15. Three Sets of Books

May 01, 2026 03:26 · 13:48 · English · Whisper Turbo · 2 speakers
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Lecture Index
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0:12
S… Speaker 1 (15. Three Sets of Books)
The reality of the business world is that every business owner should have a minimum of two sets of financial books or accounting reports. One set of financial reports will not cut it. I sometimes recommend business owners keep three sets of books, and I'll explain why in a minute.
0:32
S… Speaker 1 (15. Three Sets of Books)
Whether you choose to keep two or three sets, your different sets of accounting reports should be kept separate and distinct because what goes on in one won't necessarily go on in the other. As you know, if you've listened to the coaching video entitled Cash vs. Accrual Accounting, the first set of books is based on accrual accounting.
0:57
S… Speaker 1 (15. Three Sets of Books)
An accurate accrual accounting-based report card is the only way to go if you expect to be able to accurately measure and then subsequently reverse engineer the numbers so that you can figure out which activities need to change to create optimum and sustainable success. Then there's the financial records you need to keep for the federal government to pay your income taxes. What I'm about to say is important.
1:25
S… Speaker 1 (15. Three Sets of Books)
The government does not want an accurate reflection of what happened in your business last year. For example, in the United States, the government stipulates that half your meals are non-deductible. They limit your charitable and your health care deductions. You might have spent $40 on a steak, but you can only deduct $20 of it as an expense for tax purposes. There's another significant distinction.
1:54
S… Speaker 1 (15. Three Sets of Books)
Most of us have had the experience of getting to the end of the year and receiving a big fat check from one of our customers. Maybe that client owed you money for the last couple months and they pay you $20,000 on December 30th.
2:10
S… Speaker 1 (15. Three Sets of Books)
If you're like most business owners, you choose not to deposit that check until January 2nd of the following year. You earned this money back in August, but they're just now paying you at the end of December, probably because they want a deduction in the current year so they can reduce their income taxes. Or perhaps you write a few checks on December 29th for January bills that aren't even due yet.
2:39
S… Speaker 1 (15. Three Sets of Books)
These are payments that really should get made in January or February of next year, but you write the checks in December of this year. Sometimes you haven't even received the invoice yet, but you still pay these bills anyway. Why do we do this? Because the government uses a modified cash accounting treatment.
3:02
S… Speaker 1 (15. Three Sets of Books)
If you didn't actually receive it or deposit it this year, then you don't have to pay taxes on it this year. And if you paid for it this year, even though the bill is not due yet, then great. You get to deduct it from your earnings this year and therefore pay less in taxes this year.
3:22
S… Speaker 1 (15. Three Sets of Books)
The accounting we do for the government, listen closely, the accounting we do for the government has nothing to do with the accounting we should do to run the business end of our business, which is called accrual accounting. So far, we have two sets of financial reports. We have accrual accounting, and we have tax or government accounting. Okay, now, this is where it gets tricky, and the third set of books might come into play.
3:53
S… Speaker 2 (15. Three Sets of Books)
Before I talk about that, let me be clear. I'm not advocating a third set of books.
3:59
S… Speaker 1 (15. Three Sets of Books)
On the other hand, having advised and consulted with literally thousands and thousands of business owners, I'm convinced that most small and medium-sized business owners delay deposits, accelerate expenses, and pad their tax returns with deductions which are primarily personal and have literally zero business justification.
4:27
S… Speaker 1 (15. Three Sets of Books)
As one of my mentors told me years ago, Keith, facts don't cease to exist just because you ignore them. He was right. The vast majority of medium and small businesses play some kind of game with the government to minimize their tax bill.
4:46
S… Speaker 2 (15. Three Sets of Books)
The fact of the matter is that if you choose to play this game with your taxes, you must not allow this financial hanky-panky to contaminate your monthly 100%.
5:00
S… Speaker 1 (15. Three Sets of Books)
business related actual accrual accounting reports. It is mandatory that you have at least one set of books that's totally accurate and which reflects what actually happened in your business on a purely business basis.
5:17
S… Speaker 1 (15. Three Sets of Books)
in the time period in which it was earned, owed, or used. In other words, you need one set of books which is 100% accurate based on accrual accounting with no personal yah-yah or doodah.
5:30
S… Speaker 1 (15. Three Sets of Books)
The second set of books is the tax accounting required by the government. Ordinarily, the tax accounting treatment would not be that difficult. However, we tend to complicate things when we decide to minimize our tax bill by writing off personal or questionable expenses. This is where the third set of books comes in.
5:53
S… Speaker 1 (15. Three Sets of Books)
I don't mean an entirely new set of QuickBooks or Peachtree or MYOB or whatever accounting system you're using, but I do mean that you should keep your personal expenses that you intend to claim as a business expense in a separate category from your bona fide business expenses.
6:13
S… Speaker 1 (15. Three Sets of Books)
If you're tempted to write off last year's vacation to New Zealand as market research, or if your children are headed off to college and they somehow miraculously find their way onto your company's payroll because they're in a lower tax bracket, or if your spouse receives a new watch for Christmas and you simultaneously declare him employee of the month,
6:39
S… Speaker 1 (15. Three Sets of Books)
You're creating a nightmare with your ability to accurately measure your financial performance. All this personal stuff gets lumped into the business's expenses, and before long, no one has a clue how much the business is really making.
6:55
S… Speaker 1 (15. Three Sets of Books)
