Proper 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 (IRS) audits, insurance audits, and bank financing. Therefore, it is 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 can keep proper records by keeping in mind a few simple principles:
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. 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. Income can be verified through bank deposit slips, contracts, or a cash receipt book. 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. In Publication 552, the IRS has stated that electronic records are acceptable, as long as that system indexes, stores, preserves, retrieves, and reproduces the electronic records in a legible, readable format.