3. Categorization and Reconciliations

Bookkeeping

Jun 1

Welcome back to The Accounting Edit.
I'm Aminder Mann from Sequoia CPA.
And I am Leah McCool from Orca Accounting.
Today, thank you for joining us here again today.
And as mentioned last time, the next couple of episodes, including this episode, are going to be about little mini topics that we discussed when breaking down financial services.
So this episode in particular is going to be breaking down transaction categorization.
And then we're also going to touch on account reconciliations because those two topics tie together really nicely.
So we are excited to just cover a little bit deeper about what these topics include, because last time we just wanted to do a high level overview.
This is a little bit more of a deep dive.
Yeah.
And I think, Leah, what will really help is to use a practical example.
So let's say we use a photography business.
They earn 250K in annual revenue and they are a sole proprietor.
So let's use this example and we'll use it consistently across all of the mini series.
So you can kind of follow the flow of what this would look like.
Yes.
Yes, exactly.
Should we give her, should we give this photographer a name?
Yes, we should.
You're like, yeah, okay.
Okay, let's name her Michelle.
Does that work?
Yes, that works.
Okay, so Michelle is our photography client and she is a business owner.
She's making around $250,000 doing her photography business.
She hosts a variety of services through her photography business, wedding photography, you know, high school portraits, just professional business photography.
So we're hoping that this would be a good practical example that you can tie back both transaction related topics to and then also be able to relate to it with regards to account reconciliations.
So to start off just with the transaction bit of what we're talking about today.
So when you have your bank statement for a month, the goal of that bank statement being imported into your books is to completely reconcile that bank statement with what your books are saying.
And the transaction bit is just literally pulling the cash inflows and outflows from those bank accounts into your books and making sure that the category assigned to that transaction is going to the right place, is going to the right account code.
So in, then we believe we touched on chart of accounts a little bit, but essentially these transactions will be either assets, liability, portion of equity, revenue account, an expense account.
Yeah, on the chart of accounts, using Michelle as our example here, you could definitely see setting up her accounts, even her revenue accounts specific to the type of work she's completing.
For instance, if she has revenue from selling digital products, if she has her digital photography, you could categorize it that way, and then also have any expenses that are related to her business.
Maybe she's using any software and subscriptions that she needs to categorize any marketing, if she's running ads, and then a whole host of other type of OPEX expenses that might apply to this specific business.
But the key here is really consistency.
So, if we were to put her revenue to a specific category, over time, you want to ensure that you're using the same category.
So, you're not moving certain transactions from one chart of account to another.
That way, you're following the flow of the transactions, and you can look at the data over time, and you can compare.
Otherwise, you really wouldn't be able to look at how did her revenue change in her digital books versus her printed books over time, for instance, right?
Absolutely.
That was something I just wanted to touch on, because I think what you said about having it comparable over months, because if one month, for example, if you categorize revenue in a certain category, then you should categorize it to the same exact revenue account if it's the same type of service revenue, because otherwise, if it has variation, and you do it to another account month over month, then you're going to look back at your months and have no idea what's what.
And so that's a huge, I completely agree with that.
Yes, and in this case, I think also to keep business and personal transactions, I know we briefly touched on it before, but she wants to keep really her credit card and her bank account just for business transactions.
That way it's easy to categorize all these and they align with the chart of accounts.
Personal should be done only on her personal credit card.
That way it keeps the books clean.
Yes, absolutely.
With the personal transactions, being able to have any notes that you have on what those personal transactions may be, whether you keep a running list of your own personal expenses that you accidentally threw on your credit card, it's just easy to have some sort of reference when you're going back to categorize it or if you're having someone else do it, just so that there's some reference of what is business or personal.
And just one more thing I was going to touch on was just in terms of coding something to revenue expense, assets, liabilities, equity.
Those are all the main accounts that we do want to cover.
And a lot of default chart of accounts that you'll see also has a miscellaneous expense or ask my accountant category where it can be tempting to just throw anything you don't really know what to do with into those accounts.
