Are you a small business owner? Do you have a hobby that generates a little income? A lot of people in your position know that they should be doing some sort of bookkeeping, but they don’t have the background to know how to do it, and don’t make enough money to afford to pay someone else to do it.
The consequences for a lack of bookkeeping can be significant. If nothing else, it makes tax time a nightmare, for you and for your tax preparer (ahem!). It can also keep you from qualifying for a loan to expand your business. But more importantly, it means you may be running your business without enough financial information to have a clear idea of what is really going on.
For example, I have a client named Jeff who runs a small side-business in addition to holding down a good job. By day he is in charge of the IT department for a successful firm, but on his own time he markets magic books, DVDs and tricks. He is well-respected in the magic world, but isn’t exactly getting rich off his hobby/business. This year, as I prepared his taxes, I found that Jeff had repeatedly put cash into his business account to keep it going. This is what is called “owner’s investment,” and he was doing it to cover what he thought of as necessary expenses that wouldn’t have been met on the basis of his magic revenues alone.
Except that, when all the income and all the costs and expenses were accounted for, Jeff had made a small profit last year! Not enough to quit his day job, but more than his business had ever made before. If only he’d known he was profitable, he could have avoided constantly reinvesting in his own business, and saved that money in his personal account. But his lack of accurate bookkeeping kept him in the dark.
Jeff’s business is small enough that he really can’t afford to hire me as a bookkeeper. I give him pointers, do his taxes, and until this year he’s always taken a small loss. But because he finally had made a profit he was ignorant of until months later, we talked about a way for him to use a simple spreadsheet to keep track of his own books, and at least know where his business stands at any given time.
So for you, my readers, I have decided it might be helpful if I offer you the same advice. If your side business or hobby is too small to afford a bookkeeper, you can accomplish much the same thing if you remember a simple formula, and take just a little extra time with your receipts instead of shoving them all into a box or a drawer to be sorted out later, when your taxes are due.
Business profitability can be thought of as a simple math equation. Since business taxes are paid on business profits, knowing how to separate costs and expenses from income is the rock bottom foundation of a business tax return, and this is the two-part formula by which we do that:
Gross Income – Costs = Gross Profit
Gross Profit – Expenses = Net Profit
Net profit is what we are looking for. It’s how we know if we are making money. I have talked about this equation before, but this is, in fact, the same equation on which even the most complex business returns are based. A version of this equation is built into every business tax form the IRS uses.
So Jeff’s spreadsheet only needs to track his various income amounts, earned throughout the year, as well as the costs (DVD production, for example) and expenses (internet hosting for his website, or tax preparation fees) he has to pay. If he makes a little effort and keeps it current, it isn’t accounting exactly, but it will give him a running total of his net income or loss for the year.
If he can do it, you can do it. Where there’s a will, there’s a way, and Jeff’s resolve was firmed up this year by the embarrassment of being profitable and not even knowing it. Hopefully, his story will inspire you.