One of the biggest mistakes small business owners make is the commingling of funds between business and personal. Money just seems to flow effortlessly between the two with little thought of how it's going to impact anything other than expenses. That's a big mistake.
7:15
S… Speaker 1 (15. Three Sets of Books)
In larger businesses and publicly held companies, when management starts helping themselves to company money or the books get cooked to report false earnings, somebody goes to prison. Jeff Skilling and Bernie Madoff both wish they had heard this word of caution a couple decades ago. I'm the chairman of the board for over 50 business owners.
7:41
S… Speaker 1 (15. Three Sets of Books)
Each board is comprised of eight members. We meet four times per year for two- or three-day sessions to work on each other's businesses, review financial reports, and provide each other with optics and insight. To say that these board meetings are intense would be an understatement. A couple years ago, a new member presented his company and the problems at our first board meeting.
8:08
S… Speaker 1 (15. Three Sets of Books)
His story was that his business wasn't performing that well financially, despite the fact that his sales were almost $2 million a year. He was low on cash every month. He struggled to meet payroll. He appeared to be barely breaking even and was stressed beyond imagination. His proposed solution was to turbocharge his business and ramp sales to $3 million per year.
8:36
S… Speaker 1 (15. Three Sets of Books)
I asked for his financial reports, and sure enough, he was teetering on broke. I couldn't see the problem because of the way his financial statements were presented. I asked him to show us how much he was dragging out of the business for his personal salary and yaya. One hour later, we had reconstructed his numbers, and to his surprise,
8:59
S… Speaker 2 (15. Three Sets of Books)
He was dragging $750,000 a year. The reality is his business was performing quite well, but he was suffocating it by having his business...
9:11
S… Speaker 1 (15. Three Sets of Books)
pay for the bulk of his personal consumption an even bigger problem was that he wasn't even aware of the multitude or the magnitude of personal expenses that had crept into his business over the years because he had never bothered to request an accurate set of financial statements
9:31
S… Speaker 1 (15. Three Sets of Books)
Things like the pool repair and yard service and life insurance on his spouse, the maid, gas and repairs and insurance for the cars that he had the business buy for his three kids, vacations, eating out, and the list goes on and on. Let me tell you something. Ignorance is not bliss. Ignorance is expensive. If you choose to play this game, which is not my advice,
10:00
S… Speaker 2 (15. Three Sets of Books)
Here's how you can do it. Create two large categories of expenses. The first one is called above the line expenses. These are the legitimate expenses required to operate your business. All your personal expenses are recorded in a separate category called below the line.
10:20
S… Speaker 2 (15. Three Sets of Books)
When you're doing your measuring and financial analysis, look only at the above the line income statement to see how your business is performing on an income, net income basis. The above the line income statement will accurately reflect what's happening in your business. When you're reporting your taxes,
10:42
S… Speaker 2 (15. Three Sets of Books)
merge or combine the above the line and the below the line expenses into one chart of accounts, foul your tax return, and hold your breath. Just so you're aware, your balance sheet and statement of cash flow will both be screwed up as a result of the personal ya-ya that you're running through your income statement. And of course, this further complicates the process of measuring.
11:08
S… Speaker 2 (15. Three Sets of Books)
It's hard to know how much you really weigh if you're lugging around a boulder in your back pocket. I realize some of you might consider this advice analogous to teaching teenagers how to have safe sex and avoid pregnancy. I appreciate this concern, but I'm dealing with the realities of human nature here. And if you're going to play with fire, let's at least have the sense not to burn down the house.
11:36
S… Speaker 2 (15. Three Sets of Books)
Be extremely careful when you start messing around with these dials. Think about what would happen if somebody were to monkey around with an altimeter of an F-16. If the plane is at sea level but the gauge shows an altitude of 500 feet, chances are pretty good that the pilot, regardless of his track record or his brilliance or his experience, chances are he's going to crash the plane when he tries to land.
12:05
S… Speaker 2 (15. Three Sets of Books)
No business owner wants to crash their plane nose first into the earth because of faulty gauges and dials. Regardless of whether you decide a third set of books is right for you, having two sets of books is mandatory. You should have one set of books that is precisely accurate. You're a cruel accounting books without any hanky-panky so that you can accurately measure your performance.
12:33
S… Speaker 2 (15. Three Sets of Books)
And another set of books where you can record your expenses for the federal government using their definition of cash accounting. An added benefit of an accurate set of books is if you ever decide to exit the business, I will tell you it's extremely difficult to remember exactly which expenses were personal three years after the fact.
12:57
S… Speaker 1 (15. Three Sets of Books)
If you get this wrong, you risk devaluing your business because the expenses were inflated for tax purposes, which caused the profits and therefore the value to be understated. Lest you think I'm leading you astray here, every major company has two sets of books. IBM, Microsoft, GM, GE, Google, Apple, they've all got one that's accrual accounting.
13:26
S… Speaker 1 (15. Three Sets of Books)
and another one for tax purposes. Most small business owners, on the other hand, only have one set of books, the one for the tax man, and that's a mistake. You've got to have one set of books that's accurate, and one set of books for the tax man, and then, if you want to play the Enron game, you'll need a third.

This transcript was generated by AI (automatic speech recognition). May contain errors — verify against the original audio for critical use. AI policy

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