Episode Title

Episode 24: Accounting 101 for Business Owners: The Simple Terms Every Owner Needs to Know

In this episode of QuickBooks Mastery for Small Business Success, father-daughter team Erica Northrup and Lee Davis go back to the basics with a plain-English Accounting 101 conversation for business owners.

This episode is not about turning you into an accountant. It is about helping you understand the basic accounting language behind your business numbers so that QuickBooks, financial reports, bookkeeping, and conversations with your accountant feel less confusing.

Erica and Lee break down the accounting terms every business owner should know, including income, expenses, profit, loss, assets, liabilities, equity, bookkeeping, accounting, the Profit and Loss report, the Balance Sheet, cash, and profit.

If your QuickBooks file feels overwhelming, your reports feel confusing, or you are not sure what your numbers are actually telling you, this episode gives you the foundation you need to start making sense of it all.

Key Takeaways

• Business owners do not need to become accountants, but they do need to understand basic accounting language.
• Bookkeeping records what happened; accounting explains what it means.
• Income is money the business earns, but not every bank deposit is income.
• Expenses are the costs of running the business, but not every payment is an expense.
• Assets are what the business owns, liabilities are what the business owes, and equity is what is left for the owner.
• The Profit and Loss report shows business performance over time.
• The Balance Sheet shows what the business owns, owes, and has in equity at a specific point in time.
• Cash in the bank is not the same as profit.
• Understanding basic accounting terms helps business owners read reports, ask better questions, catch mistakes, and make stronger financial decisions.

Questions to Reflect On

• Do you understand the difference between money coming into your bank account and actual business income?
• Are you looking at both your Profit and Loss report and your Balance Sheet, or only one piece of the financial picture?
• Do you know whether your QuickBooks numbers are helping you make decisions or leaving you more confused?
• Are you relying only on your bank balance to decide whether your business is healthy?
• Could your conversations with your accountant or bookkeeper improve if you understood the basic accounting language better?

Mentioned in This Episode

Free QuickBooks Clarity Scorecard

Download at: https://lee-davis-and-company.aweb.page/unlock-clarity-free-scorecard

Send Us Your Questions:

support@leedavisandcompany.com

Recommended Resources

• QuickBooks Clarity Scorecard
• Future Episode: Applying Accounting 101 Terms Inside QuickBooks
• Lee Davis & Company QuickBooks training and consulting resources

Timestamps

00:55 - Why Accounting 101 matters for business owners

08:17 - Bookkeeping vs. accounting explained in plain English

11:29 - Income, expenses, cost of goods sold, and profit

18:45 - Assets, liabilities, and equity made simple

29:20 - Profit and Loss vs. Balance Sheet

36:50 - Why cash in the bank is not the same as profit

41:41 - How accounting terms help business owners make better decisions

46:18 - Simple Accounting 101 takeaways every owner should remember

Call to Action

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Have a QuickBooks question? Send it to support@leedavisandcompany.com — your question may be featured in a future episode.

Welcome to QuickBooks mastery for small Business Success.

I'm Erica Northrup.

And I'm Lee Davis.

I handle the tech and he handles the numbers.

And together as a father daughter team, we bring decades of experience helping small to medium sized businesses thrive.

We know that as a business owner, your time is best spent mastering your craft and growing your business, not getting lost in QuickBooks.

Managing finances can be confusing and you don't have hours to waste sorting through spreadsheets or fixing bookkeeping mistakes.

That's where we come in, helping you streamline QuickBooks so you can focus on building your business.

Each week we break it all down into simple, actionable steps so you can focus on growing your business, not fixing your books.

Let's embark on this journey together.

Welcome back to QuickBooks mastery for small Business Success.

I'm Eric Northrup, here with my papa, Lee Davis.

This is episode 24 and today we're doing something really foundational.

We're going back to the basics with an accounting 101 for business owners episode.

Now, before anyone panics, this is not going to feel like accounting class, trust me.

We're not getting into complicated formulas.

We're not trying to turn you into an accountant or.

And we're not going to use a bunch of technical language that makes your eyes glaze over.

The goal today is simple.

We want to walk through the basic accounting terms every business owner needs to understand if they want to make better decisions, trust their numbers and understand what is happening in their business.

Because a lot of business owners feel confused by their numbers.

Not because they're bad at business, but because, no, nobody ever explained the foundation.

They hear words like income, expenses, assets, liabilities, equity, profit, loss, balance sheet profit and loss, bookkeeping and accounting, and so much more.

But they may not fully understand what those words actually mean.

And when you don't understand the basic language, everything feels more confusing.

Your reports feel confusing, your QuickBooks file feels confusing.

Your conversations with your bookkeeper or your accountant feel confusing.

And your numbers may feel like something you are supposed to trust but don't actually understand.

So today we are slowing it down and we're going to define the core terms in plain English that even I, Erica the marketer, can understand and explain and why they matter for business owners.

