Developing a Set of Financial Statements

To develop a set of financial statements, you have to start with a plan for how you will organize the information. This plan is called your Chart of Accounts. It is the framework upon which the financial statements are built. In your business, you have expenses that are going directly into your product - labor, materials, freight. There are also indirect costs that are more supportive (and ongoing) in nature - utilities, telephone, and the cost of bookkeeping. An easy way to distinguish the two is that direct expenses stop when you don't have work. Indirect expenses, also called overhead costs, don't.

A chart of accounts uses a numbering system to organize the information so that it is easy to understand. All the information in your accounting reports is in numerical order. The first digit of each account indicate what sort of account it is. The digits that follow put the accounts in order. As your system develops and you want to get more intricate, you can further refine this system, but the basic outline is as follows:

Balance Sheet Accounts

1000 Asset Accounts
What you own
2000 Liability Accounts
What you owe

1000 Asset Accounts, what your own, has two subcategories: current assets and fixed assets. Current assets are cash or things you can convert to cash readily, like inventory that could be sold and accounts receivable which you've billed for and should be in the mail. All of that gets an early number and gets put at the top of the page on your balance sheet under Current Assets. You need to make certain that you have enough current assets on hand to pay current bills.

Fixed Assets are the big tools, equipment, computers, vehicles, and the building you operate in. All major items are entered in your accounting records with their purchase price.

2000 Liability Accounts also has two subcategories: current and long term. If the liability needs to be paid within the year, it is entered in the current category. If you have a loan you pay out over time, you put it under long term. However, you will have to take one year's worth of principal on each loan and enter it under current liabilities, because you do, in fact, owe that within a year.

Current liabilities also contains customer deposits. Until the product is made or service rendered, you are holding money that belongs to someone else. Even if you have spent money on contracts that is non-refundable, it still isn't earned.

Income Statement Accounts

3000 Income Accounts
4000 Direct Expense Accounts
Labor and materials: expenses that will stop if you're not working
5000 Indirect Expense Accounts
Expenses they just keep going, whether you're working or not; also called overhead
7000 - 8000 Non-Operating Accounts
Numbers whose meanings are pretty obvious (interest income, and income tax), but which are kept at the bottom of the page separate from normal operating expenses or incomes

Keeping the Direct Expenses separate from Indirect Expenses is very important. You will need to know what your overhead (indirect expense) is when you price your work. Having them clearly defined is also important when you want to calculate your gross profit. As manage your accounting entries, make a concerted effort to separate your direct from your indirect expenses to save yourself headaches down the line.

In terms of employees, overhead is the support staff - office and sales, primarily. If you are in retail sales, the wage for your salesperson is a direct expense. Shop and design are direct expenses.

Most accounting software packages come with preset charts of accounts for various businesses, which you can use to get you started, and modify as needed.