Aside from the business itself, there’s a lot that goes into owning a business that might not be in the realm of your expertise. Whether it’s managing employees, creating a business website and a marketing plan, or taking care of the admin side, running your own company will require you to become an expert in a broad number of subjects.
Bookkeeping is one of the most important subjects where you’ll need to excel in order to run a successful business, as it allows you to have a full understanding of your finances both on a daily basis as well as in the long run.
Despite its seemingly steep learning curve, especially alarming for those who describe themselves as “not a numbers person”, learning how to do bookkeeping isn’t difficult at all with the right guidance. In this beginners guide, we’ll take a closer look at the most important small business bookkeeping basics you need to know.
What is bookkeeping?
Traditionally, bookkeeping was the act of entering all your business’s transactions into a book to see how you’re spending money. While most businesses have already swapped books for spreadsheets and accounting software, the concept is still the same. Nowadays, the process generally starts by defining the limits between company and personal assets, selecting a small business accounting method, setting up payroll, and taking care of the business’s taxes.
While this might sound similar to accounting, the role of bookkeeping and accounting aren’t identical, but they do often go hand-in-hand. Bookkeeping is focused on organizing your business transactions like revenue, debits, credits, sunk costs and expenditures. Once those transactions are organized, the role of an accountant is to analyze them in order to create statements and reports for the business on where they currently are financially and how they can improve in addition to filing tax returns.
The importance of bookkeeping
Bookkeeping isn’t a task you can sweep under the rug. It’s essential that you get a good grasp of what bookkeeping for your small business looks like before you turn to outside help or even accounting software. Here are a few of the main reasons why bookkeeping is so important for small business owners:
Separate business from personal
After starting a new business, many business owners struggle to separate their personal finances from their business. While any small business owner probably feels personally attached to their business, that doesn’t mean their personal accounts need to be involved in running it. Bookkeeping helps you keep those worlds apart in order to ensure your business debts are held completely separate from your personal finances.
Help prevent errors
Everyone makes mistakes. Whether a mistake is made by an employee, a miscalculation from your bank, or something you did yourself, bookkeeping allows you to closely track all your transactions to pinpoint specific errors. While one miscalculation likely won’t throw your whole business off its financial goals, the accumulation of small mistakes over time can make a difference. Regularly keeping on top of your bookkeeping prevents these errors from impacting your bottom line and helps you prevent them from happening again.
Track your progress
There are several ways to assess if your business is succeeding, and bookkeeping is just one of them. By regularly recording your transactions and staying on top of cash flow, earnings and retained earnings you’ll be able to identify areas for improvement and get a good overall picture of your business’s finances. Furthermore, looking at where exactly your money is going and coming from, you can make smarter decisions to cut costs and decide where to focus your efforts on the things that are bringing more money in.
Make tax season easier
Filing taxes can be a nightmare for small business owners, unless you’ve been keeping track of your finances all year long. When it comes time to gather all necessary documents and turn them over to your accountant, it will be much simpler if you’ve been bookkeeping the whole year and already have a good idea of what tax deductions your business is eligible to claim. Additionally, this will reduce the chances of any surprises after submitting your tax return, giving you more peace of mind.
Allows you to get a loan
Knowing the true cost of starting a business will help you decided whether you need to take out a loan. As a small business owner, you’ll likely be asked for proof in the form of financial statements and records. Lenders want to know the ins and outs of your business’s finances, and if that’s not organized enough to begin with, your chances of getting approved will likely decrease. By clearly having records of things like cash flow, revenue, liabilities, and debts, raising money for your business will become a lot simpler.
How to do bookkeeping for small businesses
01. Set up and separate your business accounts
The first thing you want to do when establishing the bookkeeping process for your small business is ensuring that there’s no crossover with your personal accounts. Aside from making it easier to discern your business income from your personal funds, having a separate business bank account protects your personal assets from any liabilities. This means that if your business were to run into any issues such as a lawsuit or bankruptcy, your personal funds would remain protected.
After separating your bank accounts, you should also consider getting a credit card specifically for business expenses. This will help you build up credit for your business so if you ever need to apply for a loan or any type of funding, your business has its own credit history.
02. Decide on a bookkeeping system
There’s more than one way to go about bookkeeping, so one of the first decisions you’ll need to make is deciding which system works best for your business. You have a few options on how you want to go about your bookkeeping: you can do it yourself either manually or with accounting software such as Quickbooks, you can go to an external professional bookkeeper, or you can even hire your own in-house bookkeeper.
