When you get busy, you can quickly lose track of your expenses.
How can you track your expenses and create a system to manage expenses that doesn’t eat up too much time?
The first step is to understand how the accounting process works.
Understanding the accounting cycle
The cycle includes gathering information from source documents, and deciding on the financial impact of a transaction. Next, you record the transaction using a journal entry, and the information is posted to general ledger.
Once all the transactions are posted, you generate a trial balance and use the data to produce financial statements.
The accounting cycle starts when something happens in your business.
Meet Sally, who needs to record expenses
Sally owns Premier Landscaping, a business that provides landscaping and tree removal services.
On August 1st, Premier spends $2,000 on mulch. The vendor gives Premier an invoice, and Sally pays cash for the purchase. The invoice is considered a source document, which Sally can use to post an accounting transaction.
Businesses track expenses by account number.
Chart of accounts
The chart of accounts lists every account number and the account’s description. Balance sheet accounts, such as cash and accounts receivable, are listed first, followed by income statement accounts.
Expenses are income statement accounts, and are typically listed toward the bottom of the chart of accounts. Create expense accounts for each of your spending categories, so that your expense reports provide more detail.
To make decisions about Premier’s spending habits, Sally creates separate accounts for mulch, sod, flowers, seed and other expenses. To make expense tracking easier, she uses QuickBooks® reports to analyze her monthly expenses.
Premier’s mulch expense is account #7000. Sally uses the entire $2,000 of mulch immediately, and posts a journal entry to record the expense.
Post a journal entry
A journal is a record of each transaction that occurs, listed in chronological order, and accountants post activity using a journal entry.
Think of journal entries as an expense tracker for your small business. Here is the August 1st mulch expense journal entry:
|(To expense $2,000 in mulch paid for in cash)|
The journal entry is dated August 1st. Expense accounts are increased with a debit entry, and cash is reduced by a credit entry. To make the analysis process easier, each journal entry includes an explanation of the transaction.
All of the journal entries are posted to general ledger.
Reviewing general ledger
A company’s general ledger is a record of every transaction posted to the accounting records throughout its lifetime. Sally frequently reviews general ledger to verify that she’s posted transactions correctly.
The trial balance summarizes general ledger detail.
Scanning the trial balance
Premier’s trial balance is a listing of each account used to post transactions and the current account balance.
This document provides a quick snapshot of Premier’s current financial condition. Sally can scan the list of accounts and balances to decide if the accounting data looks reasonable. If she wants more detail, general ledger is the place to go.
Once Sally has an adjusted trial balance, she’s ready to generate the financial statements.
Producing financial statements
The trial balance is used to generate the financial statements, including the balance sheet, income statement and statement of cash flows.
Sally produces financial statements at the end of each month, and the accounting cycle starts over on the first day of the next month.
The accounting cycle is one tool to accurately track expenses, but you need to know more.
The best budgeting systems also follow accounting industry standards.
Accounting rules of the road
Not every purchase is immediately expensed.
To account for expenses correctly, your business needs a capitalization policy.
If a purchase will be used over a period of months or years, the cost is posted to an asset account. Purchases that are used right away are recorded as expenses.
What, exactly, is an asset?
Assets are defined as resources that are used to generate revenue. The mulch, for example, was purchased to complete a landscaping project that generates revenue for Premier. As a result, the mulch purchase is immediately posted as an expense.
Other assets are used to produce revenue over time. Here is Premier’s journal entry for the purchase of $10,000 in flowers on February 1st:
|(To record purchase of flowers paid for in cash)|
Premier will keep the flowers in a warehouse and use them over the next three months on a number of customer jobs. Instead of expensing the flowers immediately, Sally records the purchase using an asset account (#4100 flowers).
On March 15th, Premier plants $1,500 worth of flowers for the Smith landscaping project and posts this journal entry:
|(To expense $1,500 in flowers used for the Smith project)|
This journal entry moves $1,500 out of the flowers asset account and into a flower expense category. This process applies the accrual method of accounting to Premier’s accounting records.
The accrual method posts revenue when earned, and expenses when they are incurred, to produce revenue. The $1,500 in flowers purchased on February 1st are not expensed until they are used for the Smith project. On March 15th, the flower expense is matched with revenue from the Smith job.
Sally knows the true profit of loss on each customer project. Premier bills $6,000 for the Smith project and posts flower, mulch and labor expenses totaling $4,800. Sally’s profit on the job is $1,200.
The accrual method ignores cash flow when computing profit and loss. Premier paid cash for the flowers on February 1st, but the journal entry does not impact expenses.
