Are you wanting to learn more accounting terms to help you effectively run the accounting of your business? Marvin Morse will help you learn many general accounting terms and the different types of mistakes most entrepreneurs make with them.Sign Up to Watch
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-What's up, guys? My name is Daniel Mckenna. I'm the executive producer here at Thrive15, the online platform that trains entrepreneuers on marketing, sales and time management, and today, we have Clay Clark sitting down with Marvin Morse and we're talking about accounting and the 18 things that every entrepreneur must learn about accounting terms. Now, Marvin Morse, he's basically a wizard in the accounting world. He's been a professional CPA since 1971. And I'm no accountant or anything like that but that's at least 20 years that's he's been on the job doing the job CPA-style. He knows what he's talking about.
So you're the entrepreneur, right? You probably know a little bit about making the money but you have to also know about keeping the money and where that money is going and where that money is coming from. And to even be able to do that or have these sort of conversations with your accountant, you need to be knowing these 18 basic terms that Marvin Morse is going to lay out for you.
Here at Thrive15, we believe knowledge without application is meaningless, which means if you don't watch today's lesson and actually learn something and then actually apply it to your life or your business, watching today's lesson is going to be more meaningless than the Braille at drive-up ATMs. If you need the Braille, you probably should not be driving.
-Marvin, thank you for being on the show, my friend.
-Thank you, Clem. Pleasure to be here.
-Well, hey, before we get into the 18 accounting terms that every entrepreneur must learn, I really want to ask you here-- how long have you been an accountant, my friend?
-Well, let's just say it's been over 40 years.
-OK, so you've probably seen in your career some extreme examples of what to do and what not to do.
-I've seen a lot, yes.
-OK, OK. And before we kind of delve into the magical world of accounting, I really want to get to-- I want to ask you this here. Do you believe that most entrepreneurs who are operating without a bookkeeper are doing things the wrong way? I mean, do you believe that most entrepreneurs who do not have a professional bookkeeper are probably doing things the wrong way?
-More than likely, yes.
-OK. Well, I'm going to get into these terms and when I-- I'm going to kind of read the definition and I'd like for you to kind of add a little bit of a texture and explain to us what you think they-- what it means from your perspective. And then, give us some examples of really what some of the things we shouldn't be doing or some of the common mistakes entrepreneurs make. So I'll kind of lead you through it. So here we go.
MARVIN MORSE: OK.
-Term number one is the "balance sheet," the financial statement that gives business owners a quick look of the company's financial situation at a particular date and time. This statement features the assets, liabilities, and equity. Marvin, from your perspective, what is a balance sheet really?
-Well, a balance sheet is-- like you had mentioned, it's a snapshot look of the assets and liabilities of an organization at a specific point in time. It lists the assets and liabilities but if you delve a little deeper than that, it reveals things about the liquidity of the organization, their ability to pay their bills when they come due, the debt to equity ratios that are so important in maintaining your solvency, and that type of thing.
-What are some of the most common mistakes that business owners make when it comes to their balance sheet? I mean, you see it all the time, I'm sure, but what are some of the most common mistakes that entrepreneurs make?
-We see a lot of them not recording liabilities that exist.
CLAY CLARK: Really?
-So their balance sheet may look better than the facts would really indicate.
-So they maybe owe a bunch of money to other people and maybe don't put that on there?
-Or what ways do they have kind of a blue sky perspective to their liabilities? Like, what kind of things do they not put on there conveniently?
-Trade accounts payable.
CLAY: OK, all right.
-OK. And as a business owner, you just have to have an accurate balance sheet to know where you're headed, right?
-Now, the second term I want to get into is "assets." I think a lot of people get this confused but assets is all the stuff that a company owns to run its business. This includes the buildings, the land, the vehicles, the furniture, the intellectual property, the cash-- but Marvin, in your mind, what is an asset?
-That is any item that has future value to the organization.
-So as far as the assets and keeping track of the value of the assets, what are some common mistakes that entrepreneurs make when dealing with the value of their business assets?
-Well, many owners attribute more value to some of their assets than is really realistic, such as used furniture, used data processing equipment.
-And that sort of thing.
-I think I put an artificially high value on my former porcelain penguin I used to have as a doorstop in my-- in my old home office there. So I don't know if that had the value that I--
-that'd be a great example.
-OK. Now, term number three, "liabilities--" now, this includes all of the debt that the company owes, such as unpaid bills, loans, bonds, et cetera. Marvin, in your mind, what is a liability?
-Well, a liability is any obligation, of course, for which the organization is responsible, whether or not that liability would be recorded on the balance sheet or not.
-One-- one of my first businesses I started was called DJ Connection. And what we would do is we would do entertainment for weddings and corporate events. And we would charge the customer a deposit to reserve our services and then we would go out and do the event six to 10 months later, you know, typically. So a bride would get engaged. She'd book the DJ. We don't have to DJ for her until this summer so we'd have her deposit. And so when I met with an accountant, he pointed out that I had all these liabilities because in theory, I still owed these people service that I hadn't rendered yet.