So, Papa, I think this is such an important episode and let me tell you, it's taken us a hot minute to get here, but we're finally here.

Because business owners don't, do not need to know everything that accountant knows, but they do need to understand the basics.

So why do you think this accounting one on one foundation is so important for business owners, even if they have an accountant who they work with?

I think because at the core, QuickBooks is accounting software.

So starting at the beginning and understand some basics in accounting will help you in both the Setup and using QuickBooks.

Makes a lot of sense.

So I think a lot of business owners hear the word accounting and immediately think, that's not my job, that's what I pay someone else for.

And of course, they do not need to become the accountant.

This is not the whole point of this episode, but there is a difference between having an accountant who prepares your taxes and taking responsibility for your number.

So what is the difference, Papa, between.

Between a business owner needing to understand the basics versus trying to do the accountant's job?

Well, according to the irs, when you file your tax return, you are responsible for the numbers.

Truth.

And most accountants, including mine, he has a disclaimer on his information he sends me that says he's not responsible for the numbers.

He's responsible for preparing a tax return.

All right.

His expertise is in tax preparation and hopefully tax savings for you.

Right.

Making sure you don't miss out on any of the money that you might be leaving out on the table.

Deductions.

Right.

You know, what's appropriate for what falls into federal taxation, state taxes, and so forth.

But as far as the numbers are concerned and what you have in your data, you are responsible for that.

Absolutely.

So.

So do you think part of why this is important, that a business owner understands accounting and understands some of these basic foundational principles, is that if you don't understand the language, it is harder for you to set up QuickBooks.

And that's where we're going with this.

So that's why we really want to lay out the foundation for people.

Yeah, I think that it's critical.

You started your business, you probably have some type of entrepreneurial bent, some interest in a particular trade, that you feel like that you can work for yourself and that you want to build a business and do an excellent job in your particular craft.

And I think what's oftentimes lacking is the preparation.

And what does it mean to go into business.

Right.

And certainly there are lots of training, types of tools.

The SBA has various programs and.

But I find that most times people don't avail themselves of those.

You know, they just get started, and now they're going to go into business.

Absolutely.

So this is why we're focusing on this and just helping people to understand the basic language so that they know what they're looking at when they're looking at QuickBooks, that they know how to then communicate properly with their accountant.

Right.

They know the language.

They can speak.

Speak the language.

And understand when your accountant starts speaking assets versus liabilities and all these other terms that we're going to cover in this episode, that they'll be able to keep up and understand what actually their accountant is saying to them.

Yeah.

It's not the accountant's job, frankly, to handle their business finances.

They're responsible for those.

Right.

The accountant's job, again, as I've said, is to pair the tax return according to generally accepted accepted accounting principles.

So your accountant is not going to look under the covers.

Okay.

They're not going to open up and they're going to use what you send them.

So, again, it's helpful and it will save you money.

If things are classified correctly and that you've got good information, it will mean the accountant doesn't have to send it back to you and tell you that you need to redo it.

So I think that's an important step.

Right.

And I think some of the other basics of why it is so important that we understand this language is that it's going to make it easier for us to read reports, to ask the right questions, catch mistakes.

It's our job as business owners to know our numbers and to know our business and to know what's happening.

So if we don't understand any of this, we're never going to have a good basic knowledge and understanding of what's happening in our business from a financial standpoint, you know, and we'll be able to understand profit and loss.

We'll be able to make those confident decisions because we are well informed.

Business owners love that.

Okay.

So that is such an important distinction.

This is not about saying you need to know everything yourself.

And I don't think that's what we're saying at all, but it is about saying you need to understand enough to lead your business.

Well, as CEOs and business owners, we are the leaders of our business.

Whether you're leading yourself or you're leading a team, you are leading something.

So because if the numbers are always something someone else understands but you do not, then you're always one step removed from the financial health of your business.

And I think that is an important distinction, and that can make decision making really stressful, truly stressful if we don't understand what's going on.

Okay, so let's start with one of the first distinctions people often confuse they hear bookkeeping and accounting.

And a lot of times these words get used interchangeably.

I know I've heard them kind of used interchangeably, but they are not exactly the same thing, are they, Papa?

So how would you explain the difference between bookkeeping and accounting in simple terms?

Understand that bookkeepers, they are more like, I guess you might say beekeepers.

They look at the transaction and they'll record it.

They may not analyze it, they're simply going to record it and they're going to take the information that you give them and put it into QuickBooks and they're going to record the transactions as they understand them and they're going to look to reconcile them.

That's usually where bookkeepers end.

Accountants, on the other hand, are they there could be certified public accountants.

And they are primarily focused on understanding that the information the bookkeeper gives them is done according to accounting principles.

And they'll consider their work in two aspects in generally understanding the information according again, as I said, to accounting principles, but also how does it affect the tax return?

So generally that's what you want your CPA or your accounting professional who's going to prepare your taxes to understand the information they have is correct and how they will utilize that information and both advising you perhaps and preparing your tax return and doing some tax planning.

