How to Business Part I: Basic Cash Accounting

Template Ledger

Remember my warning in the intro that some stuff sounds lame and boring, but it’s important? Well, big surprise, accounting is one of those. Much as designing games requires understanding some basics about probability, understanding business requires some basics in accounting. Think of this like that bit in the front of the DMG. Even though it’s not as much fun as the others, I hope that I've been able to highlight what's interesting and avoid the boring. I’ll do my best to keep it going, and if I've flubbed it anywhere, just remind yourself that it lays the foundation for the other stuff.

[Brief Aside to accountants: If you are reading this, you are probably going to be horrified to learn that I’m not going to start with Financial Accounting, but instead I’m going to talk about cash accounting. I think if you get to the point where you need financial accounting to do better with your gaming business, you are past my tutorial and pretty firmly into “it would be really smart to hire a certified accountant, or at least buy Quickbooks” territory.]

[Brief Aside to non-accountants: If you don’t know what the hell financial accounting is, and you really want to know, ask me about it. Basically, it’s all that stuff with assets and liabilities and credits and debits that you may have heard of. Just know that “cash accounting” and “financial accounting” are related but different things, and to a hobby businessperson, cash accounting is probably more helpful.]

Cash Accounting Terminology

The single most important thing to learn for accounting is the terminology. You might assume that accounting would mostly require math, but if you can add, subtract, multiply, and divide (or tell a calculator to do so), you’ve got all the math you need for accounting.  The terminology is where it gets hairy – all of my professors compared accounting to a foreign language. See, there are a few words that have potentially vague or overlapping meanings in normal, human English, but have very specific definitions in accounting.

By defining them exactly - as we might do with game terms in a highly legalistic game - we can talk with precision about what we’re doing. These are going to be important to all of the tutorials to follow, so I’ll probably link back to them. Some of these words have multiple meanings even in accounting, but I’m sticking to the most straightforward possible, and I will use them consistently. You may find some slight variations if you do some reading on your own, though. For now, here’s what you need to know:

Cost: What you, as the business, pay for things that go into making your own product

(What a fletcher pays for wood, feathers, and arrowheads is a cost to him)

Price: What your customer pays for the stuff you sell to him

(What the fletcher charges merry men for his arrows is its price)

Sales: Number of things sold

(The fletcher counts the number of arrows he sold today and that is his number of sales)

Revenue: The total money your customers pay you for all the things they bought. This ought to be equal to price times sales in most situations

(At the end of the day, the fletcher looks at how much money he got from people for arrows and writes his revenue for the day down in a ledger. He double checks that this number is equal to the result of multiplying his arrow sales times his arrow price. A more diligent merchant might have recorded individual arrow sales and associated prices and confirmed that the running total added up the same as sales times price, but our fletcher is not so sophisticated).

Profit: The revenue minus the cost equals profit.

(The fletcher takes his total revenue for the day and subtracts from it the cost for each arrow sold times the number of arrow sales, i.e. his total cost, to find out his profit for the day)

Obviously, Revenue/Profit and Cost/Price are potential sources of trouble, because in a non-business context, these can get used pretty interchangeably. I wish I had good mnemonics for memorizing these differences, but I don’t.  Maybe something to do with the difference between the poetic meanings of “without price” and “without cost”. But if you’ve ever learned the rules of a game that makes distinctions between a hit, a critical hit, and a wounding hit, I think you’ll be okay.

Set up a Simple Ledger

Now that we have the basic terminology laid out, we can start using it by setting up a simple ledger. I promise you this is not going to be as bad as “ledger” makes it sound. Spreadsheet software makes this way less tedious than it was for most of the history of accounting, but it’s useful enough that people were doing it the hard way with abaci and quill & ink for centuries.

To get all the basics across, I’m going to run through an example with physical items, but at the end we’ll tie it into how these concepts can be applied to more intangible things. I recommend you follow along with the template linked at the top of the post.

So, if you look at the template ledger on the January tab, you see columns for “date”, “item”, “cost”, “price”, and “profit”. The first row has an example item and a simple formula (price – cost) in the profit column. The second row links refers back to the inventory tab. We’ll walk through some pretty basic spreadsheet operation here, so you can skip some of this if you already know you way around a spreadsheet.