-That's a very good example.
-And I had that all messed up. So talk to me about liabilities and maybe some of the most common mistakes that entrepreneurs you see make a lot of times as it relates to these other liabilities.
-Well, I think, again, the failure to record them or in your example you just mentioned, you might perhaps receive that money, record it as income, when in fact, it really isn't income now. It's a liability until you provide that service.
-And so in that case, you would be overstating your income and understating your liabilities. Leases are very real liabilities but don't typically get recorded on the balance sheet.
-Oh, a lease! So you owe money on the rest of your lease, your monthly payment.
-So let's just say my lease was $2,000 a month and it was for five years. I might have a $120,000 liability there.
MARVIN: That's correct.
-OK. So do you-- do you feel like that-- I just want to make sure. If you're watching this and you're thinking, why do I need to know this stuff? Well, if you go and try to get a bank loan or you try to expand your business to get the capital you need, banks want to know this stuff.
-That's right, Clay. And if they don't feel comfortable that your financials accurately reflect your-- all your liabilities, they'll likely just take the easy way out and decline your loan.
-Yeah, and this is-- this is, I think if you're watching this and you feel like, oh, man, I've been in business for five years and I've never done this stuff, I don't think you should beat yourself up. But you really do need a bookkeeper, right? Someone to help you with this.
-That's correct, someone that understands basic bookkeeping and accounting that can at least get the essentials--
-recorded properly in your financial
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-And our goal here today is that as you're watching this, maybe you can get familiar with these terms to the point that you can have a coherent conversation with your actual bookkeeper, or your tax service provider, or your accountant, there.
Let's talk about, now, term number four, equity. This is the total amount of money that has been invested in the company by its owners. If a small business is owned by one person or the group of humans, then this total should be shown in a capital account. Talk to me about why it's important to keep track of the equity of a business.
-Well, the equity is a reflection of the, essentially, the accumulated funds that have been put in the business by the owner, and the earnings of the entity since its inception. And it's important. It's used a lot by, again, the banking and the bonding industries to gauge a company's ability to take on debt. Maybe you've heard the term, debt to worth ratios. So it's used quite a bit, but yet it's never given much attention to by anyone. But it is an important number that appears in your balance sheet.
-And if you have aspirations to grow a business from small to big, you really need to know this. You need to understand your liabilities, your equity, your assets, because, again, if not, you can't get bank loans. You can't grow your business. It's really important for you to understand this. Do you find that almost every business owner, when you first sit down and look at their numbers, that their equity's wrong, and their liabilities are wrong, and their assets are wrong? I mean, is it usually just--
-Typically if they've had no assistance to that point. Right.
-So don't beat yourself up if that's you. It's OK. Now we're moving on to the income statement, term number five. This is the financial statement that provides an overall summary of a company's activity, financially speaking, over a given period of time. In your mind, what's an income statement?
-Well, an income statement is a reflection of a given time period of the funds that were earned by a company, not necessarily collected, but if you're using accrual basis accounting, which is the preferred method for management purposes-- you're oftentimes allowed to use cash for tax purposes-- however, accrual basis is the method of accounting that's preferred and is more reflective of the true results of operations, so that your income is the amount you've earned during the period, not what you've collected. And your expenses are those that have been, likewise, incurred during the period.
-If I'm watching this, and I have no idea what the word "accrual" means, can you walk me through what that word means?
-OK. Accrual means you recognize events at the time the event occurs. For example, you do a job, and you send an invoice to your customer. At that point in time, under accrual method, you recognize an account receivable and revenue. Whereas if you are using the cash method, you would do nothing at that point in time. When you collect your money, you would show cash and revenue.
-So if you have, like, a balance sheet, you would record the income the moment that you sent somebody an invoice, whether you actually had the money or not.
-If it was accrual. OK.
-Now we're moving on to term number six, revenue. This refers to all the money that has been brought in through the process of selling goods and services. So in layman's terms, what is revenue?
-Well, revenue are the, essentially, the sources of, ultimately, cash that a business realizes from providing the goods and or services that it operates within.
-So in most, when you look at most business owners, and you look at their accounting situation, what are some of the most common mistakes that business owners make, as it relates to calculating their revenues?
-Again, probably the maybe the failure to record it at the time they earn it. Or also, to reduce it at the time, maybe they realize it's not going to be collectible if someone doesn't pay you. I think one common pitfall I see is too much of an emphasis on revenue. Entrepreneurs tend to be very intense on revenue, and if revenue is well or is increasing, they think everything is fine. But the problem is, if you're not making a profit on that revenue, that can be very deceiving.
-So entrepreneurs tend to naturally focus more on the top line, the total revenue, and not necessarily on the bottom line they have left.
-That seems to be the case.
