Small Business Bookkeeping Basics: A How-To Guide
Proper account bookkeeping is one of the most critical tasks for a small business. Good records are necessary for the preparation of tax returns, Internal Revenue Service and insurance audits, and bank financing. Therefore, it's important to get started with a good accounting system, and maintain your backup records in a logical manner.
Some new business owners think they must hire a costly CPA or a full-time bookkeeper, but this is simply not the case. In fact, anyone with ample knowledge and the right systems in place can keep proper records. Read on to learn high-level bookkeeping basics, including:
- Defining what is bookkeeping and what it involves
- Bookkeeping principles
- Implementing a bookkeeping system
- How to get started with bookkeeping
What Is Bookkeeping?
Bookkeeping is the process of keeping record of financial transactions. For businesses, bookkeeping is a part of overall business accounting. A sound business bookkeeping process should include proper maintenance of records such as business transactions, operational costs, and other related expenses.
The primary purpose of bookkeeping is to record financial transactions and information related to the business. It's critical that financial transactions and records are up-to-date and accurate, and implementing the following bookkeeping principles can help.
Every business, no matter how small, should open a separate bank account for business transactions. This way, all business transactions can easily be tracked through one account. As a general rule, business owners should refrain from making personal purchases from their business accounts and business purchases from their personal accounts.
Many new business owners think that books and records need to be complicated. This is not the case. The primary consideration of an accounting system is that the data can be easily understood and used to make informed business decisions. Every business owner should be able to easily access their business results, so they can make educated decisions about the finances and direction of the business.
If a business is very small, a simple handwritten ledger or checkbook register will suffice. In the ledger or register, the owner would simply track the amount of income, where the income was derived, and any associated expenses. The same could be done with an Excel spreadsheet, showing different types of income and expenses, how they were derived, and the business purpose of those expenses.
If a business owner decides that their system needs to be more detailed, they can use an online accounting solution. In-house bookkeeping has become more prevalent in recent years, especially with the advent of do-it-yourself bookkeeping programs. There are many advantages to these programs, such as simplicity, accuracy, and ease of reporting and analyzing.
Sometimes a business owner might need to verify items contained in their books. During IRS audits, paperwork retention is an area where many small businesses fall short. Lack of proper documentation in an IRS audit can lead to disallowance of deductions, resulting in additional taxes owed. The IRS can also levy negligence penalties on a taxpayer for not maintaining their records in a logical manner.
The main rule is that any item entered into a handwritten ledger or computerized books should have documentation to show where that figure came from. For example, income can be verified through bank deposit slips, contracts, or a cash receipt book. Additionally, expenses can be verified through bank statements, credit card statements, or a cash receipt.
Any filing system that is easy for the business owner to understand is acceptable. Simply keeping receipts sorted in folders for different expense categories is sufficient. For computer-savvy business owners, systems using a scanner are convenient. Receipts and other business documents can be scanned, saved to a computer file, and accessed at any time. This way, there is no concern that small documents may be lost or destroyed. The IRS accepts electronic records, as long as that system indexes, stores, preserves, retrieves, and reproduces the electronic records in a legible, readable format.
Implementing a Bookkeeping System
Before focusing on details about specific systems or bank accounts, the first steps in implementing a bookkeeping system should include defining your business needs, setting a budget, and determining who will be responsible for certain bookkeeping processes.
Define Your Needs
When looking for a bookkeeping system for your business, look for a program that can handle all your tasks, both current and future. Even at the outset it's smart to think farther down the road, when your business will be growing and your needs changing, because switching bookkeeping systems later may be a hassle.
So while spreadsheets work well enough for simply tracking and sorting transactions, that system can get outdated very quickly, particularly when a business grows and the volume multiplies.
Set a Budget
The early stages of starting a business can be fragile financially, but there are plenty of accounting programs on the market that won't break the bank. Besides, the most expensive software doesn't always mean it's the right fit for your business. Additionally, consider the pros and cons of a custom accounting program vs. a non-custom program — the latter can usually accomplish similar tasks at a much more affordable price.
Determine Who Will Manage the Bookkeeping
It's a misconception that bookkeeping tasks can be entirely outsourced to a third party. Finding a good balance between in-house and outsourced accounting can help your business run more efficiently.
Some basic bookkeeping procedures, such as coding transactions, maintaining accounts payable/receivable, and financial reporting are good candidates for outsourcing. Offloading these tasks can free up time for in-house staff to focus on activities that grow the business.
Cash transactions are one area that should be handled in house, because cash flow is vital to keeping any new business afloat. With cash transactions handled internally, someone onsite will always know who owes what, who needs to be paid, and how much is available at any given time. In-house accounting managers should also have direct access to management, and vice versa.
How To Get Started With Small Business Bookkeeping
When getting started with business bookkeeping, it's generally better to start sooner rather than later. That means it's a lot harder to retroactively implement new software or processes than it is to take a little longer in the beginning to ensure that everything is in place. The following steps can help you get started with bookkeeping.
Formalize Your Business
Before you can start keeping track of finances, your company must be properly defined and licensed. One of the first steps to formalizing a new business venture is to apply for a tax identification number. Research state and federal corporate business permit and license requirements and file the appropriate paperwork. Also, select a business structure that's based on planned growth and the number of employees you intend to hire. Business structures can include sole proprietorships, limited liability companies (LLCs), cooperatives, and corporations.
Contact Small Business Groups
For general questions about accounting, seek out local small business associations and advisory groups. You can also check out your closest Small Business Development Center, where you'll find workshops and consulting services. SCORE, a national nonprofit dedicated to assisting small businesses, is another great resource if they have a chapter in your area. SCORE offers free seminars, accounting help, and one-on-one mentoring services from local experts.
Open Up a Separate Bank Account and Credit Card
As mentioned above, separating business from pleasure is a must. Setting up an exclusive bank account and business credit card is the best way to avoid mixing personal and business finances — a common error made by new business owners. It also eases the complexity of tracking receipts and disbursements until you establish a formal accounting system while also building up business credit. Whether your transactions appear on your personal or business credit report depends entirely on the business card issuer you choose.
Obtain an Online Accounting Program
As soon as your business carries out a financial transaction, it will need to be logged and reported. As a business expands, the amount of financial data also increases, since you'll be managing everything from simple daily invoices to complex annual reports. Online accounting offers various other benefits, such as:
- Bookkeeping collaboration through the cloud
- Information security controls designed to protect your information
- A customized mobile experience
Starting the accounting process for a small business can be complex, but understanding bookkeeping basics can help demystify some of the key steps. Affirming your business structure, separating your business and personal transactions, staying organized through an online accounting program, and seeking help from your local community can all alleviate the burdens that often accompany managing your small business finances.
Of course, bookkeeping is just one of many processes that small business owners need to think about. Fortunately, help is available. Find more information about how you can help your organization succeed through a range of flexible solutions built specifically for small businesses.