Here’s an example of a filled out ledger:

Date	Item	Costs	Price	Profit
1/1/2014	Cheap Arrow	.5	1	.5
1/2/2014	Arrow	1	2	1
1/3/2014	Fancy Arrow	1.5	3	1.5
1/4/2014	Arrow	1	2	1
		4	8	4	Total
				Okay	Check
				2	Sales

Let’s make your ledger template look like this, and then we’ll examine it and what it means.

1. First, open the Ledger Template and click on the January tab if it is not already open. For the cheap arrow, simply copy the item name, cost, and price from above into the 1/1/2014 line item (profit should calculate automatically).
2. For the standard arrow, let’s do something a little different. Click on the “inventory” tab, and replace the “Example Common Item” line item with the information for the “Arrow” line item above (again, leave the profit cell alone for now).
3. Click on the January tab again, and notice that the name, cost, and price have all changed to match what you put in inventory
4. Right click on row 5 (on the ‘5’ label to the left of the cells) and click “Insert”
5. In the new row, copy over the information from “Fancy Arrow” above, and copy one of the orange profit cells, and paste into the profit cell for the Fancy arrow (you can remove the fixed reference color coding if you want, and you can add a date)
6. Right click on the last row above the line and click “Insert”

So, now your spreadsheet should look like the example ledger above. You can see that each line item represents a thing that the fletcher has sold. He sold one cheap arrow, two arrows, and one fancy arrow. Each arrow has its own costs (feathers, wood, arrow head, et cetera), its own price, and then a per sale profit. At the bottom is the total costs, revenue,  profits, and sales for the period of time represented by the ledger. The fletcher might choose to record his costs, revenues, and profits separately per day, week, or other unit of time, or he might just keep a running total. The example here uses a month as small enough to be manageable, but large enough to have a meaningful number of entries. Feel free to modify for whatever time period works best for you.

Some things to note:

• Cost, price and profit are recorded on a per item basis, and total costs, total revenues (the sum of individual prices), and total profit are also recorded. It’s simple to capture the individual data if you do it as you go, and it can prove useful later for analysis (like finding out that your most popular item isn’t as profitable as you think, or the like)
• In the example, you actually arrived at the “Arrow” entries through two different methods – the first one is a link to another sheet, while the second was a simple copy and paste. Links between sheets can be extremely useful for hiding the “guts” of a calculation where they won’t mess up something where layout matters (like a ledger or character sheet), and if you change something, it will change everything linked. This is good and bad, see the inventory tab for a warning
• The Check box is never strictly necessary, and the calculations here are simple enough that it might not help much, but it’s a good practice to calculate the same answer two different ways and make sure they match up, especially once you start getting into multiple dependencies and nested formulas and the like
• If you go to the Annual Sales Record tab, you’ll see that the info you’ve entered has already been captured, thanks again to those linked references

What to Track

The point of this ledger is to keep track of what you spend and what you make selling what you sell, so that you know how much better off you are monetarily. This is a pretty obvious point, but the nuts and bolts of it can get a little complex sometimes. In our example, costs, revenues, and profits are all very neat and tidy. I’m going to touch briefly on how such simple elegance can get messed up and more sophisticated solutions become necessary.

Where to Assign Costs

Deciding where costs really “go” is quite possibly the hardest issue in accounting. Now, if you’re buying wood, feathers, and arrowheads to make arrows, costs are pretty straightforward – whatever you paid for your materials is your cost. But what if your son is the smith’s apprentice and he makes the arrowheads for you? Were those “free”? Will you know how it will affect you monetarily when your son completes his apprenticeship and gets too busy to make you arrowheads?

The point is that costs can be more complicated to assign to individual units than I’ve presented them here, and when they get too complicated, that’s where that “Financial Accounting” I mentioned up at the top comes in handy. Stuff like accounting for depreciation and intangible goods and what not. I’ll say more on it at request, but for now I think it would just bore most people and not do them much immediate, practical good.

Fixed Costs and Variable Costs

The simplest examples of the kind of complicated costs that might become an issue for you even as a hobby businessperson are Fixed Costs and Variable Costs.

