A Simple Guide to Small Business Accounting
Whether you’re just starting a small business or if you’re a veteran you already know small business accounting can seem daunting. Your business’ financial records have a high impact on your budgeting, decision making, financial planning, and taxes so it pays off to do this right.
This article hits the highlights of small business bookkeeping and arms you with the knowledge to set you up for success.
1. Learn the major bookkeeping and accounting lingo.
It doesn’t matter if you’re a beginner at bookkeeping and accounting or if you’re a seasoned professional, the list below get you on the right track or provide you with a great refresher”
What is revenue? Inflows of cash coming into your business bank account from delivering goods or services to customers.
Revenue has similar terms: Revenue can commonly be referred to as “Sales” or “Income”
What is an expense? Expenses are outflows of cash from your business bank account to pay for the business’s main operations of producing and/or delivering goods or services.
What is profit? Profit is the amount of money left over after all expenses have been accounted for in a certain period of time.
Example: Revenues - Expenses = Profit
Profit is measured over a period of time such as a specific month, quarter, or a year.
What is an asset? An asset is something your business owns. This could be equipment, inventory, office furniture, etc.
What is a liability? A liability is something that your business owes. This could be a balance on a credit card or small business loan. If you purchase office supplies and put the purchase on a business credit card your business did create an expense, but also a liability.
What is equity? Equity, in a simplified explanation, is the amount of money your company is worth. The equation used to calculate the amount of equity your company has is: Assets - Liabilities = Equity. In completing some simple algebra another version of this equation is Asset = Liabilities + Equity. This equation is also known as the official accounting equation.
What are accounts receivable? Accounts receivable is the total amount of money your customers owe to your company for goods or services they have purchased but not yet paid for.
What are accounts payable? Accounts payable is the total amount of money your company owes others for goods or services it has purchased but not yet paid for.
2. Learn about the top 3 financial statements.
Now that we have reviewed the most common accounting definitions let's explore where they fit into financial statements.
Financial statements are oh so very important to business owners as they help gather information on the current financial health of the company and assist in moving the company forward with developing a strategic plan to take it to the next level.
Income Statement, aka Profit and Loss Statement, aka P&L:
This is a fairly simple report and probably the most important of the three.
This statement will help you determine whether your business is profitable, and by how much, for the time period of the report (month/quarter/year).
Your P&L will list revenue at the top, expenses in the middle, and profit at the bottom. The numbers will flow to the tune of: Revenues - Expenses = Profit.
Business owners operating a business of any size will need to keep an eye on their P&L. The larger your business is the more often your P&L needs to be reviewed.
Balance Sheet:
A balance sheet shows the assets, liabilities and equity of a business.
Generally assets will be displayed at the top 1/3rd of the report, liabilities are in the middle, and equity is displayed at the bottom. The numbers will flow to the tune of: Assets - Liabilities = Equity.
The time intervals are a little bit different for balance sheets as opposed to income statements. Income statements are like a movie, they show what occurred over a certain period of time. Balance sheets are like a picture. They show a company’s assets, liabilities, and equity on a certain day. For best results generally balance sheets should display its data as of the last day of the time period in question. For example, the last day of the month that just ended, or last day of the previous year.
Business owners operating side hustles or smaller type businesses with no employees will tend not to need to check their balance sheet very often. Smaller businesses may have a small amount of assets and zero liabilities, making this financial statement very simple for them and not crucial.
As a business grows and gains more in assets and liabilities, checking the balance sheet more often will be needed for current and future strategic planning purposes.
This is by far the most confusing of the three financial statements and the one that is used the least often. The next few paragraphs will help you crack the code to the statement of cash flows.
To the untrained eye one may think: Why do we need THIS financial statement? Aren’t all of our expenses on the P&L? I totally understand. The P&L is the most widely used financial statement and one of the easiest to understand, but it can be deceiving. Not all cash outflows (and inflows) are on the P&L, which brings us to needing the statement of cash flows.
The P&L lists all business expenses for the time period, but not all cash outflows are business expenses. For example, what if the business pays off a huge loan. Is that an expense? No, business expenses are only cash outflows that relate to the central operations of the business. Cash outflows and inflows from loans are not on the P&L, but they are important to track.
The statement of cash flows has three main categories:
Cash flows from operations
Cash flows from financing activities
Cash flows from investing activities
We’ll dive deeper into a statement of cash flows in a separately dedicated blog post.
3. Learn the importance of tracking business transactions
Tracking business transactions must be done at least once per year for tax preparation purposes. You’ll need to know your total revenues, total expenses by category, and total profit.
