Bank accounts, account numbers, chart of accounts, account balance, accounting!
Accounts are one of the main components of managing your finances. Understanding the different ways this word is used and the how the various types impact your reports will help you manage your small business more effectively.
An account is a unique place in the general ledger used for recording a balance along with a history of changes to that balance. A general ledger contains all the accounts for recording transactions relating to a company's assets, liabilities, owners' equity, revenue, and expenses.
In order to create financial reports that make sense to people, accounts are classified into different types. For example, in your small business you may have a savings account, a chequing account, and another account that you use to save your tax installments in; while these three accounts all have different names and different purposes, they all fall into the same account type: bank accounts. In this way, they can be grouped together for analysis. By having categories of accounts the financial reports will follow a standardized format making it easy for people to see how well a company is doing.
A cash account is used to record payments, deposits and withdrawals in real liquid currency. If you have a petty cash account for small purchases you would set it up as a cash account. Then when you enter expenses you pay it from this account. This will show that you were paid in cash or that you paid for something in cash.
The name says it all: any bank accounts that you have associated with your business should be set up with this account type. Like in the example above you might have several different bank accounts that you use for different purposes.
This account type is used to track all the credit cards associated with your business. A credit card is an indispensable tool for a small business owner. In fact, it is quite normal for a small business owner to have several. Using a credit card for all your expenses makes keeping track of your expenses easy.
A common practice before the advent of banking apps was for a business to collect cash and cheques into an envelope and deposit them all in one lump sum. When this happens it appears on the bank statement as one transaction. To deal with this, the initial transactions are recorded in Undeposited Funds, and then when you do the bank deposit you complete a transfer for the amount of the deposit into the appropriate account. This allows the money to move through your accounting system properly and the deposits will match what you have in the accounting software.
Income accounts are used to track the source of revenue. The level of detail you want in your reporting will inform the number of accounts you create. For example, if you are a personal training studio you might sell both training services and fitness equipment, but wish to track those sales separately. You might create two income accounts, which would allow you to see at a glance the income you are collecting in the different parts of your business.
In most cases it's also a good idea to create an Other Income category for things that you are not sure about and about which you can consult with your accountant later.
An expense account is used to track money spent on any product or service that does not have a resale value. (If you are paying for an item that can be resold, it should be recorded as an asset.) Different countries have different rules about accounting for expenses so you may want to consult your accountant when setting up the expense accounts as it could make your year-end simpler.
The asset account represents the value of the assets owned by the business. Assets are items that have resale value and typically depreciate over time. (Depreciation is part of your tax return, and your accountant will usually enter adjustments for the depreciation of your assets based on rules set out by your local tax code.)
A liability account represents a type of debt or future cost for the business. You can have both short-term and long-term debt. If you have a line of credit, it would normally be a short-term liability, while a five-year loan would be a long-term liability. Pre-payments from customers for work not yet done are also a type of liability.
An equity account represents the value that has been invested or created in the company. There are many ways for equity to be built up in a company; some of these are investment from owners or contributed capital as well as retained earnings from a previous year.
Accounts payable represents all the bills that you have entered into your accounting software that you haven’t yet paid. It is always a good idea to enter the bills in with the correct due date as soon as you receive them as it will allow you to see how much money you need when.
Accounts receivable represents all the invoices that have been created in your accounting software that you haven’t received money for yet. Making sure that you are staying on top of your accounts receivable is critical to a successful business.
Cost of Goods Sold
This account tracks the cost that goes into creating the product that the business sells. You only allocate costs that are directly tied to production, such as raw materials and labour required to create the product. The cost of shipping would not be included as that is not required to create the product.
Gain or Loss on Foreign Exchange
This account is used to track the change in value of foreign currencies between the time an invoice is issued and when it is paid. If you buy and sell items in a foreign currency, this is a normal part of doing business and your accounting software should take care of this automatically for you.
This is a high-level overview of the different types of accounts in small business accounting and how they relate to your business; be sure to investigate further for more detail in each case.
Health Spending Account
A Health Spending Account (HSA) is a tax plan which turns after-tax personal medical expenses into before-tax business deductions. It is an affordable alternative to traditional health insurance for a small business owner. It can also supplement a spousal health insurance plan by removing income tax on your spouse's contribution to the insurance plan.
If you are a one person business or share the business with a spouse, download this guide to learn more:
If you own a business with arm's length employees, download this guide instead: