Financial terms and accounting methods that go beyond simple debits and credits.
Accounting is an important part of any business. It provides the financial snapshot we need in order to make informed decisions regarding the current and future health and performance of our business. If you expect your own fitness business to grow and flourish, you will need to possess more than just a passing knowledge of accounting basics.
Accounting is not something that most fitness professionals consider before starting in this industry. However, if you are even just thinking of striking out on your own, it is time to dip your toes in the water in terms of getting a handle on the accounting process. Where should you start? The best place is with the basics, from terms commonly used by financial experts to the underlying concepts that govern any successful business. That said, the information contained in this article is general in nature, and readers should always consult their own accountant or tax preparer before implementing any principles or methods discussed here.
Terminology and General Principles
Anyone considering business ownership should have an understanding of basic accounting terminology and general principles. The first step is to become familiar with the “lingo,” so to speak. For example, you should know the meaning of terms such as transactions, credits, debits, assets, liabilities, expenses, cash flow, accounts payable and accounts receivable. For explanations of these and other salient terms, see the sections that follow and/or the “Glossary” sidebar. Furthermore, you need to understand the steps involved in using a proper, consistent accounting method to handle transactions. You should also become acquainted with a few basic accounting principles required to maintain, update and balance your accounts, such as knowing what a particular financial ratio can tell you about the health of your business.
An accounting method determines how and when you will record your business expenses. Cash accounting and accrual accounting are the two main accounting methods. Although the methods are similar, they differ on one significant issue: the timing of when transactions are recorded.
For most fitness professionals, cash accounting is typically recommended. The cash method is easy to maintain because you don’t record any income until you actually receive the cash due, and you don’t record an expense until the cash is paid out. For example, you would record membership dues the day you actually received the payment from the client. Contrast this with the accrual method, in which you would record the transaction the day you sent out the bill or when payment was considered due. The accrual method also requires many more transactions than the cash method and is thus more time-consuming and more prone to error.
If your business makes less than $5 million per year in sales, the Internal Revenue Service (IRS) pretty much allows you to choose which accounting method you want to use. However, if your business stocks an inventory of products that you will sell to the general public, the IRS requires that you use the accrual method. According to the IRS, inventory includes any merchandise you sell, as well as supplies you later resell at your facility.
Regardless of which accounting method you ultimately select, it will provide only a partial picture of your business operation’s financial status. While the accrual method illustrates the in-and-out flow of business income and debts more accurately than the cash method, accrual accounting may leave you clueless as to the cash reserves available at any time. This, in turn, could result in a serious cash flow problem. For example, your income ledger might show thousands of dollars in sales, while in reality your bank account contained only a couple of hundred dollars because your customers had not paid you yet.
On the flip side, while the cash method may provide a truer picture of how much actual cash your business has in the bank, this method can often be misleading in terms of longer-term profitability. For instance, your books might show that a single month was highly profitable, when in actuality, sales were slower and several of your customers just happened to pay their outstanding bills that month.
Debits and Credits
Debits and credits are the basics of any business accounting system. They are the means by which you record all transactions for your business. Whenever you record a business transaction, you need to show it as both a credit and a debit. If you don’t, the entry will be out of balance, which is not good, because it will ultimately throw off your financial statements. This type of record keeping is known as a double-entry ledger system.
A debit entry is used to show an increase of an asset or expense, or a decrease of a liability, owner’s equity (capital) or income. A credit entry denotes an increase of a liability, owner’s equity (capital) or revenue, or a decrease of an asset or an expense.
Here is how it would work in the real world: let’s say a client purchases products at your fitness facility in the amount of $75 and pays you by check. In your general ledger, you would record the transaction in the following way:
See the sidebar “Sample Business Ledger Sheet” for a more detailed example of how debits and credits are recorded.
Income & Expenses
Income usually refers to the money you receive as a result of normal business activities. For example, most fitness professionals receive money from club memberships, personal training sessions/consulting and/or product sales. An expense, on the other hand, generally refers to an outgoing payment made by a business, such as rent, utilities or employee salaries.
For each of your income streams and expenses, you will need to create an account that allows you to record and track exactly how much you are generating in sales and paying in expenses.
If you offer several services and/or products at your fitness facility, it is wise to establish an income account for each. This way, you know what exactly is generating your income. By adding all income categories together, you will be able to quantify the total revenue of your business.