It’s not required, but its better if you keep up a record of business transactions more often than once per year to prevent a backlog, and for business financial planning/strategy purposes.
It’s crucial to have a separate business bank account where only business transactions take place. Keep the personal transactions out of it. You can have a business credit card as well if you’d like, but have the same “no personal expenses” policy.
4. Learn about completing your bookkeeping records
In short, bookkeeping is keeping track of your business transactions, categorizing them appropriately and placing them in such a way that they can be easily summarized and understood.
The simplest way to track your business transactions is downloading your bank statement into an excel spreadsheet and having an extra column that places each transaction into an appropriate category. Note that if you have a lot of transactions using the excel spreadsheet method will not be efficient, this is where bookkeeping software can be highly useful.
When it comes to bookkeeping software there are a lot of options out there. The top two options I see client’s having a lot of success with are Wave and Quickbooks Online. I recommend avoiding Quickbooks Desktop.
5. Options for completing your company’s bookkeeping
You can teach yourself how to use bookkeeping software and do your business bookkeeping yourself. It may take a few lessons, but it is something that can be done.
One thing to note if you learn how to do your own bookkeeping is: In whatever software you use I strongly recommend making sure that your company’s bookkeeping records are reconciled to the business bank accounts and credit card statements. This will be crucial for tax preparation purposes.
I recommend hiring a professional to make sure your bookkeeping gets the proper start that is needed even if you want to keep up with your own bookkeeping. Feel free to book a call with me and we’ll get your bookkeeping started on the right path. We’ll help you navigate setting up your opening balances, chart of accounts, and guide you through choosing the right accounting method.
In the long run, you probably don’t need to keep doing your books all the time. You’re better at growing and running your business. In fact, the sooner you can let go of doing your company’s books the more time you can dedicate to your more valuable tasks. When you’re ready to hand the bookkeeping tasks off to a professional book a call with me and let us take your bookkeeping to the next level.
6. Learn the importance of documentation
If you’re a business owner you know (or will soon find out) that your responsibilities are higher and your tax situation is more complicated.
For every tax deduction a taxpayer takes I always say they need to have supporting documentation to prove that they are allowed to take that deduction in the case of an audit. Get caught in an audit and can’t prove any of your business expenses that you took as a deduction on your tax return? The IRS can “disallow” all of those deductions and you’ll owe the difference in taxes (plus penalties and interest). This could be a lot of money when all is said and done.
To avoid the above situation a business owner will need to keep on file the following documents to help them prove their business expense deductions:
Bank Statements
Credit Card Statements
Canceled Checks
Receipts
Bills
Customer Invoices
Customer Payments
Sales Receipts
Deposit Slips
Tax Returns
1099 Forms
Payroll Documentation
When in doubt, scan a document and save it to a central location in the cloud. Separate files by tax year for better organization.
7. Learn about the importance of a cash cushion
One financial strategy that savvy business owners implement is having an adequate cash cushion. In business revenue can fluctuate, however there are a good bit of expenses (especially with bigger businesses) that are more fixed. Having an adequate cushion of cash helps you as a business owner be less stressed when your revenue fluctuates.
One example of this is a seasonal business that rents a building year round and has full time employees. The rent and the employees will get paid the same amount of money every month, but the revenues will be large in the peak season part of the year and small in the off season. Having an adequate amount of cash cushion will allow this type of business to make its payroll and rent payments.
For smaller businesses with no employees or rent a cash cushion is less crucial, but as a business grows, so should its cash cushion. I recommend you keep 6 to 12 months of expenses on hand for your business, especially if you’re employing people full time.
8. Learn about end of year accounting tasks
At the end of the year your company’s bookkeeping will most likely require a few year end adjustments. This can be completed through making journal entries to your bookkeeping software. If you’re using excel and have a lot of transactions or have more complex bookkeeping that comes with paying employees the year end adjustments could get complicated. It’d be best to pass all year end adjustments off to a professional accountant or your tax preparer.
Be sure to have your company’s bookkeeping records reconciled to their bank statements and credit card statements by the end of the year. A good tax preparer will be on the lookout for this to have been completed for accuracy in the tax preparation process.
Once your bookkeeping is complete for the year you can then run year end financial statements to hand off to your tax accountant.
Need more bookkeeping and accounting help?
Managing your company’s finances and taxes is daunting. Let us help you with this and take it off your plate. This way you can get back to growing your business. Click here to book a call with me and let’s take your bookkeeping to the next level.