Episode 35: Is Your Chart of Accounts Telling the Truth? Part 1: The Six Questions Every Business Owner Should Ask

Your QuickBooks transactions may contain the correct dollar amounts and still produce financial reports that tell the wrong story.

The reason may be hiding inside your Chart of Accounts.

In this episode of QuickBooks Mastery for Small Business Success, father-daughter team Erica Northrup and Lee Davis explain why the QuickBooks Chart of Accounts is much more than a list of categories. It is the financial filing system that determines where every transaction appears and how your Profit and Loss and Balance Sheet are organized.

A bank account is not an expense. A loan is not income. A credit card payment is not automatically a new expense. Money contributed by an owner is not necessarily business revenue. A major equipment purchase should not always disappear into an ordinary expense category.

When these transactions are assigned to the wrong account type, your QuickBooks reports can misrepresent what your business owns, owes, earns, spends, and may need to pay in taxes.

Erica and Lee organize the Chart of Accounts around six practical questions every business owner should be able to answer:

1. What does the business own?
2. What does the business owe?
3. What belongs to the owner or shareholders?
4. How does the business make money?
5. What does it cost to deliver the work and operate the business?
6. What may the business owe in taxes?

You will also learn why loan payments often need to be separated between principal and interest, how products and services can repeatedly send revenue to the wrong account, why cost of goods sold matters when calculating gross profit, and how properly organized tax liabilities can help prevent a future cash-flow crisis.

This is Part 1 of a two-part series. In Part 2, Erica and Lee will explain the most common Chart of Accounts mistakes and the warning signs that may indicate your QuickBooks reports are not telling the truth.

Key Takeaways

• The QuickBooks Chart of Accounts is the financial filing system behind your Balance Sheet and Profit and Loss.
• A transaction can contain the correct amount but still be wrong if it is assigned to the wrong account type.
• Purchasing a vehicle, computer, equipment, or other major asset does not automatically create an ordinary business expense.
• Loan payments may include both principal and interest, and categorizing the entire payment as an expense can distort profit and leave the loan balance incorrect.
• Products and services must be connected to the correct income accounts, or QuickBooks may repeatedly place revenue in the wrong section of your reports.
• Cost of goods sold helps business owners understand gross profit and whether their core work is priced profitably.
• Sales tax, payroll tax, estimated tax payments, and other tax-related obligations must be organized correctly so the business can plan for future payments.
• A well-organized Chart of Accounts provides useful information for your accountant, but it does not replace professional tax preparation or tax advice.

Questions to Reflect On

• Does your Balance Sheet accurately show what your business owns and what it still owes?
• Are loan payments, owner transactions, major purchases, and tax payments being categorized according to what they actually represent?
• Can you clearly see how your business earns revenue, what it costs to deliver the work, and how much gross profit remains?

Mentioned in This Episode

Free QuickBooks Clarity Scorecard

Find out whether your QuickBooks setup is giving you the financial information you need:

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

Send Us Your Questions

Have a QuickBooks question or business challenge you would like Erica and Lee to discuss?

[email protected]

Coming Next

Part 2 of this series will cover the common Chart of Accounts mistakes and warning signs that can cause your QuickBooks reports to tell the wrong story.

A more detailed Chart of Accounts training resource is also in development. It will include demonstrations inside QuickBooks, account setup guidance, and a more complete cleanup process.

Timestamps

00:56 — Why the QuickBooks Chart of Accounts controls your financial reports

02:54 — What is the QuickBooks Chart of Accounts?

03:57 — The Chart of Accounts explained as a financial filing system

07:45 — The six questions every Chart of Accounts should answer

12:24 — Question 1: What does the business own? Understanding asset accounts

21:22 — Why purchasing a business asset is not automatically an expense

23:35 — Question 2: What does the business owe? Understanding liabilities

29:46 — A common QuickBooks mistake with loan payments, principal, and interest

31:45 — Question 3: What belongs to the owner or shareholders? Understanding equity

34:27 — Question 4: How does the business make money? Organizing income accounts

38:13 — How incorrectly mapped products and services send income to the wrong account

41:41 — Question 5: What does it cost to deliver the work and operate the business?

43:20 — Cost of goods sold and gross profit explained with a contractor example

45:24 — Question 6: What may the business owe in taxes?

47:31 — Why a profitable business can still face a tax-related cash crisis

49:27 — Using tax-reserve accounts to prepare for future obligations

51:17 — Recapping the six Chart of Accounts questions

52:20 — What to review before Part 2 of the Chart of Accounts series

Call to Action

Before Part 2, run your Balance Sheet and Profit and Loss, and write down anything that does not make sense.

Look for unfamiliar accounts, unexpected negative balances, missing loans, unusually large expenses, revenue in the wrong section, or balances that do not agree with your outside statements.

Download our free QuickBooks Clarity Scorecard to identify where your QuickBooks file may need a closer look:

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

Subscribe to QuickBooks Mastery for Small Business Success so you do not miss Part 2, and share this episode with another business owner who could use more clarity and confidence in their numbers.

