small business counting money
22-Aug-2020 By - Anna Eydlish

How do you account for a small business?

Small business accounting involves the process of tracking, recording and analyzing the financial transactions of your business. It translates numbers into a comprehensible statement about the profitability of your business.

Accounting may be a more tedious aspect of running a business, but it is also necessary to avoid cash flow snafus and piles of paperwork.

Accounting for small businesses is done by keeping a complete record of all the income and expenses and accurately extracting financial information from business transactions.

This is a necessary chore that helps small business owners track and manage their money effectively – especially during the early stages. 

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Besides keeping you aware of your business’ past and present performance, small business accounting also helps in generating invoices and completing payroll.

When you opened the doors of your small business, you were probably excited to meet your first customers and start turning a profit. In contrast, you might have felt less enthusiastic about learning to bookkeep, especially if you’ve never thought of yourself as a “math person.”

But to run a small business, you have to be at least a little skilled in the art of bookkeeping. The thought might be overwhelming if you’re more passionate about, say, selling used books or offering excellent life-coaching advice than you are about numbers—but a basic understanding of bookkeeping can revolutionize your business. Bookkeeping is the process of recording and organizing a business’s financial transactions.

With the right bookkeeping tools, you’ll feel more confident in your business’s future and better able to understand (and plan for) your own profitability. Best of all, you don’t need to become an overnight calculus expert to understand bookkeeping. Instead, just keep reading—the tips we list below can help you get a handle on bookkeeping basics that will help your small business succeed.

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What is bookkeeping?

Before we dive in, let’s define what bookkeeping actually is.

Bookkeeping is the process of recording and organizing a business’s financial transactions, and a bookkeeper is a person responsible for that process. Bookkeeping is the primary way business owners can figure out if their business is profitable: keeping an eye on your numbers lets you identify financial challenges early on and address them before they blossom into a full-fledged crisis. Bookkeeping also helps you identify areas of profit expansion—areas you might not have noticed without clear financial reports you can interpret easily.

The following nine accounts should be set up and tracked by all but the smallest businesses to provide adequate financial information for the company’s accountant for financial statements and taxes:

  • Cash. It doesn’t get more basic than this. All your business transactions pass through the Cash account, which is so important that often bookkeepers actually use two journals, Cash Receipts and Cash Disbursements, to track the activity.
  • Accounts Receivable. If your company sells products or services and doesn’t collect payment immediately, you have “receivables,” or money due from customers. You must track Accounts Receivable and keep it up to date so that you send timely and accurate bills or invoices.
  • Inventory. Unsold products are like money sitting on a shelf and must be carefully accounted for and tracked. The numbers in your books should be periodically tested by doing physical counts of inventory on hand.
  • Accounts Payable. No one likes to send money out of business, but a clear view of everything via your Accounts Payable makes it a little less painful. Concise bookkeeping helps assure timely payments and avoid paying someone twice! Paying bills early can also qualify your business for discounts.
  • Loans Payable. If you’ve borrowed money to buy equipment, vehicles, furniture or other items for your business, this account tracks payments and due dates.
  • Sales. The Sales account tracks all incoming revenue from what you sell. Recording sales in a timely and accurate manner is critical to knowing where your business stands.
  • Purchases. The Purchases Account tracks any raw materials or finished goods that you buy for your business. It’s a key component of calculating “Cost of Goods Sold” (COGS), which you subtract from Sales to find your company’s gross profit.
  • Payroll Expenses. For many businesses, payroll expenses can be the biggest cost of all. Keeping this account accurate and up to date is essential for meeting tax and other government reporting requirements. Shirking those responsibilities will put you in serious hot water.
  • Owners Equity. This account has a nice ring to it. It tracks the amount an owner (or owners) puts into the business. Also referred to as net assets, owners equity reflects the amount of money an owner has once liabilities are subtracted from assets.
  • Retained Earnings. The Retained Earnings account tracks any company 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 the company has performed over time.

Bookkeeping Methods

The two methods of bookkeeping are single-entry and double-entry. Most businesses use the double-entry bookkeeping system in which every entry to an account requires a corresponding and opposite entry to a different account.