Absolutely.

So I guess a really simple way of looking at it is bookkeeping records what happened.

Accounting explains what it means.

So they both matter, but they just have different jobs.

And if bookkeeping is messy, accounting becomes harder.

If the day to day records are wrong, the bigger picture reports may be wrong as well.

So it's a good kind of looking at it that way I feel like is a good way to look at it.

Awesome.

So that is so helpful.

Bookkeeping is recording the story.

Accounting is understanding the story.

I am very visual as we know.

I went to NYU for musical theater, so visualization is huge for me.

So understanding that bookkeeping is recording the story and accounting is understanding the story for my brain, that definitely helps.

And you know, business owners need both.

They need someone to help them record the story and then someone to help them understand the story.

Because if the transactions are not recorded correctly, then the reports are not going to tell the right story.

But even if everything is recorded, the owner still needs to understand what the reports are actually saying.

So this is why it's important as you as a business owner should understand these different terminologies.

Okay, so once we understand the difference between bookkeeping and accounting, let's get into the actual term.

So what I want to start with the ones most business owners think about.

First is income, expenses and profit.

So Papa, can you explain income, expenses and profit in the simplest way possible?

Well, when you consider income, it starts with how does the business make money?

And you know, how does it earn that money?

And it usually comes from selling a product or service.

And the examples might be service income for the well guy, it might be the fact that he's out there and somebody doesn't have water.

Right.

Basic need for water.

And so he's going to be getting his equipment which so he's going to provide that service so that they may have water.

In the United States, we have a lot of small businesses that provide service income.

We are a service driven society.

We also have product sales.

You could sell a product.

And there could also be like our business, we provide consulting services.

Yep.

There's also rental income.

There's whole industry around rental income where people buy real estate and they're looking to rent.

And then there's job income by the job.

People may be independent contractors and they may provide specific job skills that they work for themselves.

And it could be independent contractor type of income.

Income is not just money that enters the bank account.

I think it's important.

A loan deposit is not income.

An owner contribution is not income.

Sales tax collected is not business income.

No.

Income is money that the business earns from its actual providing services.

Absolutely.

That is so good.

I know you've got a great example around cost of goods sold.

So what is that simple formula that you talk about quite a bit for cost of goods sold?

I think it's important that you understand what is the basic cost for you to deliver a service.

It's an elementary principle, but it's oftentimes overlooked.

Right.

Because in order to price your service, you need to know what it costs you to deliver it.

And part of that cost, of course, is labor materials.

But it also may require understanding what your overhead is.

Right.

So that you know what you should be marking up your product at.

And I think back in the early episodes we looked at the business plan and talked about, you know, how do you determine what you should price your service at?

Yeah.

And whether if you've underpriced it, you'll lose money.

You may get a lot of business, but you lose every service you perform.

So you cannot stay in business if you lose at every service you perform.

So you do need to understand what your cost of goods sold are and how you plan to include that in your pricing.

Yeah, absolutely.

Okay, so what about expenses let's give us just a basic overview of expenses now.

Yeah, expenses are what is left over.

In other words, you have some fixed expenses.

Yeah, rent's probably the best type of fixed expense I can think about.

Also, there are fixed fees that you pay each month, Right.

For example, they may be advertising, you may have a contract for advertising that you pay a fixed fee each month.

So you can look at your fixed and your variable expenses.

Fixed are what everybody can understand.

That's the same fee every month.

And it doesn't have anything to do with the amount of business you do.

Variable expenses, on the other hand, are tied to how much business you do.

So you could, if a typical type of variable expense could be utilities.

In the winter, your utility bills are higher.

Yeah.

Because the demand for energy is higher.

In the summer, perhaps if you have a typical business because you're not spending, at least in the northeast, your, your energy costs are not quite as high.

Now in the south, on the other hand, you pay higher air conditioning costs in the summer.

Right.

And so in other words, your variable expenses are going to be based on the season, perhaps.

Yeah.

Or they're going to be based on.

And it could be seasonal.

In other words, you, I mean, obviously you have a 12 month cycle of your businesses, your business.

And sometimes your wages are higher, your labor's higher in the summer.

Sometimes it's.

If you're a landscaper, you're going to spend more in the summer than you are when you might be plowing in the winter.

So again, you've got fixed and you've got variable expenses.

I think that's important to know.

Yeah, that is really important to know.

And of course expenses are going to reduce your profit.

Right.

So making sure that your expenses are low is key in retaining more of your profits.

Now, we've talked about this one owner's draw.

Is that an expense, Papa?

No, owner's draw is not an expense.

It could be considered if you are a subchapter S corp and want to be paid on a salary.

But for the llc, that's a single member llc, it's a draw.

And you can set up your draw to be weekly or monthly.

Many of my clients have a monthly draw.

Makes a lot of sense.

Okay, so let's talk about net profit.

What is net profit, Papa?

It's the actual profit after working expenses, not included in the calculation of gross profit.