And as a business owner, definitely if you need to ask your accountant or if you're putting it on hold, just in order to reconcile your account, or you have questions about what to do with it, that is a good place to put it for a temporary purpose.
But I don't know about you, but I try and move accounts out of there monthly.
I try not to have any leftover sitting because they can add up and, oh my gosh, it can be a pain.
Oh yeah.
And I think this also plays into, you can miss these expenses as deductions.
So if they're just put into a miscellaneous account, your tax accountant at the end of the year may not incorporate them in terms of your tax return.
So you really want to make sure that you're categorizing them in the right category and tracking them over time so that if it's an expense you're no longer using, you can remove it.
If it's something you're using reoccurringly, you want to ensure that it's in the right category.
So really, really important to review those expenses.
Don't just put them like Leah used to head into the miscellaneous expense or ask my accountant.
And before we move into account reconciliations, and maybe this will be a good segue into this topic, because the entire point of coding the transactions to the correct category is to then be able to reconcile that account at the end of the month on the statement date.
And so if you have all your transactions categorized, then the reconciliation bit of that bank account should be extremely easy.
In Xero, you'd see that the bank balances are matching.
There is a reconciliation aspect of it, but it really is the majority of the process is making sure that the transactions are assigned to their correct code.
Yes, and it's the same way in QuickBooks as well.
The key is that you categorize all these transactions before you reconcile.
So that's a great point there, Leah.
Yeah, absolutely.
And one thing that just to make sure that you're doing when reconciling account is, we said this prior, but if you're, whether it's a bank account, a credit card account, a loan statement, really the entire point is to, and what reconciliation means is just making sure that every transaction, every piece of financial information is included in your book so that then it does match the statement on the statement date.
And really a great way to make sure that you're, there's nothing additional or nothing missing is to then see if those balances match or not.
And anything that's throwing off the balance, that is where you will see, okay, here's a potential for missing transactions.
Duplicates are really common if you don't have the bankfeeds integrated.
And so I guess if you miss those transactions in the first round, you'll notice it in the account reconciliation.
And that's your opportunity at that point to correct your books.
So then add those entries in.
You could add the transactions manually, or you can book adjusting journal entries.
And we'll get into adjusting journal entries later on in our mini series.
But this is the point in time that you ensure that your books tie to the source documents.
With bank accounts, people typically do it monthly because there's a statement there.
It's easy to be able to see every month you get a statement that says, what your bank balance should be.
And so that's where monthly reconciliations are always what we recommend.
Because say you, like, for example, Michelle, our photographer, say she purchased something and she spent money in one month, and then there was a fraudulent transaction charged on her card the same month.
If she didn't reconcile her bank accounts until two months later or three months later, then unless she's looking at her bank account balance every single day and making sure that she knows which each transaction is coded to, the fraudulent transaction can get lost in the mix of everything else that's happening.
And so that's a huge reason why people like Michelle, it can just kind of get away from you pretty fast.
And so monthly is always what we recommend.
Yep.
And I think it's also a good time to review other types of reconciliations as well.
I know we have bank account and credit card wrecks are the main ones that happen on a regular occurrence, but you also want to be looking at, say other fixed assets.
So in this case, if Michelle has a camera that she uses, she can put this on her balance sheet as a fixed asset and depreciate it over time.
But she needs to be able to track this specific account as well to make sure she's recording her depreciation that our fixed asset account looks correct.
So I think it's important to not just look at the bank wrecks and credit cards.
There's also say accounts payable.
You can catch duplicate payments through accounts payable.
If you sent a vendor more than or under what they were expecting.
And then also on the equity side as well.
If you're doing any withdrawals or distributions, you want to track those over the period of time.
And you want to keep a good reconciliation so you can have this at year end.
So really you want to look at your balance sheet as a whole and look at all the accounts and the ending balances and see, do these all tie with what I expected?
And if they do, is all the activity within them aligned with the accounts?
A huge thing that I see sometimes with people like Michelle who are maybe doing their own books or maybe they've just started outsourcing, doing the monthly bookkeeping to someone else.
