How Accounting Blew My Mind 

Or, “How I was Doing Bookkeeping Wrong (and You Might Be Too)”  


April 4, 2023

In this post:

There are certain unforgettable moments when a concept suddenly clicks and your mind lights up like a Christmas tree. That happened to me when I took an accounting principles course online and saw the way that certain data points intersected in the three financial statements, interlocking like puzzle pieces.


It happened again (and maybe even more powerfully) when I went on to learn proper bookkeeping and saw how the matching principle works. This blew my mind because it turns out that I’d been doing it wrong, and the right way is a brilliant system that fixes all the issues I’d been struggling with. 

How I was Doing Bookkeeping Wrong (and You Might Be Too)

Like most solopreneurs, I thought bookkeeping was merely a simple matter of tracking everything in a money-in/money-out way. Money going out = expenses, money coming in = income. Subtract expenses from income to get your net revenue. Duh. 

But doing things like this means that your monthly or quarterly reports will often show big swings in both income and expenses when you do things like pay for a whole year’s worth of cloud storage at once, or get paid for 3 months of work in one invoice. 


Also, that’s just not how business bookkeeping is supposed to be done. It’s a little more intricate and for both logical and regulatory reasons. 

So how is it supposed to work, then?

Instead of tracking everything in one big bucket that money goes in and out of, you’re supposed to have several buckets (accounts.) And these buckets (accounts) are designated by the financial statement they report to. Your Income Statement (the P&L) will be fed data from a Sales/Revenue bucket and an Expense bucket (plus others, but these are the obvious ones.) Your Balance Sheet has your assets and liabilities type of buckets which track things like cash, debt, inventory, equipment, prepaid expenses, etc. 

Why all these buckets cluttering up my bucket area, you might ask? (I certainly did, it was so tidy with just two!) Let’s use that year’s worth of cloud storage as an example to show how this system is so much better. Using my old system, I would’ve categorized it as an expense. Money spent on stuff I bought for my business is a business expense, right? 


Not quite. At least, not yet. This purchase is for an entire year’s worth of cloud storage, so it needs to be dealt with a little differently.


We own one year’s worth of cloud service, and we’ll be using a little bit every day. The portion that has been used is a business expense. But the portion that remains sitting around waiting to be used is a business asset because it’s technically something your business owns.

When you bought this year’s worth of cloud storage, you have essentially converted some cash assets into this cloud storage asset. So this purchase transaction should be categorized in an asset account, not an expense account.


It’s only when you use some of that cloud storage, do you turn that bit into an expense. You want to match events (both expense use and revenue generation) to the period in which they occur, not when you paid or got paid.

How do we track that? With something called adjusting journal entries, which are created at the end of each accounting period in order to square up all these accounting events. This is where an actual bookkeeper earns their keep!


Now, your Income Statement (the ol’ Profit & Loss) and other expense reports will show how much you spent on cloud storage per accounting period, instead of showing one big spike that looks like you went on a spending spree that period. 

And don’t worry, we’re not ignoring how much you spent on that big cloud storage bill by not categorizing it all as an expense upfront. 


When you categorize the purchase as an asset, that means you’ll see that value in your Balance Sheet. The portion that is used and expensed each month is reflected under the operating expenses section of your Income Statement. 


This is why knowing how to read your financial statements is important. It tells you a ton of valuable information about what you have, what you owe, what you’ve made, how much you spent to make it, and how much money you have on hand (because that doesn’t always match up with what you’ve made at any point in time.)

This same principle applies to other things like inventory and raw materials that you’ve bought (100 tires for your custom bike business, or a box of wholesale t-shirts for your gift shop.) Those aren’t booked as expenses at first. They are assets because until you sell them, you’ve only turned your cash asset into a different type of asset (inventory asset.) It’s only when you’ve sold a thing does the cost of its constituent materials then gets expensed.


The value of any large equipment (laptops, forklifts, delivery cars, etc) also gets expensed (depreciated) bit by bit so you can incorporate that cost into your cost of doing business and how much you should charge. If you had to buy a car to be a rideshare driver, part of each fare should be allocated to paying for that car. 


Even payments for work you haven’t done yet get categorized in a similar way. If you got paid upfront for a job that takes you 3 months to complete, you won’t record the initial payment as income. It’s relegated to a liability account because it’s a debt if you don’t actually end up fulfilling the job. As you complete the project milestones, the equivalent portions then get transferred to your income account.


I ask you, is this not a brilliant system? 


Maybe I’m especially impressed by this because I had so severely underestimated bookkeeping. Or maybe it’s because I’ve struggled for years, trying to generate an accurate analysis of the data from my old in-vs-out system. 


I don’t think I’m alone in this, though. I bet a lot of people don’t realize what an intricate system that proper bookkeeping requires, and the accurate business analysis that it can unlock. I don't know how many business books I've read about unicorn startups that also did their bookkeeping incorrectly, much to their detriment (Twitter, WeWork, etc.) Never underestimate the intricacy and importance of accurate accounting!