Variable costs vary with the number of units made or sold, and fixed costs do not. For example, if you are considering making custom miniatures for people with a 3D printer, the printer cost would be fixed (it costs the same to buy whether you make 1 or 1,000), and the plastic would be variable (make more miniatures, buy more plastic). Variable costs can also be based on how many units you sell – like if you pay for shipping instead of your customer or have to pay a per-transaction fee to an online store.

Accounting for them is easy – for every unit, count the applicable variable cost.

There are some accounting issues I’m not going into here, and there’s a whole lot of interesting stuff to dive into in this area, but I’ll give you two options to get going on accounting for fixed costs:

1. At the time of incurring the cost (buying the thing), estimate how long you’ll use the thing. Divide the cost by that time, apply a fraction of the cost to every unit of time you track (so, if you buy the printer for 2,400 bucks and think that it’ll only last you two years, apply a $100 cost to every month). This is a more “accounting” answer – closer to what a CPA would do, but not quite. Record it in your ledger as a line item with 0 price, and thus a negative profit.
2. Use a spreadsheet to automatically calculate and update the “per unit cost” for every unit you sell and add that cost into every unit. This will result in your first sales being recorded as unprofitable until you “break even”. This is a more “operations” answer – closer to what a plant manager would do. When planning and figuring out price, you’ll want to estimate a reasonable number of sales to get an idea what your actual costs will be.

The Sunk Cost Fallacy

The sunk cost fallacy is related to the idea of fixed costs. There are a lot of cognitive fallacies that affect our daily lives, but the sunk cost fallacy is one of the most common and one of the hardest to ignore. Basically it is the idea that you have to “make back” spent money. A harmless enough idea on its own (that’s the root of investing, after all), but it becomes pernicious when you justify spending more money based on the money you already spent. If you’ve ever felt disappointed at how much money you got from half price books for your game books based on the cover price you paid 15 years ago, you’ve fallen prey to the sunk cost fallacy. If you’ve refused to sell those books because of it, and they’re still sitting on your shelf unused, then you’ve been hurt by the sunk cost fallacy.

Here’s the thing. Money you spent in the past? It’s gone. It is no longer rationally relevant to your decision making. It can be hard to sort out whether you are making a decision based on a rational expectation to recover fixed costs or an irrational expectation to make up a sunk cost.

To assist with distinguishing between rational and emotional motivations, allow me to introduce you to a simple statistical concept to aid in rational decision making.

Expected Value

To find something’s “expected value” takes a bit of skill with percentages. Fortunately, my target audience is rich in exactly this skill. There are two components to an expected value:

1. The value of each possible outcome
2. The likelihood of each outcome

Now, I may say “all possible outcomes”, but really it’s all the outcomes that it’s reasonable to consider. You probably don’t need to include the monetary impact of time traveling robot dinosaurs destroying your inventory, and you can skip things that are more plausible but will have a small impact if they do happen.

So, 1) is the easier part. Usually you are evaluating some options, like: sell this printer now or hold onto it to keep making miniatures I can sell with it. If you don’t know exactly how much each value is worth, try to be conservative (err in the way less favorable to you) in your estimate.

For 2) you figure out the likelihood of each outcome. Historical data is the most useful base for extrapolations here, but worst case you can “wing it” based on your best judgment, the same way you make up difficulty ratings for unexpected player actions on the fly. The more money involved, the more effort you should put into making sure this percentage didn’t come straight out of your ass, but if you’re honest with yourself and familiar with the subject, your estimate will probably be pretty good.

Finally, multiply the likelihood of each outcome by that outcome’s value, and add them together. This is how much money you can reasonably expect to make or lose (even though it’s an abstraction in the same way you can “expect” all of a D&D character’s stats to be 10). Ta-daa! You’ve just found a weighted average.  For even more granularity, keep the results of multiplying each outcome by its likelihood separate and compare them – the (outcome x probability) with the highest dollar value is the most rational choice (if you got your inputs right).

Obviously this isn’t a magical formula, and it should be used as a tool that aids in decision making, not the end all be all of decision makers. It is hugely dependent on good estimates, and the old software adage of GIGO definitely applies.