A lot of times, people do not reconcile the balance sheet accounts that are not bank account balances every single month.
It's, and with some companies, I know that at least at the startup that I was at, we did balance sheet reconciliations for some of them.
Some are more of a higher priority than others, depending on the company, at least in my experience.
And so sometimes we would do quarterly reconciliations of some balance sheet accounts, but then others, the ones that had more activity, the ones that had slightly higher balances month to month, that would be a huge area where we would do it every single month.
And really, for a company that is small and less than $10 million or so, regardless of what definition we use from the government.
But it is so important when you're a small business because that is something that can get away from you so fast and it's always a huge idea when you're reviewing your balance sheet.
If those reconciliations are already done, then reviewing your balance sheet should be just so straightforward, so traceable.
Everything should be lining up with the statement balances or just anything with regards to owner's draws or anything like that.
Just having that information in place before running through your balance sheet at the end of the month is it just gives you that fuller financial picture and just extra reassurance right off the bat.
Yeah, and the goal is really to have an accurate set of books, so you can feel confident in making decisions off of the data that you have.
So it's essential if you're following these steps, you're booking your transactions, you're doing your account reconciliations, you can then use that information to drive good business decisions.
So that's the ultimate goal in all this.
And one tool, just to call out one helpful tool with both QuickBooks and Xero, when you're going encoding transactions, it is a huge help if you have rules set up within both software's, because the rules are just there to be a helpful tool to expedite the process.
What that does is if it has a certain vendor, if it has a certain merchant, when you spend money on a card, it recognizes that merchant as, okay, if you typically code it to a certain transaction, then your software remembers that, and it makes the whole transaction coding process really easy.
So yeah, that's something that in Xero, I love using for clients like Michelle.
Well, yeah, and then even for QuickBooks, one call out though on this, if you're going to use the rules, be as specific as possible.
For instance, if Michelle was buying something from Amazon, she may think that using Amazon as the vendor and categorizing it all to home office supplies would be the best rule to apply, but this may not be the best option if she's buying other items off of Amazon, like computer equipment or food supplies.
So if you are doing a rule, make sure it's as specific as possible because Amazon, you can buy a plethora of stuff on there, right?
So just something to be aware of, a little careful of, but the rules are great and it's important to lean in to the automation there to make life a little bit easier.
Absolutely.
Yes, I completely agree.
Perfect.
So thank you, everyone, for listening to this episode.
We just enjoyed diving into these topics a little bit more.
And our next episode is going to be just a further breakdown of topics that we discussed in our last episode.
And we are going to be covering a little bit more detail on what accounts payable and accounts receivable look like on really the detailed level.
Yeah, so stay tuned.
Thank you again for listening, and we will see you all later.
You've been listening to The Accounting Edit, a podcast by Aminder Mann of Sequoia CPA and Leah McCool of Orca Accounting.
We'll be posting new episodes every other week, so be sure to follow so you don't miss out.
Does your business need help on the accounting side of things?
We would love to help you.
You can find Aminder at sequoia.cpa.com or on Instagram at Sequoia CPA.
You can find me, Leah, at orcaaccounting.com or on Instagram at Orca Accounting.
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Welcome to Episode 3 of The Accounting Edit podcast!

In this episode of the Accounting Edit, Aminder and Leah dive into the intricacies of transaction categorization and account reconciliation, using a photography business as a practical example. They discuss the importance of accurately categorizing transactions to ensure effective financial management and the necessity of regular reconciliations to maintain clean and accurate books. The conversation also highlights the use of accounting software tools to streamline these processes and improve efficiency.

What You’ll Take Away:

- Transaction categorization is crucial for accurate financial reporting.

- Consistency in categorizing transactions is key for comparability.

- Separating business and personal transactions simplifies bookkeeping.

- Avoid using miscellaneous accounts to prevent lost deductions.

- Monthly reconciliations help catch errors early.

- Reviewing balance sheet accounts is essential for small businesses.

- Utilizing software tools can enhance efficiency in bookkeeping.

- Setting up rules in accounting software can save time.

- Accurate books are vital for informed business decisions.

Contact

Website: TheAccountingEdit.com