Bookkeeping 101 For Small Businesses
Bookkeeping 101 for Small Business
Most entrepreneurs expect to work hard when starting a small business. Long hours and late nights can be par for the course. Starting off on the right foot with bookkeeping and streamlining the process of knowing exactly when and where your money is moving is key to ensuring that your small business runs smoothly. Knowing the details of your cash flow and having everything at your fingertips will not only help reduce the stress of entrepreneurship for you, but help keep you firmly in control of your business at all times.
What is Bookkeeping?
In short, bookkeeping means tracking the money that comes into your business and the money that goes out. Quite literally, your “books” are your balance sheets, and just like balancing a checkbook, keeping your books straight requires accounting for each dollar you spend and each dollar you earn.
You may be wondering what the difference is between accounting and bookkeeping. After all, accountants basically track expenses, right? Well, it’s not quite that simple – but it doesn’t have to be complicated, either. Bookkeeping is the recording of each transaction conducted in your business, whether a purchase is made by a customer (resulting in cash flowing in to you) or you need to buy new equipment (resulting in cash flowing out to another entity). In other words, it’s the recording of all the financial data produced in the short, and long-term running of your business. On the other hand, accounting is what you do with that data. Accountants classify different transactions as requiring attribution to different functions of your business, and synthesize the data to create reports that show the financial outlook of the company based on what’s coming in and going out. Accountants also use this information to see what the right tax treatment is for your business, make sure you’re following the rules and regulations of the Internal Revenue Service (IRS), and let you know whether you can do anything differently to avoid negative tax consequences.
So while bookkeepers and accountants both handle the transactions of your company, they perform different functions, working hand-in-hand to give you the full picture of your company’s fiancal health, but also organizing it in a helpful way come April when its time to report your earnings to the government.
At the end of the day, most business owners are concerned with their “bottom line” and the way to figure out what that bottom line is by using two equations.
1. Assets – Liabilities = Equity
What is an asset? Anything that adds value, really; cash, securities, and real property are all assets. The opposite of an asset is a liability, something that subtracts value, which for the most part in businesses means a debt. For example, if you own the property in which your business is housed, that property is an asset. The mortgage on that property is a liability. Subtract the amount of the mortgage from the value of the property, and you’re left with the equity. Many people are familiar with this basic equation because it’s the same one used in calculating a home mortgage. The equity in your business is part of your “bottom line” because it’s the value of what you have at any given time.
2. Income – Expenses = Revenue
The other part of the “bottom line” is your revenue, whether on a monthly or annual basis or on some other timeline. Revenue is calculated by taking your income (all the money coming in from sales) and subtracting your expenses (all the money going out for salaries, operating costs, and necessary purchases). The key to operating a profitable business is, of course, that your income needs to exceed your expenses, resulting in higher revenue as the differential increases.
A few key decisions need to be made upfront for healthy bookkeeping. The first decision is which method of accounting to is right for your business: the cash method or the accrual method. Second is whether you prefer a paper or electronic method of recording, and third is whether you will do your own bookkeeping or hire it out.
- Choose Your Accounting Method
There are two accounting methods for you to choose from, the cash method and the accrual method. For the most part, it is easier for a fledgling business to use the cash method. As you travel further along the spectrum with a growing business, increasing transactions (both in terms of numbers and complexity) may make the accrual method more appropriate.
The cash method:
revenue and expenses are each recorded when the money changes hands, flowing between you and your customer or your supplier. For example, if you run a gym and someone purchases a monthly membership, you record the amount paid each time they renew that membership, resulting in 12 transactions each year if you charge their credit card every month. If you order soap and towels for your locker rooms and they are delivered on a monthly basis and the supplier sends you a bill for the entire year’s supply that you pay in monthly installments, you likewise have 12 transactions to record.
The accrual method:
revenue and expenses are each recorded as they occur, not necessarily when the money comes into or leaves your hands (or cash register!). In the gym example above, you would record the whole year’s membership fee at once, let’s say in January, even if the money is divided into 12 payments that you receive monthly. Similarly, you would record the year’s worth of soap and towels purchased all at once, even though you’re paying off the bill a little bit each month.
The benefit of using the accrual method is that it allows you to have a snapshot of all your revenue and expenses over the course of a longer period of time, which makes planning ahead easier. It also works well if you need to balance your books in a seasonal business, where much of your money is made in a short period of time; for example, if you own a pool cleaning business, you may generate most of your revenue in June when customers open their pools for the summer, and September when they close them. But if you need to budget for the expenses of keeping your business open during the winter, it makes sense to use the accrual method to get a better idea of how much you’ll have coming in during the high season.
- Paper or Electronic?