For instance, a $10 cash sale would require posting two entries: a debit entry of $10 to an account called “Cash” and a $10 credit entry to an account called “Revenue.”

The key attributes of a good bookkeeper are a stickler for accuracy and completeness. Because even the most thorough bookkeeper can make mistakes, a bookkeeper usually works under the direction of an accountant unless the business is very small. Some studies have found that an external accountant may be best.2 If the business is very small, bookkeeping may be very much like keeping your chequebook.

Accounting

Accounting has been called the language of business. It is the process of measuring, processing, and communicating financial information. Accounting provides the business owner with information about the company’s resources, finances, and the results the business achieves through its use.

The function of accounting is to prepare a record of the company’s financial affairs. Accounting includes the interpretation of the numbers prepared by the bookkeeper to determine the financial health of the business.

It also includes the presentation of the financial health of a company, which involves preparing financial statements, and indicators that can be derived from them. Furthermore, a function of accounting is the preparation of tax and other financial materials necessary.

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Accounting Methods

There are two different methods of accounting. One is based on the cash you have, and the cash you have received. The other is accrual basis accounting. If you have an inventory or a possibility of being audited, you are required to use accrual basis accounting.

Cash-based accounting is much simpler than accrual basis accounting. In cash-based accounting, you record revenue when you receive it, and record payments when they are made. This method is usually limited to small businesses in the service industry that has no inventory.

The accrual basis accounting method is based on when revenues are earned, rather than received. This can be thought of as value being transferred between accounts. If you purchase a point of sale terminal, you transfer value from your cash account to your equipment account.

Credit is recorded to the cash account, and debit is recorded to the equipment account. A chart of accounts can help you decide when to credit or debit accounts.

The accounting function can also be outsourced to a private entity. In some small businesses, the bookkeeping and accounting functions are both outsourced. If you outsource your bookkeeping and accounting, you’ll still want to be familiar with them both to understand the reports you’ll receive.

In general, a bookkeeper records transactions sends invoices, makes payments, manages accounts, and prepares financial statements. Bookkeeping and accounting are similar, but bookkeeping lays the basis for the accounting process—accounting focuses more on analyzing the data that bookkeeping merely collects.

Setting Up the Chart of Accounts

When you start a new business, you set up your chart of accounts as a first step in establishing your company’s accounting system. Small businesses don’t all have the same chart of accounts. The accounts you include depends on the type of business. For example, if you have a service business, you won’t have an inventory account.

When you set up your chart of accounts, think of the future. Don’t just think about the accounts you need for your small business now. Think of the accounts you may need 5 or 10 years down the line and include those in your chart. You may not have employees now, but in a few years, you may add employees to your business, so plan for that with your chart. You still may have to add accounts to your chart as you go along.

You should create a numbering system for your chart of accounts. If you are going to use a computerized accounting system, use a four-digit numbering system. A block of numbers is usually assigned to each of the categories that make up the chart of accounts, and blank numbers are left at the end for additional accounts to be added in the future.

As a part of the accounting cycle, the chart of accounts is used in journal transactions, and there are five categories on the chart of accounts:

  • Assets
  • Liabilities
  • Owner’s Equity
  • Revenue
  • Expenses

Assets

The asset category is where you keep track of what your company owns. You may want your asset category to start with the number 1000. That is usually the number that computerized accounting programs use. Number each asset account in a sequence such as 1000, 1010, 1020, and so on, beginning with current assets and moving on to fixed assets.

Current assets will include accounts for cash on hands, such as cash in your checking and savings accounts. You may have customers to whom you extend credit so that you will need accounts receivable account. If you sell products, you will need an inventory account.

After your fixed asset account, put in an account for accumulated depreciation. It is always a negative number on balance and is directly related to your fixed assets since that is what you are depreciating. Do not leave any space for any other accounts between fixed assets and the accumulated depreciation. You may have accumulated depreciation for more than one fixed asset. You can depreciate your buildings, vehicles, business equipment, and so on.