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.

US today, we are talking about something that sits quietly behind almost everything you do in QuickBooks.

It affects your profit and loss.

It affects your balance sheet.

It affects how your income is reported, how your expenses are organized, where your loans appear, how your equipment is recorded, and whether the reports you are reviewing actually make sense.

But many business owners have never really looked at it.

We are talking about the one, the only, the Chart of Accounts.

And this is episode 35.

Is your chart of accounts telling the truth?

Part one, the six questions every business owner should ask.

Or as I like to tell my 11 year old, okay, Pinocchio, and that little nose is growing.

So, yeah, Chart of Accounts.

Is your nose growing?

So Papa.

We have mentioned the Chart of Accounts in several previous episodes.

We have talked about categories, financial reports, cleanup, and what happens when a QuickBooks file ends up in a ditch.

But today we are really focusing on the foundation underneath all of that.

You recorded a much more detailed training on this topic where you actually open QuickBooks, walk through the different account types, demonstrate how accounts are created and organized, answer some of the more technical questions.

We are developing that into a separate training resource because there is far more to this subject than we can cover in one podcast episode.

So today though, we want to help business owners understand what the Chart of Accounts does, why it matters, and how to recognize when the structure behind their QuickBooks report may not be working correctly.

So let's start with the most basic question.

What exactly is the Chart of Accounts?

Papa?

And you know what?

I think I've had this question myself.

So what is the Chart of Accounts?

Every accounting system has a foundation, and the Chart of Accounts is the foundation in which QuickBooks is set up in.

So when you purchase QuickBooks or when you did purchase QuickBooks for the first time.

It asks you, what type of business or what do you do?

What type of business do you have?

And the desktop has a much more robust list of types of, of businesses than the online version.

But based on your selection in that setup feature, it will load a chart of accounts.

So QuickBooks loads the list of accounts what they would consider assets, liabilities, capital, and they'll put in some expense categories, and there will be some categories that really are standard in the QuickBooks product that will go into the chart of accounts.

Yeah, so that's what the chart of accounts is.

Okay.

Love that.

It appears to me that the chart of accounts is the filing system behind your financial reports.

Every transaction has to be placed somewhere.

The account you choose determines where that transaction appears and what story your reports tell.

Does that ring a bell with you, Puppet?

Does that?

Oh, yes.

That fitting?

It does, yeah.

I think the idea of, you know, we all know before we got really automated back in the day when I worked for the college, we had, we had lots more filing systems.

Yeah.

Okay.

Back in the 80s and the 90s, we were all about files.

Watch it, papa.

You're dating yourself right here.

I know, but I guess I think about wisdom.

I think I might be dating myself, but I've gotten a lot of wisdom along the way.

Yeah.

Because sometimes, sometimes people need to grasp what does that mean?

And sometimes when you say account, they glaze over.

But when you say file.

Oh, it's a file for each type of transaction, then it becomes a little clearer.

And it's probably a little bit easier to work with.

If you go pick up file up.

Like, I know we have a lot of clients and we get a lot of work, and I don't like to have a messy desk.

Okay.

So I create files.

All of our clients, all information fits in a file in a drawer so that I can be working on one thing at a time.

Really?

That's what QuickBooks is.

When you really drill it down to the chart of account, you can look at one file at a time in the chart of accounts.

You know, I think that filing system analogy makes this much more easier to understand.

And you just say that it's a file I think will create a little ding, ding, ding for people.

It will create this, a light bulb moment that I think people are going to be able to grasp it that much easier.

Now, if we had a physical filing cabinet for the business, we might have one file for advertising, another for vehicle expenses, another for insurance, and another for office supplies.

But we would also have very different files for things such as bank accounts, credit cards, equipment, customer invoices, vendor bills, and business loans.

They may all contain dollar amounts, but they do not mean all the same thing.

Do you think that will resonate with people?

Is that resonating with you?

Papa?

Oh, absolutely.

These are different kinds of transactions.

You know, when you pull out the advertising file, you're going to have bills, right?

Yeah.

And if you organize your bills by date, then they're going to be organized maybe from the current to the latest you dealt with that particular vendor.

So if you sorted your advertising bills by vendors, because you maybe you had multiple vendors in advertising, that would fit nicely in QuickBooks because you would pull out the vendor and there would be all of their bills in date order.

Or you could, yes, search it by another way by amount.

The nice thing about the file is you can manipulate the QuickBooks file.

It's a lot of manual work if you're trying to manipulate your own file.

Yes.

But QuickBooks manipulates your file in a button so you can pull out exactly what you need.

Oh, my goodness.

I think I'm having my own light bulbs that are going off.

So good.

Okay, so that brings us to something I think every business owner should understand.

The chart of accounts is not simply one long alphabetical list.

The accounts belong to different financial families.

So let's simplify those families.

Papa.

