because one could expect that you never will discover the fraud.

External readings:

Go to: www.allianceonline.org . Click on "FAQs" and then on "financial management". Read chapters (1), (5), (23) and (24). You will find here a lot of good advices regarding organization and control. The advices are dedicated for non profit organizations but they are valuable for small business.

Go to a familiar site: bized.ac.uk . Click on "learning materials" in the frame, then on "accounting". Except "ratio analysis" that we shall study in a further module, you can do all the quiz and explore once again the accounting section of the complete case study "Cameron balloons". This free web site is really fascinating.

Go to : Accounting, Business Studies and Economics Dictionary for students

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

5-COST ACCOUNTING

Cost accounting is not the same topic than accounting; Accounting just registers the operations. Cost accounting uses accounting for evaluating the different costs of a business.

51-Principles:

I will give you a simple example: From the income statement, you know the total expenditure of your company. You divide this gross figure by the number of items you are producing and you get the cost of each item.

Unfortunately, this average cost is too global. For making improvements and lowering your costs, you have to know what are the elements of the global cost coming from the different functions.

Once again, the income statement enables you to distinguish the cost of goods sold (it means the cost coming from the production line) and the cost coming from general and administrative functions ( back office ).

However, these information's are once again too global! Let's suppose that you produce several items: How should you allocate the gross average cost between the different items?

It's here that the cost accounting appears necessary: It enables to allocate each costs to the different functions of a company and finally to the different items produced. Nevertheless, if the principle seems simple, the practice appears to be very complicated.

Direct labor and marketing costs can be easily allocated: Either you use standards according to the business branch or you register with a clock system the time spent by workers on product A or on product B.

For administrative expenses, it is more complicated: How should you share the cost of your secretary between item A and item B? What is more how should you share between different products the cost of a global leader dedicated to think about the entire strategy!

Real life example:

In many consulting group, I saw smart researchers spending their precious time in filling up stupid spreadsheets to indicate at what time they begin their research and at what time they end it.

I claim once again that creativity is not a quantitative matter and that it's non sense to measure it by a quantitative time: May be in one minute, one of these researchers will get an idea saving thousand hours for other people!

52-Limitations

I think that implementing a cost accounting system is too far complicated for a small business. You have better to use the figures coming from the income statement and to analyze carefully their meaning.

Down earth advice

You employ people for the customer benefit and not for filling up papers. Just evaluate people on their results and not on the way they do their job.

A cost accounting system is only worth for a big company and even in this case it calls for some reservations.

Real life example:

Too often , I saw cost accountants overcharging a specific Department just because they do not like his head and want him to be fired.

Cost accountants and audit people had taken too much power in business. They had fun in complicating the jobs for everybody! As for their integrity, recent events show some turmoil! I think that the Enron scandal is a good lesson for top executives who too much entrusted their auditors!

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

Lesson summary

1-A Debit always represents:

An increase in an Asset account (cash register, clients, stocks, equipment),

A decrease in an Equity or Liability account,

An increase of costs in the Working account (purchases are debited so we increase our Purchase account as purchases goes along).

2-A Credit always represents:

A decrease in an Asset account,

An increase in an Equity or Liability account,

An increase of the Funds from operations (sales are credited so we increase our Sale account as sales goes along).

Inventories accounts and depreciation have a big impact on the results and taxes. Even if you have a good experience with accounting, you have better to consult a specialized firm in such matters.

There is no need to employ a book keeper. Specialized firms can do this job for you at a less cost (charter of accounts, journal, ledgers and all the back office). The essential is to understand the documents these firms establish for you.

Anyway, you must always exercise your personal control upon staff and external firms.

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

DO IT YOURSELF

Describe in your business plan the accounting organization.

1. Current accounts operations 2. First balance sheet 3. Specific operations 4. Organization and audits 5. Cost accounting 6. Do it yourself 7. Coaching

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