-What causes this psychosis that we all do? Why do entrepreneurs, why do we do this? What makes us do this in your mind?
-Well, I believe it's a combination of just intensity of the business and the enjoyment of doing more business. It's much more fun to make a sale than it is to decline a sale because you couldn't make a profit on the sale. And so entrepreneurs tend to have an inclination to do the sale, close the deal, do whatever it takes to get the job.
-Now, you're kind of interesting because you're self-employed, right?
-And you've been self-employed for a long time. So you're an entrepreneur. But you have kind of a analytical view of things.
I think it's important that every entrepreneur who's watching this, you understand how important it is to have a guy like Marvin, a CPA, a certified- you know, basically someone who understands taxes and really get-- are you a CPA?
-I am a CPA, certified public accountant.
-When you're a CPA-- not always-- but as a general rule, the CPAs I've worked with are a little more analytical than the entrepreneur, who's kind of hell bent on growth and driving and revenue. And I think it's so important to have a mentor in your corner that can help kind of bring that analytical perspective. Do you find a lot of times with entrepreneurs that you're the only person in the room in some of these businesses that has an analytical bent?
-That is right.
-OK. And that's kind of your job?
-That's why they pay me the big bucks, to help them figure that out.
-Well, I just mentioned this because if you hire an accountant-- I remember when I hired my first accountant, a guy by the name of Frank Biskup. A great guy in Tulsa here. He was a great accountant for me.
And when I hired Frank, I was so frustrated that he kept bringing up these details. And he kept thinking so analytically. And he was so focused on the numbers. And why can't he just let me run my business?
-Make the sale.
-Yeah. And Frank had said, you know, it's not so much how much money you make, it's how much you keep.
-That is very good.
-And I'll never forget him mentioning that over and over and over. If you're watching this and you say, well, I would hire an accountant but they're so analytical. I'm just telling you, you need that balance. You really do. It's important.
-We're talking now about point number 7 here, costs of goods sold. So all the money that goes into purchasing or producing the services and products that a company plans to sell to buyers. Can you maybe add some clarity about what that means? The costs of goods sold.
-OK. Costs of goods sold are the direct cost of selling the product, making and/or selling the product or the service. And I'd say lots of businesses fail because of their inability to properly identify their true cost of goods sold.
They tend to leave out things. For example, they leave out Workers' Comp insurance. They leave out liability insurance. Or they leave out the light bill on the shop.
All those things are really integral part of producing the good or service. And so they not only don't call it cost of goods sold in their books, they don't use it when they go to bid their work.
-So for the Thrivers watching this-- we'll put a little graphic on the screen so they can get it-- but what you're saying is, let's just say that I'm a plummer. And I might say, well, my costs of goods sold are just paying my guys.
My guys go out, my guys go in, and I pay for their gas. But you're saying, no, no, no, you're paying the guys to come in, to come out, and you're paying their gas.
But now you're also paying for the vehicles. You're paying for the Workers' Comp. You're paying for the light bill. You're paying for the office space. All that factors in.
-A lot of entrepreneurs don't seem to realize that immediately.
-And, again, if you're somebody who's crazy enough to go out there and start a business. And to believe--
-Well, you have to be crazy to start your own business.
-There you go.
-Of course, I've been in business for 40 years.
-So you've had your crazy. You're done being crazy now. You were crazy back then. Now it's an established business. Now you're not as crazy?
-Not quite as crazy.
-OK. Well, if you're crazy enough to go out there and start your own business, I'm just telling honestly you have to be a little bit optimistic. You have to be a little bit passionate. You have to be.
And so that passion and optimism sometimes can glaze over some of these details. And that's what creates a problem. And that's why we need accountants.
-Now we get into expenses. Term number 8, expenses. This refers to all the money that has been spent to operate a company that is not directly related to the sale of the individual goods or services. So walk me through what the word expenses means in your mind.
-As distinguished from cost of goods sold, which are really expenses. But they are expenses that are directly attributable to providing the service. Selling, general, and administrative expenses are more along the lines of expenses that are going to occur whether you make this particular sale or not.
The phone bill in the office. The office personnel.
-Could you-- just because there's a lot of terminology that I want to make sure Thrivers get very familiar with-- could you say that the cost of goods sold is kind of like your variable costs? And your expenses could be considered like your fixed costs? Like you might not have to pay more for lease this month because you sold more or less units?
-Very, very good.
-Very good analysis.
-So what is the most common mistake that business owners make when they're looking at their expenses? Do they just miss big expenses or what happens?
-I think the biggest mistake that I see is they fail to anticipate all these experiences. And when they do their business plan, determine their startup capital or their budget for the year, that type of thing, they simply don't figure that they've got the phone bill and the cell phone bill and the office insurance and the property tax bill and things of that nature that they don't think of. And then when those items come along and have to be paid, then that disrupts their budget and disrupts their profitability.
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