So rather than giving people a technical list of every possible QuickBooks account, what are the main questions the chart of accounts should help answer?

Papa.

The chart of accounts should help you answer what you own, what you owe, and what your profit is.

Because you're able to run certain reports in the chart of accounts that help you if you narrow down some transactional work that goes in to this account.

Yeah.

And that's oftentimes extremely helpful.

But I think when you look at what it answers, because the way the structure is in the chart of accounts mirrors your balance sheet and your income statement.

So all the account types go back and line for line that you can look at them on the balance sheet and the income statement.

And that's incredibly useful and helpful when people are saying, I don't know where to look in the chart of accounts.

And it starts back on the very first with banking.

Okay.

And it's ordered in such a way that it goes down the same order that it is on the profit, loss and the balance sheet.

So once you understand that, it makes it a lot easier to be able to understand where to look on the chart of accounts.

That is so good.

You know, I do feel when really digging into the chart of accounts, there are five basic questions like you said.

A few you started with were what does the business own?

What does the business owe?

And then you have I think three other questions.

Questions, right.

What belongs to the owner or the shareholder?

How does the business make money?

And what does it cost to deliver the work and operate the business?

Do you think these five questions basically sums up what the chart of counts should help answer?

Yeah, I would add one more area that it's usually at the bottom.

It's their taxes, their costs for taxes.

After that you see your net profit.

Yeah, that does make sense because that's one of the main reasons for QuickBooks.

Right.

It's really at the end of the year to help you with your taxes.

I mean that's probably essentially why QuickBooks was created, to help people, help business owners really navigate how much they're going to owe the IRS at the end of the year.

Does that really what it boils down to?

I think it's a little combination.

Eric, Here's a little accounting lesson.

So we'll try to make it for a non accounting person.

Right?

Ding ding me.

Maybe when.

Yep.

When you owe the IRS and you filed your personal taxes, Right.

And you filed your schedule C, let's say you're an llc, a limited liability company, then you're going to pay the tax effect.

And quite often businesses will pay their taxes, their individual taxes through their business entity.

And while I don't necessarily agree with that, it's one place for us to see it and it's collectively it's not a tax deduction, although and it's considered a draw.

But there are some of the taxes that businesses pay, like unemployment taxes and they may pay a sales tax and they'll pay some taxes that definitely are paid by the business and not the individual.

So it's always good to understand the taxes in your state or I guess like in, in where you live, Eric, I think you might call it what a province tax or I don't know, I haven't been burst well enough yet in the Canadian tax system.

But you are very shortly so it's okay, we'll get caught up.

Yeah.

So taxes are important part of QuickBooks and quite honestly, when you set up your business, you tell the business what type of entity you are, whether you are an LLC or some S corp or whatever and they will set up the right tax structure.

When they set up your chart of account, it's good to know what exactly your tax structure is.

And sometimes People change their tax structure.

They move from an LLC to an S Corp, as we've had the case with several of our clients.

Yeah, absolutely.

Okay, let's break down these questions individually because I think this is a really good place for people to really start really grasping what is the chart of accounts.

So let's begin with that first question, what the business owns.

So these would be the asset accounts, correct?

That's correct, yeah.

Okay, so let's dive into that a little bit.

Papa.

So what are some of those accounts?

What are some of those examples of those asset accounts?

So they would be.

The first and largest, you know, account obviously is your bank account where you manage your business through, right?

You write checks, you deposit money, you may pay payroll through that account, although some particular businesses have a separate payroll account.

So it could be you might have a main bank account and you could have a payroll account, and you could possibly have a money market account or savings account that you put funds, transfer funds into.

A lot of my businesses have those kinds of accounts.

You will have.

Also, people don't necessarily have this type of account, but it's useful for petty cash that you want to set up a petty cash account for monies that you're going to just pay out.

If somebody comes up and to your counter and wants a donation, for example, or you buy the Girl Scout cookies or whatever you're doing, that would be cash.

It's helpful to have a petty cash account.

And so that pretty much takes care of your cash accounts.

And if you have multiple banks that you work with, it's important that you look to identify your accounts.

And so lots of times people, when they set up their bank account, when they name it, they may name it like citizens with the last four digits of the account number.

So oftentimes that's very useful when you're looking to identify the accounts, particularly maybe they've gone to one bank and then they close that bank after a while and they went to another bank.

And so it's really helpful for you to name your accountants so that it's easy because QuickBooks will never allow you to delete.

You can make an account inactive so it doesn't show up on your balance sheet.

The next area is probably something that more retail people run in with the inventory.

And so as soon as you set up an inventory account, QuickBooks will automatically set up a purchases account.

Though there are some accounts that you don't have to worry about setting up, and those accounts will automatically be triggered once you set up a host account, like inventory for example.

So yes, inventory is a.

Certainly for the retailer, inventory is critical and how it's managed and purchases and sales and so forth.

The next type of account is a little bit mysterious, right?

It's a mystery.

So we should maybe have a mystery.

