I get a LOT of questions about accounting when it comes to Quickbooks. And, quite frankly, this is one area that I think Quickbooks falls short.
Accounting can be confusing for most people, so I understand why Quickbooks tries to take all of the “accounting” out of using their software.
But still, a basic knowledge of accounting is really needed if you want to fully understand what Quickbooks is doing with all of your numbers.
In it’s most basic sense, accounting is simply a way to account for all of your business activity. It’s the way you keep track of everything.
Yeah, accounting has all of its fancy buzzwords, like debit, credit, chart of accounts, profit and loss, etc. But when you strip all the buzzwords away, it really is a simple, yet logical, way to keep track of everything.
The Basic Building Block – The Account
At the core of accounting is the account. You have to assign every number to an account and there are 5 basic accounts:
1. Income (revenue) - this is the money you charge your customers
2. Expenses – this is the money you spend on a day to day basis to run the business (telephone, rent, etc.)
3. Assets – these are things you own to run your business or money that people owe you (computers, desks, accounts receivable, etc.)
4. Liabilities – this is money you owe to others to run your business (accounts payable, bank loans, credit cards, etc.)
5. Equity – the “net worth” of your business.
So, any “account” you set-up in Quickbooks has to be categorized into one of these account types (Quickbooks labels them “Other Current Assets,” “Fixed Assets,” etc., but we will keep this basic).
The important thing to keep in mind is that every dollar amount you receive or spend HAS TO BE put into an account.
The General Ledger
If you think of accounting as a flow chart, with the account being first, the next step in the flow chart would be the General Ledger. The general ledger is basically a listing of all transactions that increase or decrease an account.
So, if you had 12 telephone bills during the year that you paid, the telephone expense account would have 12 entries in the general ledger showing each of these 12 bills paid.
If you pull up your general ledger in Quickbooks, it will list out every transaction for every account.
The Trial Balance
Next comes the trial balance. The trial balance is simply a general ledger without all the detail. It just lists out your accounts and the TOTALS of all of your transactions.
So, in the example above, instead of showing all the detail of the 12
phone bills, it would show the account, Telephone Expense, and the total of all of the 12 phone bills.
So, the trial balance lists all of the accounts and the totals for each account.
The Financial Statements
Finally, the financial statements come from the trial balance. There are 2 basic financial statements – the Profit & Loss (sometimes called an Income Statement) and the Balance Sheet.
The Profit & Loss shows you how much money you made (or lost) and the Balance Sheet shows you your Assets, Liabilities and Equity.
The numbers on the financial statements come from the trial balance, which come from the general ledger, which come from the individual transactions you put into the individual accounts.
So, if you can visualize it this way – accounting is a way to make sense out of all of the invoices, sales orders, bills, checks, cash, etc. and boil them down to 2 sheets of paper – the Balance Sheet and the Profit & Loss.
This way, it is much easier for a business owner to quickly look at how their business is doing by looking at the financial statements as opposed to trying to make sense out of the 1,000′s of sheets of paper flying around.