How to Keep Books for a Small Business: Bookkeeping & Accounting Basics
There’s a lot to love about running your own small business… You get to incorporate your greatest skills and passion into your work, you see familiar faces almost daily, and best of all, you get to be your own boss. But it’s not all glitz and glamour 24/7, especially if crunching numbers and coordinating budgets aren’t necessarily your areas of expertise. The reality is, learning how to keep books for your small business is simply part of the job description—and it should be an important piece of your day-to-day operations. Bookkeeping not only influences your business’ finance management and profitability, but it can also determine whether or not your business is in compliance with tax and employment regulations.
Like many facets of life, there’s no single right answer to managing your business’ finances. There are several ways to approach small business bookkeeping, it’s just a matter of identifying what makes sense for your business. Not sure where to start? In this article, we’re covering bookkeeping basics to help you refine your current process, or start building your bookkeeping strategy from the very beginning.
Click on the links below to navigate to each topic, or read the entire piece for a step by step overview of basic bookkeeping tips for small businesses.
- Step One: Think about how your business will function
- Step Two: Open a business banking account
- Step Three: Choose an accounting method
- Step Four: Decide on a bookkeeping process
- Step Five: Invest in the right tools
- Step Six: Create a plan for payroll and taxes
- Step Seven: Put your process into motion
- Step Eight: Evaluate and adjust
- Step Nine: Stick to it
Step One: Think about how your business will function
Before you even begin making or recording business transactions, you should take a minute to think about how you want your business to function for the foreseeable future. Do you want to accept credit or invoice payments? Or would you prefer to just accept payment at the point of sale? Knowing this information before setting up your bookkeeping and accounting system can help you develop a process that’s tailored to your business operations.
Step Two: Open a business banking account
So you’ve come up with your business plan, identified how your product or service will address the needs of your customers, and you’re ready to open up shop. But before you move any further, it’s time to open a business banking account so that you can separate your business and personal finances. Making this distinction early on can make it easier for you to prepare small business taxes, interpret financial data, and ensure your business is in compliance with IRS and other government regulations. But choosing the right bank for your business isn’t as easy as it sounds. Follow these tips to help you find the best match for your business.
- Identify Your Needs: Every small business is unique, and each bank is, too. Some specialize in lending, while others focus on investment strategy or banking services. When choosing a bank for your business, you should consider what services you need to help you find a branch that can offer you the most bang for your buck.
- Read the Fine Print: When comparing banking options for your business, you should also take a close look at each bank’s fee structures. These extra expenses might impact your cash flow when you withdraw money, get an account statement, or process a credit card payment.
- Seek Advice: Ask other business owners in your area where they bank, and see if they’re satisfied with their service. Additionally, you might consider doing a little online research on the bank’s services and customer satisfaction.
Step Three: Choose an accounting method
Let’s review: you now have a registered small business, a bank account, and you even have a general idea of how your business will operate, that’s a great start! Now that you’ve identified these important details, you’re ready to establish a foundation for your business’ finance management by choosing an accounting method. Your accounting method will help you turn daily transactions into data that can inform your business decisions, maximize profitability, and even give you clues into your business’ financial future.
Cash vs. accrual accounting
There are two basic accounting methods to choose from when you’re deciding how to manage your business’ finances: cash basis accounting and accrual accounting. Each style has its advantages and disadvantages, and the method you choose depends on how your business operates, the resources you have, and what data you want to collect from financial reporting. Let’s discuss the basics of cash and accrual accounting to help you identify which style might work best for your small business.
- Transactions are recorded immediately when funds are withdrawn or received—cash in, cash out
- Quick and simple to manage
- Shows cash flow clearly
- Does not demonstrate long-term financial trends, which can hinder financial projections and business planning
- Best for: businesses without an inventory or invoicing system
- Transactions are recorded as payments are billed and earned, regardless of whether funds have actually been transferred
- Creates an immediate snapshot of finances, but fails to provide a clear representation of cash flow
- More complex to manage
- Can reduce tax burden
- Best for: businesses with a variety of account types such as Inventory, Credit/Debit, and Accounts Payable and receivable
Note: Publicly traded businesses may be required to subscribe to the accrual basis of accounting, according to GAAP standards.
In summary, cash accounting is the simpler of the two accounting systems and might make sense for a small company with a low volume of financial activity. Cash accounting provides an accurate depiction of the business’ cash flow but does not provide much insight on long-term trends that may be key in your financial reporting.
Accrual accounting is a more complex system that can be more challenging to manage, but it presents a more detailed picture of how a business is performing in the long-term, beyond just looking at cash flow. Additionally, accrual accounting tends to be a more realistic model for businesses who invoice their customers, or those who accept credit payments that don’t transfer funds immediately.
Step Four: Decide on a bookkeeping process
There are a few key differences between bookkeeping and accounting we need to discuss before you put your small business bookkeeping knowledge into practice. You can think of your accounting process as the overarching strategy that helps you get insight into your business’ finances—such as your income, expenses, and profit margins. These details can help you better manage your money and even maximize your small business’ profits. But in order to collect this important data, you’ll need to follow a bookkeeping process that tracks your daily transactions.
The two most common bookkeeping systems are double and single entry—and can be implemented by hand, with the help of a bookkeeping professional, or through the use of bookkeeping software.
Double entry bookkeeping vs. single entry bookkeeping
Before we dive into how you can set your bookkeeping and accounting systems up for success, let’s talk about how double and single entry bookkeeping fit into the puzzle.
Double entry bookkeeping
Double entry bookkeeping is the most popular bookkeeping method among businesses, large and small—and for good reason. Although it tends to be more complicated to manage, double entry allows your business to record many types of transactions and track accounts such as inventory, accounts payable, and accounts receivable.