And, and what is prepaid expenses?

Oh my.

What is prepaid expenses?

The non accounting answer.

It's something that you have paid but you don't owe it yet.

Okay.

Because you may have prepaid when you paid wages.

This is quite often the case with people who are on the accrual basis that they pay payrolls, but they only owed two days in the accounting period of payroll.

They didn't owe the three days on the book because it crosses over two years.

Okay.

So you usually see this.

Lots of times accountants will make a adjusting entry to prepaid wages and payroll expense.

So that's very common.

Particularly again for those who are on the accrual basis.

You also have prepaid insurance because rarely does your insurance period that you pay the premium for ever coincide with the end of your fiscal year.

Oh, they will oftentimes be prepaid insurance.

And those are two of the most common prepaid type of accounts.

There could be other prepaids.

There's just generally the way you know if something is prepaid is if it goes outside of the fiscal year and you've paid it ahead.

And some people like to pay their expenses ahead.

Could be rent.

Okay.

But you can't deduct it.

You may think you can, but you can.

Okay.

If you think you're going to try avoid some taxes.

If you've got a good CPA and they see a larger rent payment than normal, they may ask what that is.

All right.

And if you've decided, because you've got a lot of cash and you'd like to decide to lower your tax burden, you're going to pay ahead.

Well, ding, ding, ding, ding.

That is a prepaid expense.

Yeah.

So the next type of account is security deposits.

And this is a pretty good account.

It's to understand what it is.

Let's say you rent for your landlord, you have a rental.

Like you do we.

Oh yeah, like I do.

We're about to enter the rental market for sure.

Short term rental.

When you collect your security deposit, you don't treat that as income.

No.

Okay.

You hold that money and depending on your state or what the laws are, whether you have to pay interest on that security deposit or not, it's driven whatever your state requires.

If you have to pay interest to your, the person that you're holding the security deposit for.

And you oftentimes have a contract that says if your security deposit will be refunded based on X, Y and Z.

And so if you make a security deposit and you should record it not as an expense but a deposit, which is exactly what it is.

And you have a way of keeping track of it so that you know if you left the premises and rented something else or you bought something or whatever you did, you would know that, oh, I've got a security deposit that I've got to make sure I get back from my landlord.

And here's what it is.

I think that's critical.

I think going on to more of the fixed assets, which is the next kind of category we're going to run into.

And that would be equipment.

And equipment is exactly that.

Somebody purchases something to run their business and typically the answer is something $2,500 has to be greater than 2,500.

Now you can have if you're interested.

Sometimes people purchase large equipment amounts.

Could be that you'd like to have a.

An equipment account that would house all of that.

Or you could have a small account, equipment account that if you're interested in breaking down your equipment, so that if your accountant, if it's useful.

So I think that is helpful.

Very helpful.

The next account I think that we are talking about is vehicle.

And it's exactly that.

It's where you put your trucks and.

And so forth, cars or things that are owned by the company, not personal vehicle.

Only those that are owned by the company and therefore are depreciated and based on the accounting rules.

So the next area that is oftentimes falls in and companies make significant computer purchases.

Yeah.

Okay.

So it's important that when you look at.

Because computers are definitely an asset.

Because the rule for a fixed asset is it has to last longer than a year.

Computers, we would hope, and I think we've experienced this.

Yep.

10 Years.

10 Years.

At least 10 years.

And so computers, not software.

No, that's the hardware itself.

The software is fully deductible and can be under software expense.

Got you.

Yes.

Furniture.

If again it meets the rule.

Yep.

And if you have property, if you have built something or you've bought something in the real estate Business, your property is set up as a fixed asset.

Okay, those were so good and so very helpful to lay those out in such a linear fashion so we can understand what actually goes into the chart of accounts and what that actually is.

Let me just snag back just so I understand from my brain about the vehicle.

So if the business buys a truck, that truck does not disappear simply because the money left the bank.

The business exchange cash for another asset.

So literally the cash that was an asset became the truck that now is an asset.

So that is very different from paying an ordinary monthly expense.

Is that that correct?

You are correct.

As a bonus to our listeners, Erica, they should look at their tax structure and find out if they are primarily using that vehicle for going to in between clients.

And they can track their mileage.

They may have a much better tax situation to own the vehicle themselves and charge mileage to their company.

That is a deductible, fully deductible expense expense.

And the IRS has a pretty generous mileage.

And therefore they wouldn't set up the vehicle.

The.

The vehicle itself.

They would own it and it wouldn't be part of the business.

So it's, it's a discussion you should have with your accountant and your tax advisor.

And so I. Oftentimes I think people leave money on the table when it comes to taxes.

So you get a good tax advisor and have them help you know how to maximize your accounting and your situation.

Yeah, that is so good.

This is such an important distinction.

The bank account went down, but the business also acquired something of value.

Your business actually retained that value because you just moved from essentially one form of asset to another form of asset.