So when you calculate your gross profit, you're taking out basically the costs that you have had to provide to deliver based on the sale labor, materials, and so Forth and net profit is everything else that got left.

Sometimes they consider in net profit, they'll look at how interest is figured.

So there are some industries have a little bit of a variation like on interest expense, where that falls.

But for a simple rule like we're talking about today, it's everything after the gross profit.

What is a good formula to find the net profit?

So it's a pretty simple formula.

It's sales minus cost of goods sold equals gross profit.

And then everything else falls below gross profit into net profit.

So rent, interest, supplies, not including cost of goods sold.

And so all those expenses that are after the.

You've calculated your gross profit.

Okay, that makes a lot of sense.

So that distinction is so important.

Income is what the business earns.

Expenses are what it costs to run the business.

And profit is what is left over after you've paid those expenses.

But just because money came into the bank account does not mean it was income.

And just because money left the bank account does not mean it was an expense.

I think that one idea alone can clear up so much confusion for business owners for sure.

So it's good to get those kind of down and understand those.

Now we just mentioned something really important.

Not every dollar coming in is income and not every dollar going out is an expense.

That brings us to the next set of accounting terms, which is assets, liabilities and equity.

So Papa, can you walk us through assets, liabilities and equity in plain English for the marketer over here?

Let's, let's really get it very simple.

Sure.

So I think we've talked about income and expense, right?

Yep.

So income minus expense.

Yep.

Equals equity.

So think about it from ice.

You know, I.

When you go to your freezer and get ice and you put it out on the counter.

Yep.

It will melt.

Yeah, right.

Ice melt.

Absolutely.

Ice melts.

Yep.

And it melts into assets, liabilities and equity.

Okay, so if you think about it from a very simple term that the meltdown of your income and expense shows up in your assets, your liabilities and your equity.

And another simple illustration is assets minus liabilities equals equity.

Ah, okay.

So as equity melts, it turns into assets and liabilities.

Is that what I'm hearing?

Okay, that's right.

Like a different form of water really is what it all liability.

It all melts into something else.

It all turns into something else.

I've oftentimes explained it that way and it seems to resonate.

So we can ask our listeners, Erica, if it resonates with them, but you know, it might be just a Simplistic way of trying to explain it.

Yeah.

Come on, listeners.

Did that help you understand assets, liabilities and equity?

We would love to know.

Absolutely.

So.

Very good.

So let's talk specifically about assets.

Is there anything else about assets that we haven't covered that you feel like people should know to understand what assets truly are?

Well, I think you have to determine when you look at an asset.

Cash is always an asset, Right.

There are different types of cash.

People have petty cash and they'll consider, they'll use that cash for somebody who goes to the store and buys something that goes into petty cash and that's accounted differently than on something out on a cash transaction from, let's say from a check, for example.

But what remains in your bank account, Cash is king.

Right.

I've oftentimes said that is the most liquid asset you have.

And because the other assets you want perhaps to turn into cash, when you think about cash is very short term.

That's a short term asset.

That it, you know, it's very fluid.

Accounts receivable is not quite so fluid.

And that takes a while to turn into cash.

Equipment is an asset, but more of a fixed asset and takes on a very different presence.

And, and that's an asset you want to produce for you.

Right.

If you're a plumber and you have some equipment that you use on your job to produce income, that is an asset.

And the more that asset is worth to you, the more it becomes valuable to your business where it's going to.

Help you to actually perform your business, actually do the thing that you say you're going to do.

That's correct.

And how can it be most efficient?

Right.

If you're able to reduce your labor costs by having an asset that's of greater value, then it's a trade off.

And you just have to look at when you purchase assets, how are they going to be used in your business to turn a profit?

Sometimes we don't ask that question enough.

We think we have to purchase this asset.

Well, could we lease it?

And then it doesn't become an asset.

Okay.

It doesn't become an asset.

It's a leased type of expense.

So you have to determine in your business what's appropriate for you to take on as an asset because it ties up your money.

So in some ways, obviously cash is a great asset.

But if you're buying a new vehicle, do you really need to spend that much money on a vehicle or could you purchase a used vehicle?

Right.

And I mean all kinds of decisions about, about assets because they also depreciate.

Right.

They do those kind of assets, they will depreciate unless to you it holds high value.

Unless you couldn't perform your job without that particular asset.

But in general, let's say a car, a truck, those depreciate over time.

So it is weighing out what is going to be best to for your business and is this the right move to make?

And there's a lot of factors that go into all of that.

Well, it also might affect your tax planning.

Right.

Because the government has certain tax rules in the U.S. for example, that will benefit you if you purchase a fixed asset like a vehicle.

But also the rule is that if you buy something like equipment that costs more than $2,500, that's a short term asset and that has to be categorized that way as opposed to an expense.

So 2,500 or more, you must consider it to be some type of asset.

25 Less you can expense.

So clients who are creative in terms of looking at how they will expense something, how they buy it.

