Basic Accounting

A Simple Introduction to Profits

One simple definition of Basic Accounting for your home business is: “knowing where your money is and what it’s doing for you.”

One definition of business that I’ve seen is: “A commercial activity engaged in as a means of livelihood or profit, or an entity which engages in such activities.”

Note that the definition uses words like, “livelihood” and “profit.” That means that you go into business to make money. This may seem obvious to you, but many people never really understand this basic accounting concept and end up failing. That is why you need to have an understanding of basic accounting ideas.

  • Any kind of business must have money coming in (revenue) and money going out (costs and expenses). What’s left is Profit.
  • Gross Profit is what’s left over from revenue after costs of sales are paid. This includes cost of goods, production costs and sales costs.
  • Net Profit is what’s left after overhead expenses like rent and office expenses are paid.
  • Where many beginning small business owners go wrong is that they forget to figure in their own salary and a return on their investment. As a result, they end up working for nothing.

If that is a bit complicated for you, let’s look at a simple real-world example of this Basic Accounting stuff.

  • Suppose you open a small hot dog stand on a street corner in the middle of town.
  • To do this, you take $100 out of your savings account (or you charged it on your credit card). You bought a little grill, charcoal, some hot dogs, buns, mustard, relish, ketchup, paper napkins and a little table.

Here’s what it looks like:

Grill $35.00
Charcoal 5.00
Hot Dogs 22.00
Buns 10.00
Mustard 2.00
Relish 2.00
Table 20.00

Now you have $100 invested in your business. On your first day, you sell your entire inventory (food and supplies) for $100. Did you have a good day or a bad day?

Well, let’s look at the basic accounting numbers. Your grill and table (plant and equipment) cost $55.00; you still have them to use again. Your inventory cost $45.00. That means you made a Gross Profit of $55.00 (Sales minus cost of goods or inventory). But, since you spent time shopping, cooking and selling, you need to pay for your labor. How much are you worth? Let’s say you worked five hours altogether. Does that mean that you can pay yourself $11.00 per hour? No.

You invested $100.00, including the $45 for inventory and $55.00 in plant and equipment (grill and table). You probably borrowed that from interest-earning savings or an interest-costing credit card. That means that the $100 is costing you money for its use; maybe $1.00 a day for interest expense.

Now there’s more to look at. The grill and table will eventually wear out and you’ll need to replace them. Let’s say those two items will have to be replaced in 55 days. That means that they are “overhead,” which is now costing you $1.00 per day.

Let’s also say we want to pay back our original investment of $100 – let’s say $1.00 a day. That also is part of basic accounting.

So, now we see that we made a profit of $52.00.

Sales $100
Inventory Cost - 45
Cost of Money - 1
Equipment Overhead - 1
Repayment of loan - 1
Left-over (profit) $ 52

So now you have a profit of $52.00 for the day. That's all there is, right? Well, not really. Here's why: 

If you’re happy with doing business this way, this is pretty simple. But, soon you may decide that you want more money and you want your business to grow. You can use your basic accounting knowledge to decide to raise prices, invest in a bigger and/or nicer grill, maybe paying for a street peddler’s license, paying for some advertising, or renting a small storefront to get out of the rain and snow.

That should leave your head spinning a bit. But, it’s not hard. Look it over if you need to. Some people never look at these things until it is too late – then they fail. You now know more about basic accounting for small business than about half of the people out there. That means you have a better chance at success than most people out there.

If I didn’t totally chase you away from wanting to be in business, think about these last few thoughts.

  • Small businesses create over two out of every three new jobs in the United States. I'd guess that it's like that all over the world – however most governments won't admit to that. Many of those small businesses are considered "black market" or "underground economy" in some countries.
  • Small businesses create more than half of the new technology in the U.S. (Microsoft was once a small business.)
  • They create thousands of new millionaires every year, all over the world, many of them without a college education.
  • By starting your own small business, you can make it as big or as small as you want. You are the boss.

Cash Businesses (NOTE): This information is only for your education and entertainment. We do not advocate that you break any laws, especially tax laws. Please consult a tax expert for tax advice.)

There are many cash businesses that people like to get into, because they deal mainly in cash, that is, the transactions do not create a paper trail (checks, deposit slips, credit cards). Because there is no paper trail, the government has trouble finding out how to collect taxes from you. Some people refer to them as black market or underground economy businesses.

The article, 10 best home based businesses, points out some of these cash businesses. For those of you who want to learn more about them, read Underground Economy.

The business accounting lesson above is very basic, but it relates to all kind of businesses. Look it over and try to see how it relates to your niche from the other articles.

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