So if the entire purchase is simply dropped into general expense category without anyone reviewing it, the profit and loss may show huge expense while the balance sheet never shows the asset the business owns.

Do you think that is right on point?

Yes, that's happened.

Yeah.

We don't want you to lose value, people.

We want you retain.

No, no.

We like to make sure the balance sheet stays healthy.

Yes.

Healthy balance sheets, people.

Healthy balance sheets.

So good.

Okay, so let's move on to the second question.

And that is what the business owes.

So these are those liabilities.

So walk us through those liabilities, papa.

What are they and how does that show up in the chart of account?

It will show up under the liabilities.

They're both current and long term liabilities.

Yep.

All right, so I would hope you're paying off your credit card balances monthly or at least you pay them off before the End of the year, so that they fall within one year.

And your credit card is exactly.

That's the account type for you.

Set up a credit card account for each credit card you use for your business that she put business expenses on.

And so that is a current liability.

And when somebody was asking me the other day about how do I record what I owe on my credit card?

Well, foundationally, QuickBooks will use the expense.

So when you go into the Create menu, while it's not entirely clear, the expense category is used for how you spend your credit card.

So, and then you, when you pay it, you write a check to the credit card company and it will go into that account on your chart of accounts for that credit card.

So that's the way an expense raises your credit card balance and a check lowers your credit card balance.

So kind of money and money out thinking.

The next current liability we're talking about is bills, vendor bills.

Okay?

Accounts payable is a liability.

So when you enter a bill, as long as you pay a bill, then that accounts payable is going to reflect the correct balance.

I cannot tell you the number of clients I've worked with who set up a bill, but they wrote a check.

Really, this can save you lots of money.

Our listeners just know if you set up a bill, pay a bill, and that will help you tremendously to keep that vendor file accurate and your accounts payable current.

The next area is sales tax payable.

Lots of states, and QuickBooks will track sales tax payable.

They have sales taxes on various items that people sell, and that's a current liability and needs to be managed and paid through.

So when you make a payment to your state government, quite frankly, that is the account you will use.

The next account is payroll liabilities.

This is an account that's very important because this is usually managed through your payroll.

Whatever payroll vendor you use, if you use QuickBooks Payroll, they will record your liabilities and they will pay them.

So this should be a relatively clean account.

Now, if you don't use QuickBooks Payroll, then you use another payroll, paychecks, ADP or whatever.

You'll need to enter those payroll liabilities.

It's important that you know that there's a difference between the payroll liabilities and payroll expenses.

Oftentimes people get them confused.

And really, the way to differentiate it, really, Erica, the best way is to say, what does the employee, what do you deduct for the employee portion?

And that's the payroll liability.

And so that's a very clear number.

And quite frankly, when it comes to the bank feed, it's one item and lots of times people won't take the whole thing and get payroll expense.

And so we have to go back and help them separate out what is the expense portion and what is the liability.

The next area is a line of credit.

You generally consider depending on how you use your line of credit, that could be either a short term or a long term liability based on how your line of credit is managed.

A lot of banks that I work with, they will require that line of credit be paid off at least once a year.

So that would be definitely a current liability we spent some time on.

When you purchase a vehicle, oftentimes you take out a loan.

The loan is set up is a vehicle loan and that's a long term liability, usually five years or so that most loans go, sometimes seven.

So you want to know that you have a liability, a long term liability.

In vehicle loans.

The only amount that goes into a vehicle loan payment is the principal amount when you pay it back.

So when you make your payment, oftentimes there's principal and interest, but the principal portion goes to the ABC loan for your car or truck.

Then you have an amount that goes to interest that falls on the profit and loss.

Then you have equipment loans.

Lots of times people will take out loans for large equipment and it could be it's for a 50 or 60 or $70,000 piece of equipment that they use to make widgets.

So it's handled that way and that's definitely a long term liability.

And then you have mortgages.

If you have a building and you've mortgaged, you're making a payment and it's definitely for your business.

And lots of times people will have mortgage that encompasses their personal residence as well.

But if it's primarily used for their business, then oftentimes it can be deductible that way.

And then there could be other notes payable.

You could have a note, I've seen this where you lend some money to an employee and they're going to pay it back through payroll and they're going to pay back within a year.

So that is definitely a current liability.

You don't want that to be something that's a long term liability.

Some liabilities are due within one year and some are due longer, of course.

Yes, absolutely.

So good.

I suppose this is where we should talk about one of the most common bookkeeping mistakes and that is treating a payment of debt as though the whole payment were a new business business expense.

Is this a problem, papa that we see pop up quite Often, yes, it.

Is because they think they pay it out.

Okay, so it's a payment.

It should be just an expense.

And especially for my friends who go through their bank feed and just enter and accept whatever QuickBooks says that it should be categorized at.

So.

Yeah, no, it has to be broken down.

Loan payment has to include principal and interest.

Now I have several clients who, when they make their GMAC payment, they don't.

On the statement, they don't break it down, principal and interest.