Yeah, that makes a lot of sense.

So it's important to, to understand the rules governing assets and what's an asset and what's an expense.

Yeah, that makes sense.

Okay, so let's move our attention to liability.

So what is a liability?

Liability is very simple.

It's something you owe, right?

Yep.

Okay.

You can cut it however you want it, but it's not an expense.

Okay.

Liability is something that you owe and on the accrual basis.

And we haven't really talked about, we've talked about accrual versus cash basis.

But it's really important when you think about what's on the balance sheet that your liabilities are based on what you pay for something.

Okay.

It's not based on what you think it's worth, it's based initially on what you paid for it.

So it's important that you understand you're trading.

Sometimes you trade services for liabilities.

A good example is when you use your credit card.

Right.

That's a big liability.

That's a liability.

But you expense on one side because you, you're not paying cash for it.

You are exchanging credit that you are getting from a third party.

Usually this idea of examples of liabilities can both be short term and long term.

If something's going to be paid within a year, it's a short term liability.

More than a year, it's a long term liability.

So quite frankly, when you take out a loan, it's usually a long term liability.

Three to five Years usually.

But a credit card is something that I would encourage.

That's a short term liability.

Right.

That those need to be paid within 30 days, otherwise you're going to fall behind and maybe a refinance issue could turn into a more of a long term liability.

Right.

You know, types of great financing options are lines of credit.

The time to get a line of credit, when you should receive a line of credit is when you don't need it.

It's when everything's looking really good.

Yeah.

When you're just apply for it, have it on hand, use it for emergencies.

Yeah.

Save it for that rainy day.

Yeah.

Don't use it to operate your day to day business.

But there are different accounts payable is certainly a liability and they all come with various accounting rules in terms of how you record accounts payable and the forms.

And then you have payroll taxes payable.

And I think it's important that one understands what falls into a payroll tax liability and how that gets reported.

Okay.

Makes a lot of sense.

Okay.

So now let's turn our attention to equity.

So let's break down equity.

What is equity?

Equity in the simplest terms is assets minus liabilities equals equity.

Ice melts, right?

Yeah.

Yeah.

And so equity is what's left over after the liabilities are considered on an accrual basis.

Understanding that equity can include owner contributions.

Yeah.

Owner's draws, retained earnings and current year's profit or loss.

So books will calculate for you automatically what falls into retained earnings.

And so you don't necessarily control that.

Well, you do control on what goes into the income and expense that drives the calculation of your profit and loss that falls into your balance sheet.

So that number will get reported on the income statement, but that same number will also go into retained earnings.

So again, understanding that the numbers really coexist, if you will.

Right.

It does really feel like equity connects the owner to the financial position of the business.

It really clears up how much money actually your business is worth.

When you look at what your equity is, when you consider assets minus liabilities equals equity.

Yeah.

So good.

So that's probably one of the biggest shifts for business owners because when you are looking at your bank account, everything feels like money in or money out.

But that is not the truth.

But accounting asks a more specific question.

Is this money the business earned?

Is this a cost of running the business?

Is this something the business owns?

Is this something the business owes?

Is this money the owner put in or took out?

So those distinctions matter because they determine whether something affects profit or whether it belongs Somewhere financial picture.

Now that we have those major building blocks, income and expenses, assets, liabilities and equity, the next thing business owners need to understand is where those pieces show up.

So this is where we get into the two reports they have probably heard of, which is the profit and loss and the balance sheet.

So can you explain the difference between the profit and loss and the balance sheet, Papa?

Well, quick explanation could be the profit loss is over a period of time, whether that could be one month or oftentimes it's measured by a year and the profit and loss is considered those accounts income and expense and cost of goods sold.

But understanding it's over a period of time, it's measured in the profit and loss.

The balance sheet is a snapshot of the assets, liabilities and capital at a point in time, I. E. The end of the year or a given close of a period.

So that's what people look at in terms of those two reports.

Okay, that makes sense.

Okay, so now can you break down gross income for us?

What is that and what does that mean?

Gross income is your total sales minus your cost of goods sold.

That's going to be your gross income.

Okay, makes a lot of sense.

Is there any particular questions that this might answer for business owners when they look at the gross income?

Absolutely.

Do you want to look at how well your business is performing from year to year or six month period or however you want to measure?

The bankers oftentimes look at startups and what did you project for income for services?

How well are you moving toward your six month, your year, your two year goals and how does it affect how much money you spent on marketing and you know what your cost generation is for that income.

So there are various ratios that are standard for businesses and while I don't want to get into those ratios, some of them could be industry specific that you have more costs on the front end for startup with some businesses versus others.

But what's important to know is that your industry has certain standards that they've agreed on to be successful.

Absolutely.

Okay, so what does the profit and loss include?

Well, the profit loss will include your income, your cost of goods sold, your expenses and will show your net profit and quite honestly it will show your non cash related expenses as well like depreciation because there are costs that are not cash related that your business can take as expense like depreciation and also interest expense.