As in many fields, it seems that the future of bookkeeping is digital. There are certainly benefits to keeping paper records, as many still like to be able to review data in hard copy, but these days your best bet is to keep records electronically and print a copy of everything for your records. There’s a lot of risk in solely keeping paper records, including the potential to lose everything if something happens in or to your office. However, if you go digital, be sure to back up your records in multiple locations (computer harddrive, external harddrive or online) so that all is not lost if one backup is.
- DIY or Hire An Expert?
Finally, every business owner needs to decide whether they’re going to take all of this information and do the bookkeeping themselves or hire someone to do it for them (either in-house or at an outside accounting firm). There’s also a third option that is relatively new which combines the two: an online bookkeeping service.
In many instances, it many make sense to take advantage of this hybrid option. In recent years companies like bench.co, are now providing an online bookkeeping service that and provides the user with interactive bookkeeping software, including reports, accounts and a mobile APP. By choosing a platform like this, you’ll save on the typical cost of an outside accountant (or paying the salary of someone to do it for you in-house) while having access to the expertise of bookkeeping professionals. You upload your data through the secure online portal and the bookkeepers do the work for you. You can call or e-mail with questions, and for the first few months you have scheduled meetings in which some of the finer points of your books can be discussed.If you decide to hire a professional, choose the professional that best suits your individual business’ needs. If you need a tax pro, go with the big tax accounting firm. If you need someone who knows your industry and how things work, make sure your chosen professional has that expertise. There are often benefits to working with a local firm, as you’re apt to get more personalized attention, but it can also be good to go with a large, national firm with many offices, where someone is always available to take your call. Always ask for references and do your homework, just as you would when making other decisions for your business.
- Choose Your Accounting Method
Five Bookkeeping Best Practices
- Track All Expenses
This one may seem like a no-brainer but it’s actually one that slips through the cracks. When you’re starting a business, there are a lot of moving parts and it can be easy to misplace receipts or forget how much you spent on a new piece of equipment. Don’t! Keep all receipts and make sure you note everything you spent in furtherance of the business. Many of your expenses can be “written off” as tax deductions and you don’t want to lose them.
- Keep Your Books Current
Like the above, this is one area where the best-laid plans can swiftly go awry. If you don’t start out keeping clear and consistent records, it can be tough to get back on track, so make it a point to do so from the start. Choose a software, online platform, or professional accountant; decide on your method of accounting, and start as you mean to go on.
- Keep Personal and Business Finances Separate
It’s never a good idea to mix business with pleasure when it comes to bookkeeping. You won’t have an accurate picture of your business expenses and that negatively affects your ability to project future revenue and know your bottom line. Plus, you will have a hard time come tax season.
- Limit Accounts Receivable
“Accounts receivable” is a fancy way of saying unpaid bills. You send a bill to a customer, and it’s outstanding until they pay the amount due. All those bills are accounts receivable. You work hard in your business and deserve to be paid, and in addition it can be hard to stay on top of who owes what if the number of invoices piles up, so try to follow up on payments owed ASAP.
- Keep Backups of Your Records
This goes back to the discussion of whether to keep paper or electronic records. The real answer is, keep both! Use an electronic system, have multiple backups, and print hard copies you can easily access should something arise that prevents you from getting to the electronic copies.
- Track All Expenses
Why is Bookkeeping Important?
Now that you know the basics, you have a better understanding of why bookkeeping is so important to your business. But it’s important to keep in mind a few other areas where bookkeeping can benefit you: potential clients, and with the IRS.
It’s no secret that people appreciate honesty. Keeping accurate records means being honest about your finances, both for your own business’ sake and for the sake of those with whom you do business. If you’re making a pitch to a prospective client and they ask a question about your finances, you need good records to refer to so that you can give an accurate answer. If you were doing the hiring, you would choose a candidate who keeps their records straight. So, be the candidate you want to hire when it comes to bookkeeping for your business.
Honesty and accuracy, sometimes to a painful level of detail, are also important for your business when it comes to dealing with the IRS. Your records need to be available at all times in the event someone comes knocking on your door to do an audit when your tax returns are filed. This is why, if you have a specialized tax situation, it might be best to hire a professional to do your bookkeeping. If an audit arises, that professional will also assist throughout the process and make your life a whole lot easier.
Time to Take Action!
Now that you understand the importance and the basics of bookkeeping for your small business, the next step is to ACTION!
If you are going to handle your company bookkeeping yourself, research the best bookkeeping software available and begin to educate yourself on how the program works and how to configure it best to suit your company. If you are hiring a person in-house check out our article of 6 things to look out for when hiring a bookkeeper for tips. Or if you think that an online bookkeeping service is best for you take a look at our Best Online Bookkeeping Service Providers post.
Remember, knowledge is power and knowing exactly how and where and to what degree your money is moving around can be the difference between a stagnant business and a thriving business.
May 20, 2019
Alyssa specializes in creating content and website copy for law and accounting firms and nonprofit organizations. She has an undergraduate degree in history and a J. D. from Columbia Law School.