Bookkeeping 101 For Small Businesses

This post contains references to products from one or more of our advertisers. We may receive compensation when you click on links to those products. For an explanation of our Advertising Disclosure, visit this page.

 

 

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.

  • As you read through the article, I will offer my professional insights, tips, and strategies for small business owners to gain the maximum understanding of the content.

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. 

  • Bookkeeping can be a task accomplished by anyone who is educated on the ins-and-outs of your business and the software you choose to handle your books. That could be anyone from the business owner, an administrative assistant, personell specifically hired to manage the books or an outside bookkeeping agency or online service. 
  • Check out this article to better understand your online options: 6 Things to know about Bookkeeping Services

Bookkeeping Basics

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.

  • Here are some really important concepts that many business owners find difficult to understand:
  • Owners’ Equity  This account tracks the amount each owner puts into the business. Many small businesses are owned by one person or a group of partners; they’re not incorporated, so no stock shares exist to divide up ownership. Instead, money put into the business is tracked in Capital accounts, and any money taken out appears in Drawing accounts. In order to be fair to all owners, your books must carefully record all Owners’ Equity accounts.
  • Retained Earnings The Retained Earnings account tracks any of your company’s profits that are reinvested in the business and are not paid out to the owners. Retained earnings are cumulative, which means they appear as a running total of money that has been retained since the company started. Managing this account doesn’t take a lot of time and is important to investors and lenders who want to track how well the company has done over time.
  • If you are operating as a S corp, you might also want to know AAA account. It is a special account is used to track undistributed earnings of an S corporation that have been taxed to shareholders previously. Distributions from this account, known as the accumulated adjustments account (AAA), are tax-free.

First Steps

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.

    1. 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.

    2. 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.
    3. 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.
  • The first-choice entrepreneurs need to make is whether to use cash basis and accrual basis, while IRS does allow startups to use cash basis at their early stages under certain restrictions, I personally suggest any entrepreneur who is ambitious about growing their companies bigger over time choose accrual basis from the start because adjusting from cash basis to accrual basis is very troublesome.
  • The difference between cash and accrual accounting lies in the timing of when sales and purchases are recorded in your accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it’s earned, and expenses when they’re billed (but not paid).
  • Accural basis gives business owners a more realistic idea of income and expenses during a period of time, therefore providing a long-term picture of the business that cash accounting can’t provide.

Five Bookkeeping Best Practices

    1. 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.
    2. 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.
    3. 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.
    4. 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.
    5. 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.
  • It is important to review your books and make sure all transactions are recorded properly at the end of each month. Thus, your book will be up to date and gives you real-time data.
  • If your bookkeeping is constantly behind, it becomes increasingly difficult to make strategic decisions or analyze the health of your business when you need to most. No matter where you are in your business’ journey, immediate access to critical information like cash flow forecasts based on outstanding accounts receivable and accounts payable will allow you to make smarter choices about how to grow.

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.

  • Besides the fact that you are required under law to maintain accurate books and records, and you will need to turn in your books when you file for tax, doing so will save you frustration later on.
  • “Poor Accounting” is one of the top reasons businesses fail. A lot of business owners are not aware when their business is running out of cash, and they are not aware when the net profit margin is extremely low. A lot of business owners keep selling products that cost more to make, as well as running advertisements that don’t bring in profit. 
  • When bookkeeping is done properly, it allows you to take control of your business’ finances. Bookkeeping paints a clear picture of how you spend money. You can see outstanding invoices owed by you or your customers. You will benefit from paying your bills on time and receiving payment for your products or services on time too. You will be aware of the balance of cash inflow and outflow so that you don’t suddenly run out of cash.

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.

  • While talking about bookkeeping can be intimidating for business owners, small business accounting software helps you manage companies’ finances by tracking the money you receive, owe and are owed. These accounting tools use technology like AI and machine learning to automate repetitive tasks and reduce the need for manual data entry. When you’re categorizing transactions, for example, the software learns to recognize how you categorize things so it can do it for you automatically 
  • Here are some affordable and effective accounting software I would recommend:
  • QuickBooks – QuickBooks Online from Intuit is one of the most popular small business accounting solutions on the market – and our pick for the best business accounting software overall. It’s easy to use and loaded with features, including several that can save you time. The company estimates that, on average, it saves its users 40 hours each month on accounting tasks. It can be used by nearly every type of business and has plans for businesses of all sizes.
  • Xero – I personally like the invoice generating feature in Xero. Xero can save users time and simplify accounting by automating tasks and integrating with more than 700 apps. Xero also comes with 24/7 email and live chat support and outbound phone assistance at no extra cost.
  • Zoho – Zoho does not have many complicated features, but sometimes, really small businesses need really simple accounting software. Too many features can be confusing for users. Zoho Books offers all of the basic features that microbusinesses need as well as advanced tools like project billing and time tracking. It also has integrations, so you can continue using the software as your business grows. Zoho is also cheaper.
  • You can also hire accountants who are experienced with operating these accounting tools to help you with bookkeeping. The price range from $200/month to $1,000/month depend on the complexity of your business and how many transactions are incurred every month.

 

The comments on this page are not provided, reviewed, or otherwise approved by the bank advertiser. It is not the bank advertiser's responsibility to ensure all posts and/or questions are answered. Editorial Note: The editorial content on this page is not provided by any bank, credit card issuer, airlines or hotel chain, and has not been reviewed, approved or otherwise endorsed by any of these entities.

May 20, 2019

Alyssa Cotler

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.

Leave a Reply

Your email address will not be published. Required fields are marked *

DMCA.com Protection Status