Bookkeeping Basics Every Small-Business Owner Should Know
Imagine having to sift through hundreds of receipts or paperwork just to find one single transaction. It’s like trying to get somewhere without a map. Sure, you’re going to make some distance, but eventually, you’ll lose your way.
In this guide, we’ll walk you through the bookkeeping basics you should know, explain what bookkeeping is, why it matters, and how you can start doing it yourself.
What Is Bookkeeping and Why Do You Need It?
Bookkeeping is keeping track of your business’s entire financial history by recording and detailing all transactions, either in reliable accounting apps or physical books. Here’s a short list of reasons why you need it.
1. You need it for your taxes.
To do your taxes, you need to know what your net profit is. To figure that out, you have to know what your total expenses and income are; and you can only know that through knowledge and practice of at least simple bookkeeping.
2. It helps you borrow money.
Getting a loan from a formal source requires paperwork. Bookkeeping provides you with financial statements, which are essential for most forms of credit, loans, and seed investments.
People lending you money want to know the financial state of your business. To do that, they need to know your cash flow, revenue, expenditure, liabilities, and assets. These can be obtained from your income statement, statement of cash flows, and balance sheet.
3. You’ll always know where your money is going.
What’s the financial health of your business? Is it good? Or do you need to strategize? Is your cash flow increasing or decreasing? The only way you can answer these questions is through business bookkeeping.
4. It helps you notice errors quickly.
Waiting till the end of the year to get your transactions history or keep your finances in order is a recipe for disaster. For one, you won’t know if there’s an error until it’s too late and you’re knee-deep in papers during the tax period. A much better practice is keeping your books regularly updated and in order - so when that error pops up (and it will), you can catch it while it’s fresh.
5. It ensures you don’t miss out on tax deductions.
Having financial books that are up-to-date and accurate is a sure-fire way to keep track of all those tax deductions. Through bookkeeping basics, you can get proper records on tax deductions (expenses you can deduct from any taxable income).
The more information and documents you can provide to the tax CPA during tax time, the more deductions you can claim, thereby increasing your tax return. Beyond that, the Internal Revenue Service is very strict with its requirements for recordkeeping on tax deductions, and having your books in order can go a long way to save you a truckload of stress in the event of an audit.
How To Do Bookkeeping for a Small Business
With the advent of technology, bookkeeping practices have thankfully become more automated. Still, there are some decisions and steps you need to make to set up your books.
1. Separate your business from personal expenses.
The first step to successful bookkeeping is pretty straightforward: Get a bank account for your business and separate it from your personal finances.
This step is one of the bookkeeping essentials. There’s a pretty big chance your personal assets can be held liable for any debts related to your business, and that’s bad for both you and your business.
This mixing can also create unnecessary complications when you do your taxes. A business expense could get muddled up with your personal account, and you could miss out on tax deductions. It could also mean you have to hire a CPA for longer. Either way, it’ll cost you money.
2. Choose a bookkeeping system.
There are two small-business bookkeeping methods: double entry and single-entry bookkeeping.
With single-entry bookkeeping, you record journal entries once, either as an income or expense. Assets and liabilities are recorded separately. Single-entry bookkeeping is perfect for the initial stage of your business or for when you are handling your books yourself. It’s a fast and straightforward bookkeeping method.
Double entry is more complex but is better suited for businesses that are getting big. With double entry, all transactions are recorded in a journal, and then each entry is recorded into a general ledger twice, with debit and credit balances. Most modern-day accounting software uses the double-entry accounting system for both advanced and basic business accounting.
3. Pick an accounting method.
One other decision you must make when setting up your books is whether you’ll use accrual accounting or cash-basis accounting.
When using cash accounting, financial transactions are only recorded when money has been exchanged. If a customer is billed, it isn’t entered in the ledger until actual money has been received. Cash accounting is easy to maintain, so many small businesses prefer this method. You don’t have to keep track of payables and receivables, and you’ll always have an accurate knowledge of how much cash there is.
On the other hand, relying on accrual accounting when doing bookkeeping for your small business means recording income when you bill customers, and classifying these entries under accounts receivable, even if you haven’t been paid. This also applies to unpaid expenses, which are recorded under accounts payable.
Accrual accounting is more suitable for bigger businesses that are more established because it paints a much clearer picture of the business’s income and expenses - not to mention it gives a long-term view of the business’s state.
