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Bookkeeping Basics: How to Make Yours More Productive and Sustainable
The Problem
Do these questions sound familiar?
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How can I set up (or improve) my bookkeeping system so that I can not only get the information I need but also make it a productive and sustainable process for the long term?
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Where did the money go? What do my expenses look like?
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Where could I save money by cutting back on expenses? I wish I knew what my largest expenses were.
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How much am I wasting on things like bank fees, credit card late fees, finance charges, etc.?
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How do my income and expenses for this year compare to last year?
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How could I make preparing my taxes easier, for me or my tax preparer? How can I gather that information with less work?
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Which of my business clients still owes me money?
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From which clients do I earn the most? The least?
The answer: Put a practical and effective bookkeeping system into place.
Bookkeeping is relatively simple, but not necessarily easy.
For the purposes of this discussion, I will use terminology from Quicken, which is a popular bookkeeping program from Intuit. Most other bookkeeping programs have similar features.
Whether you use software on a Windows or Macintosh computer, in the cloud using a service on a website, or on paper using a pencil, doing your bookkeeping well will require time, planning, and discipline.
Motivations and benefits
In my experience over about 30 years with both my own bookkeeping and helping a number of clients with theirs, I have seen two distinct high-level benefits:
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Curiosity: The ability to get relevant and useful information about your income, expenses, and more.
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Taxes: Making it easier to gather the information needed to prepare your federal and state returns.
Overview and terminology
At its core, bookkeeping involves:
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Capturing information about all of the money you receive: Income or Inflows
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Capturing information about all of the money you spend: Expenses or Outflows
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Assigning the appropriate concept to each transaction: Categorization
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Confirming that you’ve entered everything properly: Reconciliation
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Using that accumulated information to review your finances, learn things that you couldn’t know before, and make better financial decisions: Searching transactions and generating reports
By “information,” I mean the transaction details, including the dollar amounts down to the penny. The information you get out of your bookkeeping is only as good as the data you enter into it.
Bookkeeping can also include:
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Capturing information about the money that you expect to receive: Receivables
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Capturing information about the money that you expect to spend: Payables
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Tracking your investments (stocks, bonds, mutual funds, etc.), assets (property), and liabilities (loans and debts)
How to make your bookkeeping more productive and sustainable
The collection of categories that you choose will have the biggest effect on how useful your bookkeeping will be.
If you’re starting a new bookkeeping system, take out a pad of paper (or start an empty document or note) and write up an initial list of categories by working through the following ideas. If you want to improve your current bookkeeping, use these ideas to review your existing categories.
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A category describes the reason for (or type of) income you receive or an expense you spend.
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Quicken has 3 types of categories: Income, Expenses, and Transfers (for money that you moved directly from one account to another, which is neither income nor an expense).
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Personal income categories could include Salary, Bonus, Gifts Received, etc.
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Business income categories could include Consulting, Commissions, Bonus, etc.
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Some income categories will be taxable and others won’t.
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Personal Expense categories could include Taxes, Insurance, Parking, Groceries, Rent, Mortgage, Loans, Medical, Doctors, Prescriptions, Charities, Children, Pets, Gifts Given, etc.
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Business Expense categories could include Meals, Entertainment, Supplies, Parking, Tolls, Dues, Subscriptions, Payroll, Gifts Given, etc.
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Some expense categories will be tax-deductible and others won’t.
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You assign one category to every transaction; if you split a transaction into pieces, you assign a category to each piece.
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Create categories to track each of the concepts that interest you.
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What level of detail will you want see on your reports? For example, “Telephone” could track all phone-related expenses together, whereas having the separate categories “Telephone Service,” “Telephone Accessories,” and “Telephone Equipment” would provide a more detailed breakdown of those same expenses.
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Categories can be hierarchical. For example, you might have Consulting Income with subcategories for Coaching, Projects, and Workshops, and you might have Medical Expenses with subcategories for Health Insurance, Doctors, Prescriptions, Lab Work, etc.
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Here’s the best way to decide whether a concept should be a category: Does it deserve to be a line item on the report that summarizes the entire year in review? If so, then make a new category for that concept. If not, then there should be another existing category that implicitly includes that concept.
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You can find another good collection of category ideas in the “tax organizer” or other information that you give to your accountant each year to do your taxes.
Also, keep the following in mind:
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Be specific; only use “Miscellaneous” for occasional, unusual, or unique things that don’t deserve their own category.
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The names of people and vendors are usually not good choices for categories. Instead, use the purpose or service or product that you received. For example, instead of Comcast or Verizon use Telephone or Internet or Utilities; for Staples or Best Buy use Supplies or Equipment or Software; for United Way or Red Cross use Charity.
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Avoid redundant categories, for example, use only one of these, not both: Charity or Donations, Car or Auto, Pet or Pets, Tax or Taxes.
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Don’t create special categories for refunds, rebates, returns, or reimbursements. Instead, use the same category as the original expense. For example, if you use Supplies for paper that you bought at Staples and you later returned it, use that same category for the credit that you received.
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Will you be tracking the combined finances for you and a business or for you and someone else? If so, you’ll probably need to use additional categories and a category hierarchy to organize them, e.g., “Carol” vs. “Bob” or “Personal” vs. “Business” categories.
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Most bookkeeping programs will list your categories in alphabetical order, so if you want to force a different order you’ll have to name them using prefixes. For example, to force your Cat Food expense subcategories “Dasher,” “Prancer,” “Dancer” into that particular order, you could use numbers as prefixes, e.g.: “1 Dasher,” “2 Prancer,” and “3 Dancer.”
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You will not create a perfect list on the first try, but with careful adjustments over time, your categories will evolve to become more and more useful.
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Do you have a friend or colleague in a similar situation that you could talk to about this? How did they get started? Could they coach or mentor you?
Note that in QuickBooks, the equivalent to a Quicken “category” would be an “income or expense account” (as opposed to an asset or liability account).
Where to go from here
As always, if this seems too difficult to accomplish on your own, I recommend that you find someone you know and trust to help you.
Note that some of these searches will probably yield articles about “budgets” which is a more complicated topic, but will still provide good suggestions if you’re looking for category ideas.
Note also that if you search for “how to get started with bookkeeping” (instead of “bookkeeping beginner” which I recommend) you’ll find many articles on how to start a bookkeeping business, which is probably not what you’re looking for.
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