Quite simply, accounting tells you if you are making money. If you create a profit and loss statement each month, you can ascertain your position quickly. If you are losing money, you can make changes in your operations, such as increasing prices or reducing expenses, to correct the situation long before the year’s end and ensure that your overall year will still be profitable.
If you don’t do any accounting, then that’s probably all you’re doing—making deposits, writing checks, and paying taxes, but not making any profit! Even in a very small business you need to be in control of your expenses. This doesn’t just mean having the money, it means knowing what portion of your revenue gets spent for what purposes. What percentage of revenue do you spend on marketing each month? What about labor? What about supplies? If you don’t track and control these expenditures, you are not managing your business—you are just blindly hoping there might someday be a profit.
A good bookkeeper or even a good accounting software program can help you organize your accounting quickly. But you still need to understand the basic principles of accounting. This will allow you to use the information supplied by the bookkeeper or software program intelligently, enabling you to make the changes in your business that will keep it on track toward success and profitability.
At the risk of sending all accountants into apoplexy, I feel that the income statement is the more important document. The income statement tells you if you are making money and delineates your costs and expenses.
A balance sheet shows you how your assets are being used. For instance, from a balance sheet you should be able to tell whether or not your inventories are too large, whether your receivables are growing, or whether your ratio of debt to equity is getting too high.
Not at all. Let your accountant figure these out, precisely, at the end of the year. Just plug “ballpark” numbers into your monthly profit and loss statements if you like.
If your business is really small, you can manage it fine without creating a balance sheet each month. But any size business, including a part-time one, needs to create a good profit and loss statement each month. And, if inventories or accounts receivables are important in your business, balance sheets will clearly point out any significant fluctuations that you should be aware of.