In part 1, we covered assets. In part 2, liabilities. The two components make up the balance sheet. Now, we move on to the second most important document in the accounting world - the profit and loss report (P&L). This document shows this equation:

Sales – Expenses = Business' net profit/loss for a period of time

This could be a month, whereas the balance sheet shows for a point in time, say on a particular day.

Sales basics are obvious. Joe Gymrat sells memberships, personal training sessions, or supplements, and it counts toward his sales. This is one form of income. Income yields profit, which comprises one side of the profit and loss report.

One very important thing to remember is that the more Joe sells, the more taxes he accrues. Tax laws vary widely from state to state. In some places, supplements demand sales tax; in others, they do not. Make certain that you have consulted with a good tax attorney if you do not have a point of sales (POS) system. If possible, I would highly recommend purchasing one.

A point of sales system is the modern equivalent to a punch and ring cash register. Basically, it takes all of the thought out of tracking sales. It then becomes the manufacturer's responsibility to program what is taxed and what is not. In sum, it covers your ass. So long as you pay your sales taxes, any errors an IRS audit uncovers become a lawsuit to the POS manufacturer. Trust me, with penalties and interest, those audits can become very expensive.

If you want to go the old fashioned route, as stated, research tax laws. If supplements are taxed at seven percent for example (as they are here in Taxachusetts), take the month-end supplement sales figure and multiply it by .07. This will give you the dollar amount estimate you will need to pay. I say "estimate" because generally, government websites have tax calculators based on your sales figures.

One thing I see over and over again is business owners not accruing for their taxes. Think of tax collecting as taking in and holding funds for the government, since that is exactly what it is. It is not income to be spent. The same applies with payroll taxes. Take all of the tax liabilities (payroll, sales, and otherwise) and put them in a separate account. Do this on a weekly basis. Trust me when I say that the government does not screw around with money. They will hound you day and night and charge outrageous fees if you are late. I have recently seen the government outsourcing to collection agencies, who will also call constantly demanding money.

With the tax accrual strategy, you will have a clear picture of what is actually in your operating (business) account to spend. This is the safe, smart way to deal with abominable government thing.

With that being said, the accounting world presents data as debits and credits. To simplify, debits are where money goes, and credits are from where it comes from. See the example below...

If Joe Gymrat sells a protein bar for four dollars, this is a credit. ALL income is presented as credits, as this is where money comes from. To balance that (every transaction must wash, or ultimately net to zero), the customer pays Joe $4 in cash. This is a debit. Joe puts the money into his bank account (debit) and his sales for the day increase (credit).

Sales are income (always credit), and the balance to them, which is just people paying, is called a settlement (always debit).

One important concept to remember is that prepaid memberships and gift certificates should not count as sales. As discussed in part one, these become liabilities.

It works like this:

Customer purchases membership.

Credit: prepaid memberships. As time passes (monthly, say, if that is how you bill), the credit will move to sales income. Many people will inflate their sales numbers by counting the entire prepaid membership toward the date of the transaction, but that is not correct. It becomes real income when services are rendered.

Debit: the bank account (the settlement, or payment).

The reason for this is if the customer cancels, you will have to refund some of that cash. It will then come out of prepaid memberships and will not count toward future sales. If you put it all to sales, you now have a bookkeeping mess on your hands.

When the service becomes due, the credit moves to income, and the debit moves to whatever settlement account you are using to balance. It is best to credit and debit one liability account. If you credited prepaid memberships for the original transaction, debit it when it actually becomes income. Ideally, this account will net to zero—that is, if people pay as they are supposed to.

Say Joe sells a one-year membership for $1200, which breaks down to $100/month. Here is how to properly record the transactions:

And so on. This is called a journal entry, and it is how every single transaction gets recorded in bookkeeping and accounting.

On the P&L, what reduces the bottom line is expenses. These are fluid items that Joe needs to run his business. They are all of the little things. Everything from pencils, paper, small repairs, equipment upkeep, gas for his car, uniforms, supplements, the chair at the front desk, computer software, accounting fees—you name it. Unless it is a major purchase (generally $500 or more), it is an expense.

How one tracks expenses is arbitrary, but they all require transaction journal entries in your “books.” Some companies break categories down into unbelievable detail. For example, Joe might just stick pencils, paper, toner, paper clips, etc., into Office Expenses, while other companies will track how much they spend on each individual item—Expenses – Paper Clips, Expenses – Toner, and so on. The latter shows a much clearer picture on exactly how much is being spent on certain items, but it is also much more time-consuming. For a very busy athletic facility owner, it is best to be somewhere in the middle. However, it is completely up to you.

Expenses are not be confused with Cost Of Goods Sold (COGS), although both take away from net income. COGS are those items you purchase specifically to make money. Supplements for resale is a great example. This differs from purchasing a pair of work shoes, which is an expense.

One other distinction to make for expenses:

Fixed Expenses: a great example is rent. This is an expense that will be uniform no matter how much or little business you do. Another example is interest on a loan.

Variable Expenses: most other expenses. If your stock of Muscle Milk is not selling due to decreased membership in the winter time, you certainly would not stock up. This would lead to waste.

In sum, the P&L will show sales/revenue – COGS/expenses, which = net profit/loss for a period of time. One shortcoming the P & L has is that it does not take liabilities and assets into account. For example, when Joe puts money toward his monthly equipment loans, some goes to principal, some to interest, and most likely the rest to escrow, which is basically a savings account the bank uses to pay taxes and insurance. The interest and escrow portions are fixed expenses, whereas the principal portion subtracts from the loan's liability on the balance sheet. Unfortunately, this is money taken out of the business, so it may be confusing if the net profit on the P & L is large but there is not that much money in the bank.

On a personal note, for tracking all of this, I highly recommend Intuit Quickbooks (QB) and Intuit Payroll for all small businesses. I have used many accounting platforms, and this is by far the easiest with which to deal. If you can learn accounting basics—about as much as I have presented in these articles—there will be no need to hire a bookkeeper or a payroll company, which can save many thousands per month. There is a one-time expense for a QB license, and then a small monthly expense for payroll. When your business is small, it makes more fiscal sense. In only a couple of hours per week, you can take care of all of this yourself rather than dealing with someone who could potentially embezzle from you. I juggle twenty to thirty accounts—some of them multi-million dollar businesses—and must perform accurate bookkeeping on a weekly basis, so it can be done. It just takes a little practice.

One other benefit is that once the year end tax time comes, you will have a neat package ready for your accountant. I have witnessed accountants charging gratuitous fees (sometimes in the tens of thousands) to sort out bank statements, sales, and the infamous “box of receipts.” Often CPAs will charge retainer fees, which is them monitoring your books throughout the year. It is not worth it. Persistent bookkeeping will take care of all of these problems and keep money in your business and your pocket.