Double entry bookkeeping is structured like this: for each account type you have, there will be two columns for each transaction (debit and credit). The double entry system creates a balance sheet that shows where the business stands with their assets, liabilities, and equity. If balanced properly, assets should equal liability, plus equity.
Assets = Liability + Equity
Most small businesses have a variety of accounts to keep track of, making double entry bookkeeping and accrual accounting the dynamic duo that most business owners opt for when it comes to managing their finances.
Single entry bookkeeping
Like cash basis accounting, single entry bookkeeping is a simple method of tracking finances and works best for very small businesses that do not have a high volume of activity or multitude of accounts to keep track of. Single entry bookkeeping means only one entry is made for each transaction—either negative or positive, depending on whether money is incoming or outgoing. This strategy is definitely easier to manage but business owners, beware: single entry bookkeeping can present a narrow view of how your business is performing as a whole, which could translate to issues later down the road.
Step Five: Invest in the right tools
Between managing your inventory, employees, and finding opportunities to grow your business, bookkeeping may not be at the top of your priority list. But as you know, proper bookkeeping and accounting are crucial to your business’ success. The good news is, there are many tools out there that can support your bookkeeping efforts to ensure consistency and improve efficiency. Let’s take a look at your options:
- DIY bookkeeping: Wondering “how do I keep my own books—let alone keep books for my business?” Well, you’re not alone. Few business owners dive into the world of bookkeeping for their business simply because of the potential for error and tedious nature of tracking each and every number that passes through your accounts. But, it can be done—use this guide as a starting point!
- Bookkeeping software: Now, even DIY small business bookkeepers need a little backup to curtail accounting mistakes and get better reports. In fact, 4% of business owners surveyed said they use accounting software to help them manage their business finances. A bookkeeping software system not only provides a platform for you to record transactions, but many have additional capabilities like payroll processing that can be useful for businesses that have employees.
- Bookkeeping and accounting services: If your head’s spinning thinking about all of these numbers and processes, you may consider hiring for bookkeeping and accounting services. A professional accountant or bookkeeper can handle transaction recording, create financial reports, and provide financial advice based on their findings. Not only does this minimize the potential for error, but it also frees up time for you as the business owner to focus on whatever else may be on your plate—such as generating leads or expanding your services.
Step Six: Create a plan for payroll and taxes
In addition to tracking your revenue and expenses, you will also need to consider two factors that impact your business’ financial standing and compliance with the IRS: payroll and small business taxes. Let’s discuss what you should know about these topics to effectively manage your business’ books.
Many small businesses operate on with a small-but-mighty force of employees—but with each member on your team, you’ll need to pay payroll taxes and set up a schedule for them to get paid. Both of these details should be included in your bookkeeping process, as these are expenses that your business should account for.
If you decide to hire independent contractors instead of employees, you won’t need to contribute to their FICA taxes, but you should be keeping track of each payment you make in your payroll ledger.
Small business taxes
Like individuals pay income tax, small businesses are responsible for their own contributions to the federal and state governments. Your bookkeeping process can help you plan for these tax expenses, record previous tax returns, and plan for your future tax bills. In addition to supporting your business’ financial goals, your bookkeeping process can help you stay in good standing with the IRS by providing documentation in case of an audit. The IRS recommends including these records in your books for their review:
- Gross receipts
- Travel, transportation, entertainment, and gift expenses
- Employment taxes
Step Seven: Put your process into motion
You’ve got all of the key components to begin bookkeeping for your small business, and now it’s time for you to take all that you’ve learned and put your knowledge into practice. Make it a habit for yourself and anyone else handling funds for your business to always keep receipts and follow the documentation process that you have in place. You and your staff should have a regular schedule for posting receipts and sales numbers to your general ledger, whether that’s once a week or every day if you need.
How often your post depends on how many sales you make and how many expenses your business has. A grocery store, for example, likely does hundreds of dollars in sales each day, so they would want to post their sales to the ledger daily. Most point of sale (POS) systems will automatically record this information to record in the ledger, but whether you do it by hand or with the help of a software program, this step is crucial if you want to stay on track with your books.
Step Eight: Evaluate and adjust
Even if you’ve nailed down a bookkeeping and accounting process that seems just perfect for your business, you should always take time to evaluate what is and isn’t working—and adjust if there’s any room for improvement. Hint: there’s always room for improvement.
In addition to taking a look at your process as a whole, it’s also important to look back at your books on a regular basis to identify trends, red flags, and ultimately, use these numbers to help you grow your business. Here are some key figures to pay attention to as you review your financial reports:
- Gross Margin: Your company’s gross margin is your net sales revenue minus the cost of goods sold (COGS). This number gives you insight into how much profit your business is actually making on sales. The formula for gross margin is: Gross Margin = Net Sales – COGS
- Profit and Loss: A profit and loss statement takes all of your company’s streams of revenue, and subtracts any expenses from that number. This is similar to the gross margin but considers factors beyond the products or services you sell, such as other assets like property or equipment.
- Trends: When you’re reviewing your books, you should also pay attention to any trends you notice in sales or expenses. Is there room for improvement? What can you do to fix downward sales trends? Are there expenses you can cut down on?
Step Nine: Stick to it
No matter how small your business is, it’s important to have documented procedures in place when it comes to managing your business’ finances. This way, anyone that’s recording transactions, looking at budgets, or entering data can follow the same process—which can help you avoid errors and obtain more valuable information.
Keeping books for your small business is no simple task—it involves attention to detail, a dedicated process, and a dose of trial and error to make sure your setup is just right. Use this guide as a resource to help you learn bookkeeping basics to manage finances on your own, or learn more about Community Tax bookkeeping services.