So in that case, you're going to have to accept just the principal payment and then adjust your interest at the end of the year when they send you a tax form telling you how much interest you paid on each loan you may have.

But generally if on your monthly statement they provide a principal and interest breakdown, you record it there.

I suppose you wouldn't want to guess at this.

We would want to make sure that is pretty accurate as far as what the amounts are.

The IRS gets the reporting of your interest.

Big Brother knows a lot more, I think, about your tax situation than you do.

I'm sure.

I'm sure, I'm sure they're more informed than you are, especially about what you owe.

Right.

So just be careful about knowing what you should document and record.

I suppose a payment leaving the bank does not automatically make the.

The whole payment an expense.

You have to ask what the payment actually represents.

Would you say that is pretty accurate?

Of course, yes.

Because people pay things through their bank all the time.

Yeah.

So you need to clearly identify who the payee is and what it's for.

Yeah, super important.

Okay, so the third question is what belongs to the owner or shareholders?

This is where equity comes in.

And I think equity is one of the most confusing areas for business owners because they know money moved, but they may not know whether it should affect their profit.

Would you say that is pretty accurate, Papa?

Yes.

Lots of times people think if they purchased an asset and an expensive one, let's say a truck, and let's say they spent $80,000 on a truck, they may think in their mind, I've got $80,000 in my bank account and I'd like to buy this truck now.

That means I won't have to pay tax tax on that $80,000.

Not true because you are not.

You are just swapping assets.

Now, will that truck qualify for special tax incentive?

It could.

Very well.

And again, that's where you should enter into your.

With your accountant or your tax advisor.

Some tax planning.

90 Days before the end of your tax year.

So if you are thinking about making significant purchases that would affect your tax situation, go into it understanding exactly what the tax effect is.

That makes a lot of sense.

I think that is some really strong advice.

So if I transfer personal money into the company to help cover payroll, that does not necessarily mean the business suddenly earned more revenue.

And if I transfer money from the business to myself, that doesn't necessarily mean the business inc. A new advertising supply or payroll expense.

Is that, Is that right on the money there, Papa?

Right on the money.

I think you're going to kick me out of a job because you seem to be grasping exactly what's going on.

This is so good.

We were talking about this a little before we started recording, but this is a little bit of a drier subject.

But it is so important to understand the fundamentals.

And I think this is where the chart accounts come in.

Because how often we've talked about this with so many clients, you know, simply their QuickBooks mistakes comes back to the chart of accounts.

This is really why I felt compelled to do this podcast episode, was to help our clients, to help our listeners help you understand the chart of accounts so that you could go back to your QuickBooks and really have a better understanding of what's going on there and how to clean up your QuickBooks more effectively and efficiently.

And that does start with the chart of account accounts.

So good.

Okay, so let's move on to question number four.

How does the business make money?

So the fourth question is how the business makes money.

These are the income accounts.

So how much detail should a business have in its income section?

Papa?

I think they should have their major income sources.

So because I'm an advocate of a budget budget, I think it's useful if you can break down not in the minutia detail of your income.

Yeah, that's why you should have an other income category.

But break down what your main lines of business are so you can compare them year to year.

I was talking with somebody the other day, a client who had a photography business, but she's expanding her business into working with companies and doing other types of work on their marketing and their overall evaluation of their business and products and services and so forth.

And so she would definitely want to track her income by the types.

If there were just two types, then it might be certainly useful that can do that.

But if there are four or five types of income, you can definitely track them individually.

And the other area to try and keep your business financial cleaned up is QuickBooks offers a class categorization which can only be Used for people who have QuickBooks plus and above.

And the class operation allows or categorizing means you break each type of your main business business.

Think about it like a department.

If you had one restaurant versus another and you wanted to see how each restaurant did, you might have a separate class designation for each restaurant and they would share the same types of income streams.

It just means you're able to separate their income and expenses based on each particular restaurant or each particular class path.

So yes, I think from a budget perspective, I highly recommend you break down your income in more detail because it will help you in your whole budgeting process and trending and so forth.

That is so good and such a good reminder.

And it does feel like an incorrectly mapped product or service can repeatedly send transactions to the wrong place.

If you're not putting things in the right place, it can really screw things up.

Up.

Is that, is that, is that true?

Yeah.

And you want your profit loss to paint a picture.

I haven't caught up lately on your painting, Erica.

Oh man.

You're doing mostly outdoor painting.

I am.

But if you paint something that presents a picture.

Yeah.

Then you want to get as correct picture as much as possible and really depends on your end users.

I worked with a client several months ago who wanted wanted some of their income recategorized to rental income and didn't want it in general income because he wanted to see what exactly his rental income was.

So I think it's important that you get the picture of what the end user wants to see.

And also if you're looking for bank financing, for example, and somebody's looking at your profit and loss, they could see where there might be a drop of income here.

But there is some corresponding increases in income in some of your other lines of service or business.