For instance, if you derive income from memberships, individual training sessions, group classes and product sales, you may want to develop four separate income accounts, as follows:
- sales revenues from memberships
- sales revenues from individual training sessions
- sales revenues from group classes
- sales revenues from product sales
The same basic principle applies to expenses, meaning you would create separate accounts for rent, telephone, electricity, etc.
When recording transactions for these accounts in your general ledger—which represents the summation and repository of all financial transactions undertaken by a business entity—you would use credits to increase your income accounts and debits to decrease them. If these were expense accounts, you would use debits to increase the accounts and credits to decrease them.
Assets and Liabilities
Assets refer to items of value that your business owns. For example, the cash in your bank account is considered an asset, as is money owed to you (i.e., accounts receivable) or any fitness/office equipment or real estate that your business owns. Contrast assets with liabilities, which are any debts or obligations you owe to others. Examples of typical liabilities in a fitness business may include bank loans, payments due to vendors, rent, telephone service, payroll, laundry service, etc.
There is a general rule of thumb when working with assets and liabilities: increase assets with a debit, and decrease them with a credit. Increase liabilities with a credit, and decrease them with a debit. For a look at a sample business ledger sheet for a typical fitness facility, see the sidebar “Sample Business Ledger Sheet.”
Financial statements provide owners, accountants and lending institutions with valuable insights into a business. If you know how to read and interpret financial documents, you will know the true “health” of your business. More important, these statements will help you anticipate and confidently answer lenders’ questions in the event that you want to grow your business in the future.
You would typically prepare financial statements using information from your ledger accounts. Because some financial statements require data from other financial statements, it helps to prepare them in a logical order:
- income statement
- balance sheet
- statement of owner’s equity
- cash flow statement
Creating a master budget allows us to plan for the future success of our business. Budgets provide direction, motivation to meet goals, better coordination for all business activities, and resources to evaluate progress.
A master business budget usually includes an operating budget, a capital expenditure budget and a financial budget. The operating budget sets the target revenues and expenses (and ultimately net income) for a particular period of time. The capital expenditure budget outlines the planned purchases of property, equipment and other assets. The financial budget projects the means of raising money from stockholders and creditors, and plans cash management.
As you prepare your master budget, keep in mind that you are developing your business’s operating and financial plan for a given period. The steps in this process may seem mechanical, but remember that budgeting stimulates thoughts and ideas about pricing, product lines, job assignments, needs for additional equipment or bank loans to facilitate future growth. Preparation of a budget leads to decisions that will affect the future course of your business.
Remember that the whole purpose of accounting is to provide information that is useful and relevant, not just to you, but to other interested parties (e.g., your investors, lenders, bankers, etc.), when it comes to making decisions about the operation of your business. The common language that allows you to effectively communicate to all parties what is happening financially in your business is the language of accounting.
Once you’re familiar with the basic terms and procedures outlined in this article, you’ll be better prepared to make sense of basic financial reports and better able to communicate with others about important financial information. More important, you will have a deeper understanding of just how fit your business is financially.
account: a collection of financial information grouped according to customer or purpose
accounts payable: the amount of money that your business owes to others
accounts receivable: the amount of money that is owed to your business and you expect to receive
asset: an economic resource that a business owns that is expected to be of benefit in the future
bad debt: money owed for a business debt that cannot be collected; it can, however, be deducted as an operating expense
balance sheet: a statement listing a business’s assets, liabilities and net worth, or equity
budget: tool for forecasting a business’s future in quantifiable amounts, including the quantities of products or services to be sold and their expected selling prices, the number of employees and their salaries and an array of other amounts that are ultimately expressed in dollars
capital: another name for the owner’s equity in a business
cash flows: funds your business receives for products and services sold, plus funds the business pays out for items such as rent and salaries
chart of accounts: a list of all the business accounts and their account numbers in the general ledger
current asset: an asset that is expected to be converted to cash, sold or consumed during the next 12 months, or within the business’s normal operating cycle if longer than 1 year
current liability: a debt due to be paid within 1 year or one of the business’s operating cycles if the cycle is longer than 1 year
fixed costs: costs that do not change in total as volume changes
income statement: a list of a business’s revenues, expenses and net income/loss for a specific period of time
invoice: a written record of a transaction, often submitted to a customer or client when requesting payment
ledger: a physical collection of related financial information, such as revenues, expenditures, accounts receivable and accounts payable
liability: an economic obligation (debt) payable to someone outside of the business
net income: gross income less expenses; it represents a business’s profit for a given year
operating expenses: expenses, other than cost of goods sold, that are incurred in the business’s major line of business (e.g., rent, depreciation, salaries, wages, utilities, supplies, etc.)
