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business accounting

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Business cycle accounting is an accounting procedure used in macroeconomics to decompose business cycle fluctuations into contributing factors. The procedure was introduced by V. V. Chari, Patrick Kehoe and Ellen McGrattan but is similar to techniques introduced earlier. The underlying premise of the procedure is that the economy has a long run trajectory which is perturbed by various frictions. These are called wedges and the earliest version of the procedure includes a productivity wedge, a labor wedge, an investment wedge and a government consumption wedge. Business cycle accounting decomposes fluctuations in macroeconomic variables, such as GDP or employment, into fluctuations of each of these wedges (and their combinations).

Business cycle accounting has been done for various countries and various periods of time. The procedure suggests for the U.S. after World War II most fluctuation in GDP is due to fluctuations in the productivity and labor wedges.

How Business Accounting Works

People are starting their own businesses every day. If you're thinking about joining them, you probably have a vision of what you want that business to be. What may excite you about your business is the product or service you have to offer, the success that you imagine, and the freedom of lifestyle that you are sure will come -- in time. What may bore or even frighten you is the plethora of numbers you have to wrestle with. You will be asked business questions that may elicit a blank stare as your response. Cash accounting? Accrual basis? Profit and loss statement? Projections? Huh?

Whether you want to create fine oil paintings or sell pork bellies on the street, your business will require some form of accounting. That term alone can cast a glaze over the brightest eyes, but in this article, we'll show you that accounting is a process larger than crunching your numbers. It is a tool that will help you "account for" what your business has done, is doing, and hopes to do in the future. Accounting can be a bit like painting a picture, and a little like solving a puzzle. Despite its bad press, it can actually be fun.

Keys to Success

The first step to making accounting fun is to get a grip on the terminology. If your heart skips a beat when someone asks about your balance sheet, you can calm yourself by learning exactly what a balance sheet is and how it can help you. We've added a glossary of accounting terms at the end of this article to get you over the hump.

Second, realize that accounting is more than numbers. It includes databases of your customers, your vendors, and your employees, if you have them. The information you keep on these people and companies will help you track your business and plan your future. With proper accounting, you might discover that people in the Florida Keys buy barrels of pork bellies in February. You can legitimately plan a sales trip for the entire month. See? This is getting interesting.

Third, the key to successful accounting is in the establishment of your accounting system and the reliable input of data. You will set up a system that is uniquely yours. Recording the transactions and information is called bookkeeping, and it must be done regularly. You won't get a good picture of your company if the paint (data) is stored in boxes in the basement. There is nothing harder than the task of going back to find and key in reams of old information. When you do, you stand a good chance of getting something wrong.

Do You Need a CPA?

CPAs can provide a wide range of services, from setting up and administering your accounting system to consulting and tax preparation.

If for no other reason than tax planning, it is a wise move to consult an accountant. Accountants can help you generate the reports and financial statements you'll need to manage your business, as well as help you keep up with tax laws and reduce tax liabilities.

You need to find an accountant that you can build a friendly and trusting relationship with. Here are some things to look for when hiring accountants or CPAs:

Are they licensed to practice in your state?

Do they have experience with your size and type of business?

Do they have good references? (Remember to ask for referrals from your banker, associates, or peers.)

Will they be accessible and return your calls promptly?

Can they provide insights into other areas, such as human resources or operations?

Are they respected in the community?

Do you trust and feel comfortable with them?

Do they represent themselves in a professional manner?

In addition to helping you set up your accounting system and assisting you with tax planning and preparation, you may also want to consider hiring an accountant or CPA to:

compile financial statements

review the statements you've generated yourself to find any problems or questionable items

perform an annual audit of your books to ensure everything is being maintained accurately

For help locating an accountant or CPA, there are many searchable databases on the Internet, but the best bet is to get referrals from friends, business associates, your legal advisors, bankers, or other trusted sources.

Software or Shoe Box?

An early question you'll want to answer is whether to set up a manual system or purchase a software program. You might think that your small, sideline business doesn't merit a software program that looks, from the splashy box, like it could run the government of the District of Columbia. Think again. Let's say you cater weddings on weekends, one a week. The maximum events you'll do in a year will be 52. That sounds manageable from a shoe box. But you purchase meats here, cheeses there, and the wine is shipped in. You use some for Sally's wedding, the rest for Sue's. Sally's mom needs to pay you in three installments, and you've gotten so busy you can't remember if the last check came in. Did you write it down? Where?

Software can simplify your bookkeeping by avoiding double (or triple) entries of data. You log it in here and the system will put it there, where you'll need it another day. It will tally sums and group numbers for you, saving endless hours on the adding machine. Software will help you set up procedures for handling the endless flow of paper that your business generates. But, you'll need a system that ensures that Sally's payment was recorded, whether you put that system in a shoe box or into your computer.

Accounting vs. Bookkeeping

On to the terminology: We have already said the words "accounting" and "bookkeeping." Accounting is the big picture, the system that keeps track of data (including people), records your transaction history, gives you reports -- those all-important pictures of your company. Accounting also encompasses payroll, an area of particular concern since huge fines can accompany small mistakes. Of equal weight is the tax status of your company. Accounting is the system that will provide the reports and information you need.

Bookkeeping is the tedious part -- the systematic recording of amounts, dates, and sources of every revenue and expense you generate. Think of accounting as a giant sifter and of bookkeeping as the process of pouring stuff into it. Things get stirred around and you get the information you need to run your business.

Cash or Accrual

Somewhere along the line, you will be asked if your accounting system is on a cash or accrual basis. If all your sales are cash sales, and all your purchases are paid when you pick them up, then the answer is easy -- that is cash accounting. If, on the other hand, you deliver goods or services and are paid sometime later, or if you take delivery of supplies and pay for them at another time, an accrual basis might make more sense for you.

These two bases of accounting produce wildly different results. If you are already doing business and it is not strictly cash, you can try it both ways. Choose a month (or a quarter, if you don't have many transactions) and for that month, record cash in and cash out -- actual payments you receive and make. Add the columns (in and out) and subtract the smaller from the larger. You've just created a cash-basis Profit and Loss Statement (P&L) for the month (or quarter). Now, run the numbers again, but this time list invoice amounts and cash sales (but not payments on invoices), and list the invoices that you have received from your vendors and cash purchases you made. But don't list the payments you made on invoices. Add the columns and do the math. You'll get a different outcome. Accountants usually recommend the accrual basis to get a better picture of how your business is doing. This is one of the first questions you'll have to decide when you set up your books.

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