Interest expense can be a very big factor in businesses, especially if they are incurring a lot of debt initially.

So watching your interest expenses is something that Bankers will generally be concerned with in terms of what is your carrying costs or your finance charges.

Is there anything that the profit and loss does not show?

Yeah, the profit and loss won't show you how much debt you have.

Okay.

There.

There may be some red flags on your profit and loss comparative from year to year, but the profit and loss will not show you what types of business decisions you might need to pay attention to around cash.

For example, like what's in your accounts receivable.

Is your accounts receivable not being collected in a timely basis?

That may show up in the fact that your revenue is down.

But again, you have to be careful that you can't mix and match your.

Your assets, liabilities and your capital with your income and expense.

You have to understand that each report should stand on its own.

They each play a part.

And it's crucial.

Correct.

That you keep them separate so they do their job.

Right.

And you understand how they work together.

Yeah, absolutely.

Okay, so let's talk about the balance sheet.

Break that down for us, Papa.

What is the balance sheet?

Well, the balance sheet, again, is a snapshot in time of what you own, what you owe and what your equity is.

In other words, how much your business were in accounting.

Do you feel like there's anything that business owners ignore often when you're looking at the balance balance sheet?

Well, basically, a lot of my clients don't look at them at all.

I hate to be honest with you, but I look at them.

And when they look at them, it's usually from the lens of what their banker wants.

And I have to try and explain it to them.

Right.

As to how the banker may have come up with a decision about a particular financing option and the ratios the banker might have used.

So I find that a lot of business owners will shy away from the reports instead of understanding them from a cursory perspective.

In other words, they don't have to if they use professionals, but if they don't, they need to be the professional because they need to be able to interpret the numbers important.

Even if they don't want to, they need to understand them well.

It's important because you're making decisions about your business.

That's right.

Again, yes.

What they need to do is be able to understand how their numbers can be interpreted.

Right.

Because interpretation.

The banker may look at it one way and say, well, no, but you're not seeing this.

My business has changed from this year to this year in a positive stance.

We still may have certain obstacles.

Yeah, it could be seasonal in nature.

So just understanding the numbers and how they affect the decision would be up to you to explain because the bank is going to look at some very clear numbers.

Okay.

They're going to come up with ratios and formulas and.

But you should know your own numbers, right?

Absolutely.

That's so important.

Okay, so now let's break down the simple differences between the profit and loss and the balance sheet.

Let's get it really dialed in for people.

Super simple.

How would you put this?

The difference is, I think clearly it's the profit and loss is over a period of time.

Right.

The balance sheet is a snapshot.

Right.

You know, if you want to see how your business is doing, you look at cash.

Yeah.

And if you want to see, okay, how well did my business do last year?

In a clear number, you look at the profit and loss, right.

Did we make any money?

Did.

Yeah.

How much money did we make?

How much money?

That's also important question.

Actually thriving.

Yeah, those are two questions.

Two separate different reports.

Look at the profit and loss and say, well, how much did we make?

And then how much cash do we have at the end of the year?

Yeah.

So good.

And I guess then the balance sheet would ask, where do we stand?

Like where are we at right now, currently in time?

Yeah.

So simple.

Okay, so that is such a clear way to say it.

Papa.

The profit and loss tells you how the business performed.

The balance sheet tells you where the business stands.

And you really need both.

I mean, you need the big picture and you need the day to day picture.

You need the small picture.

The both are super important because a business can show a profit and still have cash problems.

We've seen that so often.

And a business can have money in the bank and still owe a lot.

So a business can look busy and still not be financially healthy.

So if you only look at one report, you may miss part of the story.

And that leads us perfectly into one of the most important parts of this whole conversation.

Cash versus profit.

Because this is where so many business owners get confused.

They look at the bank account and think that tells them whether the business is doing well.

But cash and profit are not the same thing.

So, papa.

So why is cash in the bank not the same as profit?

Cash in the bank is an indicator, okay?

It's a number.

It's simply a number.

Because that number can change.

Tomorrow you could have an outstanding check for $20,000.

All of a sudden you might have only a small amount in the bank.

So again, the bank can't be an indicator of the health of your Business.

Right.

It can be a red flag if you are overdrawn at the bank.

Right.

Definitely a red flag if you're seeing red numbers.

We got to have a conversation.

And if people are managing their business from a day to day perspective as how much they have in their bank, it's a very unsettling feeling and they have a lot of stress around that.

So I don't recommend checking your balance every day and figuring how well you think your business is doing.

As you said, it's just an indicator of where things are at.

It's not the whole picture.

Of course.

Absolutely.

Okay, so then that was really about cash.

So break down profit.

Profit's important.

It's a number that can be measured from for a six month period.

A month period.

You need to look at that and say, okay, from an accounting perspective, what does the profit and loss look like?

Are we going in the right direction or the wrong direction?

Yes, absolutely.

Because it's what your business has made.