I think that last part is important because someone could create an invoice, correctly select the service they provided, send it to the customer, receive the money, and still have the revenue appearing in the wrong section of their reports because the product or service was connected simply to the wrong account.

Does that about sum up all of that there?

Absolutely.

You need attention because there is a differentiation between mean you can enter in a product and service.

Okay.

And you can think that you've decided that goes to an account it is directed by.

When you set up that product and service, it asks you what account it will be reported into the chart of accounts.

So very important and regardless of what you see that you think it should go where something, maybe you chose it an expense account for that product and service.

Or maybe it went to the wrong account because that's what you told QuickBooks to do and that happens.

And regardless of how many times you delete it and put it back in, that product and service is going to go to that account every time.

So pay attention, people.

I'm not sure our clients or the people listening to our podcast understand the importance of products and services because it's very different the way the desktop manages products.

They don't call it products and services, but the online community is definitely all about products and services.

That's a great call out to our listeners to really tune into the product and maybe that's a good call out for us in the future to be doing a future episode strictly on products and services.

So stay tuned for sure.

Good.

That will be coming.

I feel like also something to tune into and I think this is important for our listeners to just grasp right?

When the same mistake keeps happening, do not only fix the last transactions, look for the setting or workflow that is creating the mistake.

There's always a root, right?

I even feel this in my own life with things around the house or projects that I'm working on.

If the same mistake keeps showing up time and time and time again, I think it's also important to take a step back and say why does this keep happening?

What is happening here?

And really address it from the root.

Because if you do, it will save you a ton of time in the future.

Yes, you might have to slow down just a smidge, but it's more of that slow down to speed up mentality.

So if you take the two extra seconds, diagnose what's actually truly happening, you'll be able to move forward and you won't encounter that hopefully ever again.

So I think that's important for our listeners to really grasp.

Okay, very much so.

Yeah, it's important for on many levels, but I think that don't expect Google to help you with it.

All right?

Seek a tax Advisor.

Seek a QuickBooks advisor or somebody who can just save you a bunch of time and get it fixed in a speedy order.

You might have to spend a couple of hours getting your house in order, but once you do, everything will just, just flow so much easier and will save you so much time and so much money, you'll be able to move forward with confidence.

Because I think that's truly what it's all about.

Okay, so the fifth question is what it costs to deliver the company's products or services and what it costs to operate the business.

This is where we have cost of goods sold and ordinary operating expenses.

So what is the difference?

Papa, break it down for us.

Cost of goods sold are anything that goes in to making your product.

So ask yourself, does this particular item like materials used on customer jobs?

Products purchased for resale?

Direct subcontractor costs that go into sales.

Direct labor is certain in accounting structures.

Labor is a direct sales component.

You bill out, you invoice out for labor the person.

If the you're talking about mowing lawns, okay?

That is a cost of goods sold, freight or other direct production costs that you pass on to the customer or the client.

Those are direct costs that you want to categorize as cost of goods sold.

And it's really important because you want to know how much your direct costs are and operating your business so that you can look at to say, do I need to increase my rates?

What's happening?

And be able to zero in not on just your overall expenses, but those that are related to cost of goods sold.

Love that.

Let's give our listeners a practical example, because I think we all thrive off of examples and analogies and helping us tie these concepts to practical advice.

Okay, so recently we had someone, we had had a business come in and do a fence for us.

So we're going to use this fence with arbitrary numbers to really help you guys really get this hit this home for you.

So suppose our fence contractor, he collected $20,000 from us for this fence project.

And the materials and the direct subcontractor work cost them $12,000.

The business did not really generate $20,000 to cover rent, insurance, offer, office staff, advertising and profit.

It only generated $8,000, a gross profit before those other expenses were collected.

Is that correct, Papa?

That's correct.

And a good example on this $20,000 is.

Yeah, if that contractor, if you pay that contractor when he gives you a bill, then he gets the $20,000.

And if he thinks he can spend all of that $20,000 because he got a big bank account, he's.

He or she are very mistaken because they will have to pay the payroll and they will have to pay for the items that were included that they charged for materials.

That bill may land 30 days later.

So just understand that yes, you may get a $20,000 payment, but part of that's going to be required to pay the cost of goods sold, the wages and the materials and whatever else you purchased that might be directly relating to that $20,000 fence.

So revenue tells you what you sold.

Gross profit begins to tell you what was Left after delivering our fence.

After they installed our fence.

Absolutely.

So good.

Okay, so moving on to the sixth and final question.

So the sixth question is the new one we really want to hit home, what the business owe in taxes.

So a chart of accounts cannot prepare the tax return by itself, but it has a major effect on whether the information needed for taxes is organized correctly.

Papa, is that correct?

That's absolutely correct, yeah.

So the chart of accounts should help identify several different types of tax related activity.

Correct.

So what is that activity?

It should identify.

It's going to identify and help categorize on your tax return because oftentimes the tax entities, even the IRS want to know what your sales tax collected from customers were.