Intangible Costs

I’ve purposely stuck almost entirely to “tangible costs” here – things you pay real dollars out of your paycheck for. When it comes to figuring out how much money you’ll make doing something you’d be doing anyway (because it’s the hobby you love) this works pretty well. But what about intangible costs? Stuff like your time, missed opportunities, or the wear and tear you put on your computer? These things have real value, but most of us don’t spend too much time assigning a dollar value to them. In a hobby business, it’s easy to think of the costs as being zero, but that’s not really true.

There is a whole art and science that goes into figuring out stuff like this, but for this primer, I just want to get you thinking about the fact that pretty much anything that went into making your stuff could be considered a cost. The most salient example is likely your time. So, I’d encourage you to figure out a couple of things:

1. Figure out how much time you put into each thing you make,
2. Figure out what that time costs you.

Time is a hugely imperfect measure of productivity in general, but it has the distinct benefit of being clearly measurable. So, if all of the time you devote to your hobby business is as enjoyable as anything else you could possibly use your free time doing, maybe it really isn’t a cost. Hell, maybe it’s practically like you’re being paid to do this stuff. But if any fraction of it is more work and less hobby, or even if any fraction of it is just less enjoyable than something else you could be doing, slap a cost on it, then apply that cost to the things you sell. Your time is valuable and you want to make sure you’re using it where you really want to. Monetary values can help throw that into stark relief.

(Semi-relevant aside: want to compare what you’re making at your hobby to your job on an hourly basis? If you’re paid hourly, skip this part, you already know. If you have a salary, your pre-tax hourly pay can be roughly estimated by dividing your salary by 1,000, and then divide that by 2. So a $40,000 salary is roughly equivalent to $20 an hour, if you assume a 40 hour work week)

When Things Get More Complicated

Okay, so far I doubt anything I’m sharing with you has rocked your world that much. Basically I’ve recommended keeping careful records and giving a bit of thought to what goes into making your stuff. If you start to get to where you are hiring other people, setting up a separate business account, buying or selling things on credit, or the like, then it’s probably “talk to a CPA (professional accountant)” time. At the very least, start seeking out some knowledge on accounts and balance sheets (I’ll be happy to answer questions, but it’s not my area of expertise.)

Get thee to a spreadsheet!

As for how to actually get all this done, I invite you to open up the spreadsheet template linked at the top if you didn’t earlier and start monkeying around. Some of you are probably already hotshot excel jocks, considering you can make a wicked automated character sheet for a point buy game in it, but many of you may recoil from them in horror and panic. I’m here to tell you that if you can learn an RPG, you can use a spreadsheet just fine.

I think that a full-on introduction to spreadsheets is a little out of scope for this tutorial, but I’ll be happy to provide more if people are interested. Instead, I want to prove my thoughts on a couple of options, and some pointers on getting better with spreadsheets. In the meantime, if you’re a total spreadsheet newb, I’ve made a template with labels and instructions to get you started. If you’re hungry for more, head over to youtube and search for “[spreadsheet program of your choice] tutorial”. There’s a ton out there.

Spreadsheet Options

I’m familiar with two main options for spreadsheets, but there’s a few others floating around out there (like Open Office):

Microsoft Excel – The standard for spreadsheet software, Excel has more hidden functionality than you’ll discover in a lifetime of looking.

Pros: support, functions, ability to use it at work without looking suspicious

Cons: expensive to buy, online collaborative version sucks

Google Docs – Has almost all of the functionality of Excel, but way better ability to collaborate and access remotely. The Labyrinth Lord to Excel’s D&D

Pros: free, good collaborative/remote access, consciously mirrors Excel functions

Cons: not quite as functional as Excel, access at the mercy of your internet connection, fewer tutorials and resources available

Some Tips For Spreadsheet Success

• If you find yourself going “I think I should be able to do this” or “this seems like a complicated way to do something that should be simple” – search for a tutorial. Chances are that you are right
• Google is your friend. Whether on the official Microsoft help pages or in forums, there are tons of people asking and answering spreadsheet related questions, and Google is the best way to find them
• Learn how your spreadsheet software handles relative versus fixed cell references, and then learn to use them – it’ll save you from a ton of headaches (This is explained a little more in the template). Especially useful is renaming cells so you can reference them by name in formulas.
• Always try to minimize the number of times you have to enter data – refer back to a single point of entry as much as possible, and anything the spreadsheet can figure out automatically, let it do that