So profit is really income minus those expenses as we've talked about before.

And this is a good indicator of how because it's also a future indicator of where things are going to go or potentially going.

Right.

If you've had a pickup in business, possibly that is a trend that's going to continue to happen.

Yeah.

So good.

So why does this matter, Papa?

It matters because this is the way business gets measured.

And there are standards that people will look at.

Indicators.

And the bankers run the ratio, they run the numbers.

While you may think your business is exceptional.

Right.

Your banker may think otherwise.

Yeah.

And there may be some indicators that you need to pay attention to that are trends that you want to be concerned about or trends you're excited about.

Yeah.

That new contracts that are generating higher profit for you.

Right.

And that maybe you want to refocus your business.

They become planning tools as well as reports.

So using them wisely or paying attention to them will help your business in both a positive and both short term and long term perspective.

Feels like cash asks, do we have money available?

And profit asks, are we earning more than we are spending to operate?

I feel like those are good kind of indicators.

Excellent.

Okay, so this is such a big one because the bank account feels real.

I mean, those are real numbers.

Although it's.

It is a little bit crazy because someone was talking about this recently.

But so much of the way we do business now is really numbers that show up on a screen.

I think about Mr. Scrooge, right.

From A Christmas Carol.

And he had all this, this coin he had all this.

This gold in his room, like it was something you can pick up, you can touch.

But today it's swiping up the credit cards.

It's on your debit card, it's on your bank statement, their numbers on screen.

So it's just.

It's kind of surreal in some ways, you know, But, I mean, this is how we do it, right?

Because the bank account feels real.

It is what business owners look at every day.

But the bank account does not tell the whole story.

Some of that cash may already be spoken for, as we talked about with liabilities.

It may need to cover payroll or taxes or vendor bills or credit card payments or loan payments or future expenses.

And on the flip side, the business may show profit, but still feel tight because customers have not paid yet.

I mean, that's a big one.

You put an invoice in and you send it to somebody and they have not paid that $50,000 that now you're counting on to cover these bills you have or this thing that you have.

So cash matters, profit matters, but they are not the same number.

And I think that is super important for all of us non accountants to understand.

They are not the same thing.

So when you put this all together, we start to see why these terms matter so much.

They are not just accounting vocabulary.

They are the foundation for understanding the health of our businesses.

So if a business owner understands these basic terms, how does that change the way they look at their numbers?

Papa, what do you see show up in our business?

I can say it in a very succinct way.

They don't lay awake at night worried about their business, Right?

Yes.

That peace comes.

Yeah, that is huge.

Where else do you see it show up?

Well, I think it shows up when they are in need of financing.

As I've said to a lot of my clients, the time to get financing is when you don't need it.

When you don't need it.

So you get it lined up.

You get it based on historical information.

And so again, having good reports.

And if you're looking at financing terms, whether you perhaps might get more favorable terms based on your numbers.

So you want favorable interest rates.

Yeah.

And.

Or you want the best financing options.

So that having your numbers and presenting them in a way that creates that picture can be very beneficial to your business.

Yeah, that's huge.

And at the end of the day, they're going to have more confidence and they're going to have more confidence in their businesses, and they're going to make better decisions because now they know what they're looking at, they understand what they're looking at, and they can confidently say, yep, we can do that because we know we have the money in the bank, or, nope, we should definitely not do that.

That is going to sink us if we do that particular thing.

I think we've talked about this before, but you become less reactive and more proactive.

Right.

So you stop being a reactive business owner and you start making decisions and choices and you start deciding things around hard facts that you actually know what you're looking at, which I think is huge and massive.

Would you agree to that?

Yeah, I would think.

One of the areas I'm noticing when I am doing loan applications for some of my business clients is these days, bankers want.

They want you to know what your website is.

So they're looking not just at the numbers, but they want to know a little bit more about your business.

They want to know that you've got a credible business that's got some good reviews, that's got good information out there.

Because they're also investing in your business.

Absolutely.

They don't want to invest in the wrong thing.

Bankers, insurance companies, you name it.

The people that you do business with, they all want to know about the scope of your business and what the potential is.

And so it's interesting these days.

Yeah, it is really fascinating.

Yeah.

The landscape and the kind of culture of business has shifted quite a bit.

And it's exciting where things are going.

And I do think that it's even going to shift even more as some of the new technology that's coming along is going to just get better and better.

And so that's what we're here for.

We're here to help you navigate all of this.

It's very exciting, even for our business, Erica.

But as well, Mama pointed out, and she generally has an interesting scope on our business.

She says, well, you've got a good business reputation now.

You've got a global presence.

I know, it's crazy.

Thank you, all of you international listeners.

We haven't called you out yet, but we're gonna meet some people from all around the world.

And that's exciting to be able to speak to a broader audience.

Right?

These very core principles that I think resonate with anyone no matter where you live.

I think that's huge.

And that's the real goal, right?

Not to overwhelm people with accounting terms, not to make them feel like they need to become financial experts.