And usually that's a state issue.

So it's of course some reporting that must be done to the state.

And so they're always, the states are always looking for money.

So they're going to look at your.

Especially if you do business in other states, states beside your main, your home state payroll taxes withheld or owed.

While the reporting is done, usually through the 941 process, the tax effect, which is deductible on your profit and loss will show up as a separate line item for payroll tax expense.

That's a very important distinction.

And we'll get a deductible expense.

Feds love that.

So Papa, would you say it's fair to say that a well organized chart of accounts helps answer two tax questions?

First, what tax liabilities have already accumulated?

And second, how much profit may be exposed to income tax?

That would be absolutely correct.

And oftentimes people, that's why they panic.

I can't tell you the number of panic calls I get in November or December or January or February because they simply are asking what do I do now?

Yeah, yeah, absolutely.

This is important for cash planning.

Right.

A business can look profitable and still experience a major crisis if the owner spends money that should have been reserved for sales tax, payroll tax or income tax.

Would you say you see that often, Papa, that aren't really preparing properly for those things.

Yeah.

So I had a client that I took on who's been a longtime client of ours now because he had significant payroll liability because he didn't report to the irs.

Payroll.

Yeah, his payrolls.

And people necessarily are not trained when they start a business.

They expect their wife or significant other or their girlfriend, somebody to do their taxes and make the payroll.

They could just be writing checks out, but not understanding that there's a payroll liability.

And believe me, the IRS is not short on Garnishment around payroll tax taxes.

That is not something that they mess around with.

They will knock on your door and say time's up.

Give me what I'm.

Owe me what I'm.

We're gonna leave your bank account so you have to pay 20, 30, 40.

And fines.

Yeah.

Significant fines or not reporting correctly to the irs.

Yeah.

So important listeners hear us do the correct things in the right order.

So good.

And, and payroll is so cheap.

Cheap frankly, you know that is something that you take off your plate right away.

But you also need to be responsible for making those payroll deposits.

When your payroll company says you owe your net check plus your payroll liabilities and that's going to be deducted from your bank account, pay it, get your money.

You know that you've got to have enough money to cover payroll.

Payroll, yeah.

So good.

The chart of accounts does not place money in a separate bank account for you, but it can help show that the obligation exists.

I think this is the important key, key takeaway for everyone.

Right.

Business owners should consider maintaining separate savings or tax reserve accounts so that the cash is available when the payment comes due and pay it when it is due.

So that is the key takeaway.

Your chart of accounts should help you see tax related liabilities and provide organize financial information for your accountant.

But it should not be treated as a final tax calculation.

Would you say that is right on point?

Yes, I think make sure you understand what you owe.

And lots of times I see this with people who owe estimated taxes.

They will get a calculation from their accountant or their tax preparer and based on their last year's tax return, they're going to owe.

Let's say they're going to owe 30, 40, $50,000.

While they think that's a lot of money, then they've got to make sure they make those quarterly tax payments on time because otherwise a little letter comes from the IRS to say you owed this, you paid it then, now you owe us $2,000 or we owe us $500.

Yeah.

So just understand penalties are very real.

And you listen all the time to these ads that say if you owe $100,000, you can get it repeated reduced Weed can do that.

Call us today.

You know what?

Those really are gimmicky.

And they make more money than you do.

So just know that there's no quick fix.

If you owe government taxes, you pay them.

Keep your nose clean.

Yep.

And you can sleep well at night.

Yeah.

That is huge, papa.

I think those six questions give business owners a much clearer way to Think about the chart of.

I know it does for me.

It should help you understand what the business owes, what the business owns, what the business owes, what belongs to the owner or shareholders, how the business makes money, what it costs to deliver the work and operate the business and what the business may owe in taxes.

And I think that is probably where we need to stop for today because there is still a lot more to cover and I can tell you that we have done it again.

We have created a value page packed episode.

So stay tuned.

There will be part two next week for sure.

But that was so good Papa.

That was just.

I think that is going to help people to truly understand what the chart of accounts is.

Yeah.

I would tell our listeners to get a cup of coffee or something, energy drink.

Yeah.

And, and stay with the whole episode because it will help them.

Yeah, absolutely.

So we are turning this, this into a two part series, people.

And that brings us to the end of part one.

Today we covered the six questions your chart of accounts should help answer.

In part two, we'll walk through the common mistakes and warning signs that can cause your reports to tell the wrong story.

Before the next episode, take a few minutes to run your balance sheet and profit and loss and write down anything that does not make sense.

You can also download Download our free QuickBooks clarity scorecard using the link in the show notes or on our [email protected] it will help you identify where your QuickBooks file may need a closer look.

Make sure you subscribe so you do not miss part two and share this episode with another business owner who could use a little more clarity in their numbers.

Thank you so much Papa.

That was so good.

Again, another fire packed episode and I cannot believe that we just created another one that needed a two parter.

So thank you so much for listening you guys.

We'll see you next week.

Bye for now.

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