Accounting
The chart of accounts

You must choose to do accounting on a "cash basis" or on an "accrual basis." On a cash basis, all sales occur when you get the cash. All expenses occur when you pay the bill. There is no inventory. Nobody owes you money (because the sale hasn't occurred until you get the money). It seems oversimplified, but it is legitimate, and you don't want to choose the accrual alternative unless you have an accountant on staff

My typical custom furniture transaction consists of several parts:

• The customer gets a rough idea of the cost of my making something, either from discussions or from my web site. They either specify a budget, or we agree on a rough estimate.
• I receive a deposit, typically at least $200, towards the design of their custom furniture, and prepare a proposal.
• If the proposal will exceed their budget, or is more than 20% above the agreed rough estimate, I can immediately stop working on the design, and will return their deposit (thus protecting the customer from a financial surprise, and limiting my time loss). Financially it is a small initial deposit on a piece of custom furniture but a sale has not been made.
• If the customer would like to proceed, additional deposit is collected, normally to a total of 50% of the proposal price. Still not a sale, because the customer has not received anything, and if I die, they get all the money back. (If they decide not to proceed, they forfeit the design deposit, and at that point it becomes my money and I report it as income.)
• When the item is ready to deliver, I submit a bill for the total amount, plus sales tax, less deposits paid. When the money is received, the sale is made. On a cash basis, you do not extend credit... the sale isn't made until cash is transferred. (One of the complexities of accrual accounting is that the sale is made when the transaction is complete, and the sales tax is reported at that point. If you do not collect the money until months later, you still had to report and pay the sales tax at the earlier date.)

Accountants like to speak about a "chart of accounts." That has nothing to do with bank accounts, but just different lists or "pockets" or "purses" for money. If you use Quicken, they are often called "categories."

Deposit Liability: If you collect a deposit, that money is still the customer's and not yours. It may be in your bank account, or you may have used it to buy materials, but if you "drop dead" and the sale is not completed, you owe this money back to the customer. This means you should have a liability account for the deposits you have collected. Only when the sale is complete does it become your money, and it is transferred from the "Deposit liability" account (purse) to your "Sales asset" account, and ultimately to your pocket.

Sales Tax Liability: As you collect sales tax, it isn't your money even though it is in your bank account. Therefore it goes into a Sales Tax liability account. When you send the state the sales tax, it comes out of the Sales Tax liability account.

Income - Sales that are exempt from sales tax: If you sell something to a church or to another business for resale, they will provide you with a tax exemption certificate just like you provided your vendors. You must these sales when calculating your income taxes, but you need to keep a record of sales tax-exempt sales. Sales shipped out of state by common carrier are also recorded here.

Income - sales for each sales tax jurisdiction. Be sure to record the income separately for each tax jurisdiction that you sell in, so that jurisdiction can get their share of the tax you collect. When you pay income taxes, you will add these together, but you need separate totals for reporting sales tax.

Expense accounts: Don't get carried away in setting up a complex system for expenses... I have found a few general categories are helpful, and the rest can be quickly broken out when I do the federal taxes (rather than struggling with each expense). My big categories are

• materials used in building the goods - "cost of goods sold."
• travel (running to the store, sales calls, trade shows, etc.)
• business meals (kept separate because they are handled funny in the federal taxes)
• tools and machines (over $100 - small stuff is an expense)
• sales tax paid (If I pick up materials used in building my product, but use an alternate vendor and pay sales tax, I can get a credit on this sales tax paid against the sales tax owed.

If you are starting a larger full-time business, you will probably want a larger "chart of accounts" to help you manage different expenses, such as utilities, rent, office supplies, dues and contributions, and so forth.

If you work from your home, it is possible to deduct the portion of your home costs that are used exclusively for your business. If you have a room that you use as an office, but occasionally use it as a guest room, or do non-business work in that room, it cannot be deducted. I have not found it worth the effort to totally isolate an area so I can take a business deduction. If I had a separate shop, at my home or elsewhere, then the business use deduction would probably be worthwhile.