That's not what we're doing here.

But what we are doing is we want to give you our listeners, we want to give you enough understanding so that you're not flying blind.

Because when you understand the basic language, your numbers become less intimidating.

You can start to look at your reports and ask different and better questions.

You can start to notice when something looks off.

Like, I think that is a huge one to call out, right?

Because when you know what you're looking at, when you understand what you're looking at, then you understand, oh, something over here does not feel right.

And that is important.

And you can start to see your numbers as a tool for decision making instead of something you avoid until next tax season, next back time.

Okay, so before we wrap up, let's make this really practical and simple.

If someone is listening and they only remember a few things from this episode, I to give them a simple summary.

Papa.

So what are the main accounting 101 takeaways every business owner should remember?

I guess don't avoid it.

Don't avoid learning about your numbers bookkeeping records.

What happens?

Yeah, and you know, if you're using a bookkeeper or you're getting some help with your bookkeeping, just make sure you hire someone who's competent in, in bookkeeping, somebody who's trained.

If somebody's helping you with your books, just make sure that they understand how QuickBooks if you don't use QuickBooks, how your accounting system works.

Accounting explains what it means.

And, and I think that we've talked about some basic principles that you need to look at in terms of your accounting because at the end of the day, when you look at your numbers, you want to know that your numbers are useful for whatever purpose you're going to use them for.

Absolutely.

The income is money the business earns.

Expenses are costs of running the business.

Net profit is what's left after income minus expense.

And that looking at your gross profit.

Numbers are important because they measure your profitability after your direct expenses, labor, materials, et cetera.

And assets are what the business owns or controls.

It it means what do you have to work with?

And liabilities are what you owe.

So what you're stuck with and equity, it's what you have.

It's what's left for you to dispose of.

Whether it's in salary or draw or whatever equipment.

The profit and loss shows income and expenses and profit over time.

Again, it's over time, a period.

Right.

The balance sheet is a snapshot of a point in time with that shows assets, liabilities and equity.

And cash is not the same as profit, but cash is king.

Absolutely.

Business owners do not need to become accountants.

Mountains.

But they do need to understand the language.

Huge.

Absolutely.

I think just understanding the language.

And you know what?

It doesn't all have to be.

We've talked about this before, Eric.

It doesn't all have to be overnight.

No, it's something that you can educate yourself on and then learn.

Absolutely.

I think that is the foundation right there.

I think this is what it is all about.

And once those terms start to click, everything else becomes easier to understand.

I even feel like even in this.

This recording of this episode, things have even sunk in a little better for me.

And I think that's what it's all about.

It's not about getting everything overnight.

Because the more exposure you get to all of these terms, the better off you're gonna be.

And the better that you're gonna learn things, which is what it's all about, the easier it all gets.

You know, once those terms start to click, everything else becomes easier to understand.

You guys, your reports make more sense.

Your conversations with your accountant make more sense.

Your bookkeeping makes more sense.

And yes, QuickBooks starts to make more sense too, if that's what you use.

Absolutely.

If you've ever felt intimidating by accounting, I hope this episode helped to simplify it.

Because accounting does not have to be this mysterious thing that only your accountant understands.

And at the most basic level, it is helping you understand what is happening financially in your business, you guys, what came in, what went out, what the business owns, what the business owes, what belongs to the owner, whether the business is profitable, and whether there is enough cash to support the business.

Those are not just ideas, you guys, those are business owner ideas.

And the more you understand that language, the better equipped you are to lead your business with confidence.

That's what we've talked about, and this is why we're doing this.

We want you to be confident business owners that are proactive, not reactive.

You do not need to become an accountant, but you do need to understand the foundation.

And this foundation is exactly what we are going to build on next week.

So now that you understand these terms, we're going to move this into understanding QuickBooks even more.

So this is the foundation, exactly what we're going to build on next week.

Because in the next episode, we're going to take these accounting terms and show you where they actually show up.

Inside of QuickBooks, we'll talk about how income, expenses, assets, liabilities, and equity connect to the chart of accounts, the forms you use, and the reports you rely on.

So today was the foundation.

Next week, we'll apply that foundation directly to QuickBooks.

And if you want a simple way to start identifying where your own QuickBooks file may be unclear, we have a free tool for you.

It's called the QuickBooks Clarity Scorecard.

It will walk you through a few simple questions and help you see where your QuickBooks file may be clean, unclear, or unreliable.

You can find the link in our show notes or on leedavis and company.com Papa thank you so much for making accounting feel simple.

You really did a really good job of dialing in for us today, so I really appreciate that very much.

I tell you, Erica, you did an excellent job helping me through getting it clear, breaking it down now.

So we're a great team and our listeners, I think are benefiting.

So thank you.

Yeah, they are benefiting.

That's exciting.

That's what we're here for.

So you guys, thank you so much for listening to QuickBooks mastery for small Business Success.

We'll see you next week.

Bye for now.

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