Reading this will either make you understand the basics of bookkeeping and encourage you to do it yourself as a small business owner or convince you to hire someone else. Do take note that this is written for small business owners in the US, as the names and laws may vary depending on where you are in the world.
What Is Bookkeeping And Why Is It Important?
In short, bookkeeping is keeping an accurate record of a business’s financial affairs. To rephrase this, bookkeeping is keeping track of money going in and out of a business. Being able to see the cash flow of a company is integral to knowing how to make things run in a more efficient manner. Knowing where you’re spending the most money and what sources are bringing you the most money can help you “trim the fat” off your business.
Another important benefit of keeping accurate track of your financials would be the tax deductions that you may be eligible for. Having an organized list of your expenses makes it easier to find out which deductibles you can avail of, even those commonly forgotten one-off tax-deductible expenses.
You’re also able to generate income statements based on your bookkeeping. This is critical for anyone applying for small business loans as it’s a requirement to show an income statement. If you’re planning to expand your business through the use of a loan, having proper up-to-date books goes a long way.
Steps To Start Bookkeeping As A Small Business Owner
Whether you’ll be hiring someone else or learning and doing it all yourself, here are several easy steps to start bookkeeping:
1 – Separate Business And Personal Finances
It might be tempting to combine the two as it would be easier to file taxes, but making sure it is clear what your business is earning and spending will make sure you’re abiding by the law. This is especially important in the event of an IRS audit, as mixing personal expenses with professional revenue may cause legal problems. On a separate note, as a small business owner, you should have a separate bank account for your business, to truly keep your finances separate and organized.
2 – Choose Between Single Or Double Entry
As a small business owner, you have the option to choose between single-entry and double-entry bookkeeping.
Single entry as its name suggests is where you input transactions only once, either as a positive or a negative. This method is simple and easy to do but is only meant for small businesses with a low volume of transactions. Meant to keep track of transactions but cannot be used for tax purposes.
Double-entry bookkeeping involves keeping track of the transactions between different accounts with two columns, debit and credit, with each transaction balancing itself out. For example, if you buy office supplies worth $100, you’d write $100 in the credit column, then also write $100 in the debit column because you gained $100 worth of office supplies which count as assets. Double-entry bookkeeping uses the following formula:
- Assets = Liabilities plus Equity
- Assets are the company’s non-monetary resources
- Liabilities include the debt your company owes others
- Equity is the amount of capital invested or owned
- Equity is calculated by subtracting the company’s total assets from its total liabilities
Types of accounts in the double-entry system:
- Equity (also called capital)
- Revenue/Income – capital generated from a sale or transaction resulting in a positive amount of money gained
- Expenses – capital lost from a transaction; business costs
3 – Choosing Cash And/Or Accrual Accounting
The cash basis is regarded as the easier method as the bookkeeping only follows cash. That means the only recognized transactions are when money is received or spent. This means cash basis bookkeeping doesn’t include accounts receivable or accounts payable accounts as those involve credit. This style of bookkeeping allows you to accurately track how much cash the business actually has at any given time.
The accrual basis of bookkeeping records transactions as they occur regardless of when the cash is received or paid. This means that credit is a factor in this style of bookkeeping. The major benefit to this method is that you get a better look at the overall income and expenses for a set period of time.
Many businesses actually use both styles but the cash basis is for normal bookkeeping while taxes are filed using the accrual style. Do take note that this involves an extra step and is more labor-intensive than just simply picking 1 style. However, selecting both would mean having the best of both worlds, being able to see how much cash you actually have, and the ability to file taxes on an accrual basis.
4 – Selecting A Bookkeeping System
While this sounds complicated, it’s actually just picking how you’re going to do your bookkeeping. It can be done manually, so you have a hardcopy ledger like back in the “good ol’ days” when everything was done with pen and paper.
If you elect to do it in a more modern way, you can use something like Excel or any spreadsheet-style program. Do note that more commonly used spreadsheet applications like Excel or Google Sheets will have templates available for download which will make your life easier, you just need to see which has all of the tools you need.
For more premium solutions, you can look into cloud accounting software. Two well-known applications that small to mid-sized businesses often use include Xero and QuickBooks. While the two systems function differently, the end goal of being able to keep accurate and easy-to-analyze records is achieved through either one.
5 – Have A System To Organize And Store Your Financial Documents
If you’ve ever held onto receipts for a long period of time just for tax season, this is essentially that but on a more professional level.
- For purchases over $75, make sure you have proof of the transaction
- Keep records going back 3 years
- Records can be digital
- Receipts are needed as proof during an audit, they’re not needed to file taxes
6 – Stay Consistent
This step will change depending on whether you’re doing the bookkeeping as the business owner or if you’ve hired someone full-time to do it, with the latter option nullifying most of this step as it’s their full-time job.
Staying consistent in your record-keeping will help keep everything in order. If you’re swamped and cannot update your records at the end of each day without working past the clock, set aside at least 1 day a month dedicated to the task. Updating your records daily is ideal, but might not work without having a dedicated bookkeeper.
By keeping a consistent schedule when updating your records, it will soon become second nature. Getting to this point is important in order to make tax season a breeze instead of a constant nagging pain.
The Wrap Up
Bookkeeping is a necessary part of owning a business and successfully doing it means keeping your business running efficiently. Setting everything up is the most laborious part but once it’s set up, everything should run smoothly as long as you follow the basic steps and make it into a habit. For those who have too much on their plate, hiring a dedicated bookkeeper is probably the best option in order to avoid any legal issues down the road. For those who cannot financially afford to hire due to budget restrictions, hiring remote staff bookkeepers or accountants is always an option, as not complying with tax regulations would put your business at risk.