Every small business should use the accrual method of accounting. When you use the accrual method, your financial statements are comparable with other firms in your industry. Investors, creditors and regulators need financial statements that comply with accrual accounting.
Managing your accounting transactions is time consuming, but you can work more efficiently when you automate.
Save time with automation
Think about the August 1st purchase of mulch, and all the accounting-related tasks that must be completed:
- File the vendor’s invoice as a source document.
- Post the journal entry and review the general ledger to verify that the entry is correct.
- Generate a trial balance and post entries to adjust the trial balance.
- Use the adjusted trial balance to produce the financial statements.
- Reconcile each of the bank accounts, and confirm that the vendor was paid through the correct checking account.
Here are other tasks that create more accounting work for your small business:
- Credit card transactions: If you pay business expenses by credit card, you must review the credit card statements. Each expense must be posted to the correct account, and you must make credit card payments on time to avoid interest and penalties. Any late payments will impact your business credit score.
- Debit card activity: Payments using a debit card must be posted to the correct expense accounts, and debit transactions impact your checkbook.
- Personal capital: Sally contributed $50,000 of cash and equipment into Premier when she started the company. To record this capital contribution, Premier not only increased the cash and equipment asset accounts, but also increased equity. Sally must carefully track her personal capital balance, so she can report her ownership interest on her personal tax return.
Technology can help you save time and reduce complexity in your business.
Streamline your accounting
An excel spreadsheet is a terrible way to manage any part of your accounting process.
Spreadsheets require manual entry, and your risk of error is high. Owners who use spreadsheets may use an outdated version of the file, or lose the document. If spreadsheet links contain errors, your data will be incorrect.
Use QuickBooks to save time and increase the accuracy of your accounting records. If you need a real-time spending tracker, select from the expense reports available in the software.
You can scan receipts and other source documents, and attach them to specific journal entries. Use software to download your bank statements and credit card activity directly into your accounting records. You’ll save time and reconcile your bank account faster.
Technology also helps you scale your business efficiently.
If you grow sales, you’ll need to post more accounting transactions. With accounting software, you can process more transactions in less time. Make the switch to accounting software, so you’re ready to take on more business.
The owner’s personal budget and financial goals are closely tied to the success of the business.
Assessing your personal finances
Every business owner needs personal money management skills.
You may use budgeting apps to monitor your personal spending. Many consumers link a checking account and a savings account to a mobile app. Each month, you can save money by transferring a fixed amount from checking into savings. Once your savings balance is large enough, it becomes your personal emergency fund.
Intuit® offers personal finance apps for Android and other mobile devices. Tracking expenses is much easier when you move away from excel spreadsheets and use technology.
You need a plan for your personal and business finances. To track business expenses accurately, create an annual budget.
Use a budget to increase profits
Before the start of each year, Sally creates a formal budget and makes a number of assumptions:
- Sales: She estimates the total dollar amount of sales that Premium will generate.
- Materials and labor costs: Using the sales estimate, Sally forecasts the amount of material (mulch, sod and flowers) and the hours of labor she will need for the year.
- Standard costs: Standard costs are the price per unit your business pays for material and labor. Sally estimates the cost she’ll pay for each pound of sod, and the hourly rate she’ll incur for labor costs.
A variance is defined as a difference between budget and actual costs, and Sally performs variance analysis each month. There are two reasons for an expense variance:
- Price variance: Premier pays more or less than budgeted. A tight labor market may require Sally to pay $27 per hour for labor, rather than the budgeted $25. The higher actual price is defined as an unfavorable variance because total expenses are higher.
- Quantity variance: Premier uses more or less than budgeted. If Sally is able to hire experienced landscaping workers, they may complete work in less time than budgeted. Fewer labor hours reduces costs and produces a favorable variance. Spending is less than budgeted.
If Premier to pays $27 for labor, but experienced workers complete a particular job in less time, Sally has two difference variances. She paid more per hour than planned, but used fewer hours than budgeted.
In this case, Sally should look at the total dollars spent for labor costs, which takes into account price and quantity variances. If Premier spends $3,500 on labor for the Johnson project rather than the $4,000 budget, the total variance is favorable (less spending).
Sally can use variance analysis to make changes and increase profits. She can negotiate lower costs for materials, or train her staff to work more efficiently. If she makes changes each month, she’ll generate higher profits for the year.
How can you use all of this information?
What to do next
Managing expenses well can make or break your business. Here’s what to do next:
- Understand the accounting cycle and the accrual method of accounting.
- Assess your current system for managing expenses. Use QuickBooks and other tools to automate the expense management process.
- Perform variance analysis and make changes to increase profits.
Use these steps to manage expenses in less time and lower your total costs.