Liabilities

The liabilities category is where you keep track of your company’s debt obligations or what your company owes or may owe in the future. You may want to start numbering the liabilities section with 2000. Just like with the assets category, you want to follow the traditional form of the balance sheet in developing the liabilities section of the chart of accounts. You will have a current liabilities section and a long-term liabilities section.

The current liabilities section will include short-term debt accounts like accounts payable, the account where you will record what you owe your suppliers. It also will consist of your accrual accounts, which include what you owe in payroll taxes and sales taxes. You also will have an account for accrued wages. You might also have a current liability account for credit cards payable and short-term loans payable.

In the future, you may incur some long-term debt such as a mortgage. You should include space in your chart of accounts for other long-term debt accounts.

Owner’s Equity

The owner’s equity accounts include your investment in the business. In case you decide to take on other investors somewhere along the line, you should include accounts for common stock and, perhaps, preferred stock. You will want an account for retained earnings for any profits you plough back into the company. You usually start the owner’s equity accounts with 3000.

Revenues

Sales revenue is the first account on the chart of accounts related to the income statement. Sales revenues are the primary source of income for your business, and this section of the chart of accounts usually starts with 4000. Along with the sales revenue account, you may want to include an account for sales discounts and sales returns and allowances. You also will want to include an account for interest income for any income you earn on your company’s investments.

Sales costs or costs of goods sold is usually the next type of account to consider. Even service businesses have to consider sales costs. You also include accounts for discounts from suppliers, costs of shipping, and miscellaneous sales costs.

Expenses

The last category listed on the chart of accounts is the expense category, which usually is numbered 5000. A handy way to list expenses in the chart of accounts is to look at IRS Tax Form Schedule C and follow the way expenses are listed on that form. That makes it easy for you and your accountant when tax time comes. Develop an account for each of the expenses listed on Schedule C plus any other expenses specific to your firm. Leave several blank accounts available in case you need them in the future. Assign a number in the 5000-5999 range to each.

Why is small-business bookkeeping important?

Bookkeeping is essential to the vitality and long-term success of any small business. How? Primarily, you need to have an accurate picture of all the financial ins and outs of your business. From the cash you have on hand to the debts you owe, understanding the state of your business’s finances means you can make better decisions and plan for the future.

Accurate bookkeeping also protects your business. For example, you may find yourself in a dispute with a vendor or under audit by the government. Without clean financial records, you may be at risk of paying settlements or tax penalties for avoidable financial errors. You also may be able to prevent or uncover fraud, whether from customers, vendors, or employees.

Bookkeeping also saves you time. From payroll taxes to managing invoices, efficient bookkeeping smooths out the process of all your business’s financial tasks and keeps you from wasting time tracking down every dollar.

You can focus on what matters to you most; building your business, saving you time and money, plus giving you peace of mind with right Business Bookkeeping.

When do I need extra bookkeeping help?

If you’re a small-business owner, you’re probably used to doing everything yourself. You’ve used your entrepreneurial prowess to produce a product or service that your customers need. And avoiding spending any money when you think you can just take care of a task yourself is tempting.

But bookkeeping mistakes are costly and threaten success. For instance, ever looked at your bank statements and thought, Where is all the money we made this month? Then it’s time to get help with bookkeeping.

As a small-business owner, you have a few cost-effective bookkeeping solutions:

  • Hiring an in-house accountant or bookkeeper
  • Investing in bookkeeping or accounting software
  • Outsourcing your bookkeeping to a third-party company

Both in-house and outsourced bookkeepers are pretty expensive, but since they handle every bookkeeping task for you, they take a lot of time, effort, and worry off your plate. If you need a cheaper solution, though, bookkeeping software takes care of the basics without foisting too much manual work on you: they reconcile bank transactions, adjust account balances, and generate financial statements.

Whether you take on your small-business bookkeeping yourself or get help from an expert, understanding the basics will help you better manage your finances. You’ll save time chasing receipts, protect yourself from costly errors, and gain valuable insights into your business’s potential.

Guest post by : Anna Eydlish Form -

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