The past two columns have talked about accounting — how financial transactions are recorded (in Journals) and summarized (in Ledgers) and how the number and types of Journals and Ledgers may grow as your business grows.
One thing we didn't talk about was what happens to all the pieces of paper that you recorded these transactions from — the customer invoices and payments, vendor invoices and payments, employee time sheets and payments, etc., etc... You guessed it — they get bound — chronologically — into Manila folders.
These pieces of paper are your "source documents". They're the supporting documentation for each financial transaction you make. They're what you'll show the IRS auditor when he questions the validity of a transaction, i.e., was that payment really a valid business expense.
Note: If you can't "prove" that the payment was a valid business expense, he can, and probably will, disallow it. Every expense he disallows goes right to your bottom line, increases your supposed "profit" and, therefore, your "tax due" — which, of course, makes the time he spent with you that much more worthwhile — and, of course, makes it that much more likely you'll see him again next year.
If you don't have a source document for a transaction, e.g., you pay cash to someone and don't get a receipt, make one. Every source document should show what you did and, if it's not obvious, why you did it. It's a whole lot easier to jot that down when you do it (or when you record the transaction) than to try to remember several years later with an IRS auditor hanging over your shoulder.
When To Close
Another thing we didn't talk about is how often we should "close the books", i.e., post the Journal(s) to the Ledger(s). If you're keeping your accounting records only for the government (e.g., tax records), or to show the bank or investors, a month-end closing is probably adequate.
But if you're using the financial records to manage your business — as you really should be — you really need to "close" more frequently — like weekly. Keep in mind the axiom, "You can't manage what you can't measure".
Financial recordkeeping gives you the means to manage your finances — your cash, the monies you have coming in and going out, and when. Of all the things you have to "manage" in a business, how it's doing financially has to rank way up near the top of the list.
The only difference between a "business" and a "hobby" is that a business makes money and a hobby doesn't. If you don't diligently manage your finances, it's likely you'll watch your business dream turn into a very-expensive hobby — and one you can no longer afford.
With paper accounting, there's a lot of work in closing weekly (well worth it — but still a lot of work). With computer accounting, a week-end closing is no big deal. The computer can do all that posting and error-checking — that used to take hours — in microseconds.
With the computer, it really doesn't matter whether you record your transactions in ordinary text files and use programs or "scripts" you write to use the data — or with the spreadsheet or database tools you may be familiar with — or with full-fledged "accounting packages".
In all cases, "closing" reduces to printing out your Journal data (hardcopy record for auditor or tax preparer — or for your own use if you neglect recommended "computer backup" procedures), and any other Ledgers or summary reports that you find useful in hardcopy form — a 5-minute job.
In subsequent columns, we'll review the Journals we've previously mentioned in much more detail — but we'll focus on the data that should be recorded and the uses of that data, rather than the actual mechanics of the recording or reporting. This (hopefully) will make it useful whether you choose to use paper or computer — or how you choose do it with computer.