4. Categorize your transactions.
You need to categorize every single transaction when you enter it into your books. As mentioned earlier, it helps you claim more deductions and makes audits less stressful.
Categorizing transactions depends on the business and industry. Generally, in basic accounting for a small business, transactions are classified into the following: owner equity, liabilities, assets, expenses, and revenue. Individual items are further broken into what we call accounts. Say you run a furniture business, some entries in your ledger may appear as “utilities - furniture electricity,” “revenue - furniture sales,” etc.
5. Choose the right tools.
When it comes to bookkeeping tools, you have three options.
You could opt for bookkeeping software, like Xero or QuickBooks. They can be very helpful. However, if you lack bookkeeping knowledge, it could turn out to be stressful for you, considering you may be using them incorrectly.
You can also use spreadsheets to record all your transactions. One of the simplest small business bookkeeping tips would be to make use of the Excel Income Statement Template.
The final option is to have someone else run your bookkeeping for you. Online bookkeeping services are the best for this line of action and are very convenient since they are cloud-based. They’ll handle your bookkeeping for you, prepare your financial statements, give expense reports and financial insights, and some of them can file your taxes as well.
It also pays to set up your payroll. How that works depends on your business. Some businesses have their payroll within their accounting software; others use separate payroll software or have payroll companies handle this aspect of their operations.
6. Choose a system for storing your documents.
One of the most important bookkeeping tips is to have your own system where your transactional history can be stored safely. The best option is to digitize your records and store them on a cloud service or digital platforms like Google Drive, Dropbox, and Evernote.
7. Keep your deductions organized.
The IRS has a rule on deductions; they must be an ordinary expense in your business’s field and must be necessary to your business’s affairs.
Determining what exactly you can deduct is still very tricky. This comprehensive guide from the IRS on what counts as deductions can help you organize yours.
8. Make a habit of bookkeeping.
Basic accounting for a small business can be tasking, especially if you have a lot on your plate - as small-business owners usually do. It’s easy to forget regular bookkeeping; however, this can be avoided.
Set aside a day for bookkeeping once a month and set a reminder so you don’t miss it. That day can be used to keep track of all financial history. Alternatively, if this is still too much for you to handle on top of your other tasks, hiring a bookkeeper to help you catch up is also a valid plan.
By now, you may have noticed the correlation between accounting and bookkeeping. While they work hand in hand, they are not synonymous. Let’s break that down.
Bookkeeping vs. Accounting
What are the differences between these two?
- Most bookkeepers have work experience and knowledge acquired by doing the job. There are some who may seek proper certification.
- Bookkeepers can’t typically perform attestations or audits.
- They are usually only aware of the business’s finances.
- They don’t file tax returns other than payroll and sales taxes.
- They are familiar with a wide variety of software solutions.
- Accountants usually have an accounting degree.
- They make use of accounting solutions for tax planning and financial insights.
- Accountants can typically file personal and business income tax returns.
- Certified accountants can carry out attestations and audits, and also produce certified financial statements, which basic bookkeepers aren’t qualified to do.
- They have much more extensive access to the business’s affairs so that they can pull out crucial financial insights.
Bookkeepers are usually in charge of the following tasks:
- Maintenance of up-to-date records
- Keeping businesses in line with tax regulations
- Day-to-day accounts management
- Handling accounts payable
- Bank feeds management
- Sending invoices out and accounts receivable management
- Payroll processing
- Cash flow monitoring
- Performing stocktakes
- Preparing businesses for tax
Bookkeeping is something you can learn on the job, through a formal college degree program, or through self-study. To be successful as a bookkeeper, you typically need to be meticulous, have an eye for detail, and be good with numbers.
Bookkeeping basics that every bookkeeper should have knowledge about are:
- Retained earnings
- Double-entry bookkeeping
- Cash-basis accounting
- Single-entry bookkeeping
- Income statement
- Accrual accounting
Yes. You can teach yourself bookkeeping, for example, by enrolling in a bookkeeping course. There are many of those online.
For years, the clients I worked for were banks. That gave me an insider’s view of how banks and other institutions create financial products and services. Then I entered the world of journalism. Fortunly is the result of our fantastic team’s hard work. I use the knowledge I acquired as a bank copywriter to create valuable content that will help you make the best possible financial decisions.
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