BUSINESS Demystifying Your Income Statement Filling Up the P&L’s Category Buckets Reflecting upon this simplified P&L, we see only one expense summary category on each line. But we realize that there can be many individual transactions behind that consolidated category number. As an example, our “sales” number on the P&L could possibly be comprised of dozens or even hundreds of individual sales transactions and invoices. It’s easy to see that we need some sort of mechanism to keep track of our activities and transac- tions, in such a manner as to be able to facilitate grouping or rolling up all of these income and expense items into organized category and subcategory summary buckets. These organized buckets represent the category lines on our P&L. We should mention that certain activities will be grouped and recorded on our balance sheet instead of the income statement (P&L), but let’s focus on the P&L to avoid confusion. Instead of buckets, our accounting system uses “accounts,” just like they did back in the day of paper ledgers and journals. The master list of our accounts is called the “chart of accounts,” and these will correspond with the categories on our P&L/balance sheet. Let’s look at some analogies that may help us to imprint these conceptual principles in our brains. General Ledger and Chart of Accounts The general ledger is the heart of any accounting system, whether manual or computerized using soſtware, and the chart of ac- counts is the heart of the general ledger. Rather than risk im- mediately getting turned off by sinking into the quagmire of accounting mumbo jumbo, let’s instead picture a Home Depot, Lowes, Sam’s Club or other big-box type of store where there is signage indicating the product categories found in each partic- ular aisle. Plumbing, hardware, lighting etc. The general ledger (GL) uses a chart of accounts to essentially list a directory of the various “aisles” in your metaphorical warehouse, set up in the same fundamental manner. Of course, unlike the big-box store, our GL is storing information by category rather than products. 2 3 Did you ever wonder if the real reason they call it “do it yourself” (DIY) is because you can never find any help in such stores when you need it? Perhaps it should be called FIY or “find it yourself.” To use our accounting system in a traditional for-profit com- pany (not-for-profit principles are the same, but formats and categories are a bit different), we must first set up our GL with various categories (aisles) to record and store our information. A File Cabinet Metaphor If the big-box warehouse example doesn’t float your boat (sorry if this nautical reference is perhaps sensitive because you have personally been responsible for numerous business shipwrecks), an alternative would be to think of a room with four walls. Each wall has a set of file cabinets, and each file cabinet has four drawers. Each wall is for one of these categories: income, cost of goods (COS), expenses and profit. Within each wall, separate file cabinets are dedicated to sub- categories. For instance, on the expenses wall, we might find a cabinet for occupancy-type expenses. In this cabinet, one drawer might be for utilities, one might be for rent, one might be for lawn care, etc. (See Figure 7.) Whether we use the “aisle in a big-box store” metaphor, or the “file cabinets” approach, the organizational concept is the same. We have categories and subcategories for tracking and grouping various activities. Since file cabinets on this wall are expenses, you’d expect to find paperwork such as paid bills or invoices for products or services we received from our suppliers. The category labels on each file cabinet tell us the type of cat- egory in each cabinet, whereas each drawer label tells us which subcategories are in that drawer. Thus, if I am looking for an Uber expense record (referring to our illustration), I know to look in cabinet #5, drawer #3. Fortunately, we have soſtware to perform what would otherwise be a nightmarish tracking task, but we still need to enter the details into our accounting system. On a fundamental level, the general ledger’s chart of ac- One Wall of File Cabinets – Expenses Category 1 OCCUPANCY Utilities Property taxes Common area Maintenance COMMUNICATIONS MARKETING Phone Internet Mail Advertising Social media Web 4 PAYROLL Salaries Hourly Overtime Payroll taxes 5 TRAVEL Air Auto Taxi/Uber Rental car Figure 7. PIcturing a filing cabinet can be a useful visual, whereby each cabinet has one expense category, and each drawer is a subcat- egory of expenses. 30 KEYNOTES APRIL 2021 WWW.ALOA.ORG