receipt: a written record of a business transaction
retained earnings: the capital that is earned through the profitable operation of the business
statement: a formal, written summary of unpaid, and sometimes paid, invoices; generally used more as a reminder to a customer or client that payment is due or that payment has been made
statement of cash flow: a report of cash receipts and cash disbursements classified according to the entity’s major activities (i.e., operating, investing and financing)
transaction: any event that affects the financial position of a business and is reliably recorded
variable costs: costs that change in direct proportion to changes in business volume or activity
SIDEBAR: SAMPLE BUSINESS LEDGER SHEET
Here is a series of business transactions that a fitness facility manager or studio owner may encounter on a regular basis and then record in the business ledger.
Scenario: In this particular example, the following transactions were recorded in the general ledger sheet using the double-entry system:
- The owner invested $50,000 cash in the business (see entry 1).
- He paid $20,000 cash for exercise equipment (see entry 2).
- He purchased $500 in office supplies (see entry 3).
- He received $5,500 cash from clients for club memberships (see entry 4).
- He performed $3,000 worth of personal training services for a client (see entry 5).
- He paid cash for rent ($1,100); employee salaries ($1,200); utilities ($400) (see entry 6).
- He paid $400 on the amount for office supplies bought in transaction 3 (see entry 7).
- He received $1,000 owed to him from transaction 5 (see entry 8).
- He sold equipment for cash equal to its cost of $6,000 (see entry 9).
- He withdrew $2,100 cash for personal living expenses (see entry 10).
GENERAL LEDGER SHEET
SIDEBAR: Additional Resources
- Introduction to Accounting: An Integrated Approach with NetTutor & PowerWeb Package by Penne Ainsworth and Dan Deines (McGraw-Hill/Irwin 2003): good accounting book for beginning and intermediate accounting topics; offers numerous examples at the end of each chapter.
- Intermediate Accounting (with Thomson Analytics) by James Stice, Earl K. Stice and Fred Skousen (South-Western College Publishers 2004): presents accounting from the perspective of the essential activities of business: operating, investing and financing.
- Accounting by Carl S. Warren (South-Western Educational Publishing 2001): the authors adapt their proven approach to accounting’s evolving role in business and use the preparation of financial statements as the framework for understanding what accounting is all about.
- Accounting 1–26 and Integrator CD (6th ed.) by Charles T. Horngren, Walter T. Harrison and Linda S. Bamber (Prentice Hall 2004): this introduces readers to all the key financial and management accounting concepts, citing actual examples from companies such as Target, Oracle and a variety of companies doing e-business.
On the Web
- So, You Want to Learn Bookkeeping! by Bean Counter’s Dave Marshall (www.dwmbeancounter.com/tutorial/tutorial.html): free bookkeeping tutorial geared to business owners, managers and individuals who have not had any formal bookkeeping training or on-the-job experience, and who need or want to learn the basics of bookkeeping.
- Accounting 101: The Fundamentals/Kutztown University of Pennsylvania Small Business Development Center (www.kutztownsbdc.org/course_listing.asp): an e-learning site with one of the largest collections of free entrepreneurial training resources available on the Internet.
- Accounting Information at www.business.com (www.business.com/directory/accounting/): a directory of information and resources for accounting professionals, including data on accounts payable, accounts receivable, asset analysis, budgeting and forecasting, financial statements, payroll accounting and taxes.
- SmartPros Accounting (www.smartpros.com/): a resource for accounting professionals or anyone interested in accounting; the site covers news, research, products and online interactions with accounting professionals.
- Understanding Financial Statements (www.bizzer.com/images/financial/index.html): this website provides an introduction to financial statements and financial statement concepts. Some of the concepts covered are the accounting equation,double-entry accounting, and debits and credits.
- Principles of Accounting (www.principlesofaccounting.com/default.htm): a free online accounting textbook for reviewing accounting principles.
- Small Business Bookkeeping & Accounting (www.waybuilder.net/sweethaven/business/bookaccount/bookkeeping01_TOC.asp): a free short course that introduces you to a variety of accounting events related to such business activities as setting up your records and bank accounts, preparing for a loan request or developing a financing plan.
Tom Perkins is a fitness business coach/adviser; a radio host, speaker and author; and a certified personal trainer and nutritionist. He holds a degree in business management/accounting and has been involved in fitness businesses for more than 30 years. Contact him at www.megafitnessbusiness.com.