The option you choose will likely depend on where your business is at. If you’re just starting out, you’ll likely be fine with using DIY software and you can move on to an in-house bookkeeper when you grow.
Aside from deciding how you’ll go about bookkeeping, you also need to decide on the method you’ll use. Generally, you can use either a single-entry or double-entry method.
Single-entry bookkeeping: you record each transaction in your books one time. For example, if you made a sale and received payment, that would be noted in your books as one transaction.
Double-entry bookkeeping: each transaction has its own credit and debit, so the same amount is noted twice in your book. Most professional bookkeepers and accounting software will use the double-entry method.
In addition to your bookkeeping method, you’ll also need to decide on your accounting method. There are also two options for this: cash and accrual.
Cash method: you note all transactions only when the money is received or paid. For example, if you invoice a customer today but don’t receive the money in your account for another week, then it would only be noted when your money enters your bank account.
Accrual method: you note all transactions at the point when you invoice someone or receive a bill. With this method, you’ll need to track your accounts payable and receivable.
For both bookkeeping and accounting methods, you’ll need to determine which is better for your business. In general, for smaller businesses it’s recommended to start with single-entry bookkeeping and cash accounting.
03. Categorize all transactions
Once you’ve selected which bookkeeping system you’re going to use, you’ll need to start recording every transaction regularly. It’s smart to input transactions as they happen, since otherwise you might forget what it was for and thus won’t be tracked correctly.
When categorizing your transactions, there are a few ways to break them down. For starters, each transaction should be noted as either a credit or a debit. A credit refers to money coming into an account, and a debit is the money going out of an account. In a double-entry bookkeeping system, you would have both a credit and debit for each transaction.
Aside from debits and credits, you can further categorize where money is going to and from by referring to different accounts. Generally, there are five types of accounts:
Assets: anything that your company owns, like equipment, cash, or inventory
Liabilities: money owed to someone, such as a loan or payment to a vendor
Equity: money that comes from the company owner, usually that won’t be paid back
Revenue: money received as a result of sales or services performed
Expenses: money you use to run your business
04. Decide how to store your documents
Bills, invoices, expense reports, credit card statements… The paperwork adds up and it needs somewhere to be safely kept in. Not only is it important to keep documentation of your transactions for yourself, but occasionally the IRS (internal revenue service) might request to see the documentation as proof of expenses.
That being said, you don’t need to start stacking shelves full of folders to store all your documents. You can invest in a way to store them digitally to keep all your transaction records in one place. Apps like Dropbox, Google Drive, or Shoeboxed help you store your receipts in one place so you never need to worry about losing, misplacing, or having the ink fade on a receipt from a client's lunch.
05. Balance your books
If you’ve been recording all your transactions and noting them as credits and debits, then you’ll eventually need to balance your books. Whether you choose to do that at the end of every month, quarter, or each year is up to you.
For many small business owners, balancing the books mainly means looking at your assets and liabilities using a simple equation to figure out your business equity. The equation should look like this:
Equity = Total Assets - Total Liabilities
It’s normal for there to be some mistakes while balancing your books. The original number you get from this equation is often referred to as your trial balance. After arriving at this balance, it's a regular procedure to go over all the data and make sure to correct errors in how transactions were recorded.
If after correcting any mistakes and going through all the transactions and subtracting your liabilities from assets your assets still come out on top, then your business is going in the right direction.
06. Create bookkeeping reports
Once your books are balanced, it’s time to create some reports on your business’s finances. You’ll likely already have a balance sheet from the previous step, which is a great report that analyzes the overall progress of your business.
Some other types of reports you might want to use include:
Profits and losses: similar to an income statement, this report allows you to compare revenue and expenses over a set period of time to ensure that your business is bringing in more money than it’s spending.
Cash flow: this statement shows you where your business is earning and spending the most money, and how able it is to pay off its expenses.
Accounts payable/receivable ageing: whether a customer has been taking a while to pay you or you haven’t yet paid a vendor, this will allow you to make sure you’re sending and receiving payments on time so that you can follow up.
07. Make a bookkeeping schedule
Once you start getting into the flow of bookkeeping, make sure that you stick with it and update your books regularly to maintain a good level of organization. By turning bookkeeping into a habit, you’ll be able to ensure that nothing is forgotten and you can minimize accounting mistakes.
Try and set a date each week to record all your weekly transactions, and then set another time each month or quarter to balance your books. It may seem like a chore, but you don’t want to let your bookkeeping fall through the cracks and then suddenly have months or even years of transactions to record and balance.