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Bookkeeping 101 for Small Business Owners: Setting Up for Success

Bookkeeping 101 for Small Business Owners: Setting Up for Success

What is Bookkeeping and Why is it Important?

Bookkeeping is the process of recording, organizing, and storing financial transactions and accounting documents. As a small business owner, getting your bookkeeping right is critical to running a successful business. We’ve created this bookkeeping 101 for small business owners to show you what bookkeeping involves and some different ways to do it well.

For more content on the basics of staring and running your own business, checkout our 101 guides on business structure and entity registration and tax.

What Does Bookkeeping Mean For Small Business Owners?

In simple terms, the process of bookkeeping for most small business owners involves:

  1. Identify each transaction as either income or expense
  2. Identify the income or expense category of the transaction following the IRS guidelines 
  3. Record the amount of the transaction that’s shown on the invoice or receipt, and the income or expense category
  4. Store the invoice or receipt in your files in case you get audited
  5. Create reports using the transaction records to understand the money movements and their implications

A bookkeeping cycle is one fiscal year. A fiscal year may be different from a calendar year. For example, you may want to set your fiscal year to run from April to March instead of January to December. This is up to you to decide based on what makes most sense for your business.

Why is bookkeeping important to small business owners?

In simple terms, the process of bookkeeping for most small business owners involves:

Here are the top 5 reasons why you should invest the time and resources to set-up a robust bookkeeping system:

1. Get paid on time.

One of the biggest concerns for small business owners is getting paid on time or their products or services. Bookkeeping helps you track who owes you money and how much, issue invoices and payment reminders.

2. Good bookkeeping habits makes tax season a breeze.

One of the most tedious and time consuming tasks when it comes to filing your business taxes is going through receipts and invoices to get the various totals of income and expenses. If you’ve been keeping up with your bookkeeping throughout the year, you should be able to easily compile reports to get all the information you need to file your taxes. And trust me, it makes a HUGE difference!

3. Be prepared in case of IRS audits.

We all hate it when we get audited by the IRS, but it happens. When you do get audited, a well kept book will help you pinpoint the transactions and information required by the IRS with ease. Imagine having to pull out all your receipts from years ago!

4. Optimize your business tax deductions and credits.

An important way to save on taxes is capturing all the deductions and credits your business qualifies for. Maintaining a well-kept book with clearly identified expense and credit categories aligned to the IRS guidelines will ensure you do not miss out on any eligible deductions and credits. 

5. Gain insights into your business for better decision making.

As a small business owner, it’s important to understand your key performance indicators (such as revenue and cost) as well as the movement of money and its implications to your business. The process of bookkeeping will help you generate financial reports which provide such insights.

Should I set up a separate business account?

While some business bank accounts have features catered to small business owners such as invoicing and tax management, the most important purpose of a business bank account is to keep your business finances, records, and transactions separate from personal. 

By law, you must have a business bank account If you’re registering as a limited partnership, LLC, or corporation. To open a business bank account, you will need to apply for an Employer Identification Number (EIN) from the IRS, and you must file a Doing Business As (DBA) name with your state or local government if you plan to operate as a sole proprietor or general partner.

Pros And Cons of Having a Business Account

PROS

  • Flexibility for future growth (if you have plans to become another type of business entity or hire employees)
  • Make your business appear more legitimate and credible
  • Special features catered to business owners which can make life easier
  • Be prepared in case of an IRS audit
  • Some low or no fee options in the market

CONS

  • Higher cost – some business accounts are associated with account fees

Sole proprietors – using a second personal account for business

If you’re a sole proprietor, you have the option to use a personal bank account for business. This might be preferable to some business owners as business bank accounts usually have higher fees. 

If you decide to opt for a personal bank account for business, make sure you open a secondary checking account and a credit card to process all your business transactions to keep your business finances separate from personal.

How to set-up my bookkeeping system for success?

While some business bank accounts have features catered to small business owners such as invoicing and tax management, the most important purpose of a business bank account is to keep your business finances, records, and transactions separate from personal. 

Bookkeeping basics

Before you set up your bookkeeping system, you have to understand some basic terms and concepts. The two most important concepts you should know are: 

  1. Assets = Liabilities + Equity
  2. Profit = Revenue – Cost of Goods Sold – Expenses

Assets, liability & equity

Assets are things your company owns such as its inventory and accounts receivables. Liabilities are things your company owes – such as to your suppliers (accounts payable), bank and business loans, mortgages, and any other debt on the books. Equity is the ownership that the business owner, and any investors, have in the firm.

One of your key objectives for bookkeeping is to balance your books. In order to do so, you have to keep careful track of these items and be sure the transactions that deal with assets, liabilities, and equity are recorded correctly and in the right place. 

The accounting equation means that everything the business owns (assets) is balanced against claims against the business (liabilities and equity).

Profit, revenue, cost of goods sold & expense

The second fundamental concept that small business owners must understand is the Income Statement Basics – Revenue, Cost, and Expense.

Revenue is all the income your business receives in selling your products or services. Costs, also called cost of goods sold, is the money you spend to buy or manufacture the goods or services you sell to your customers. Expenses are all the money you spend to run the company that is not specifically related to a product or service sold, ex., salaries and wages.

What are the different options for bookkeeping?

The tasks of bookkeeping may seem simple and straightforward to some people and daunting to others depending on your interests and skills. At the end of the day, bookkeeping requires consistent effort to do it well. You need to develop a system and processes that works for you. 

There are two bookkeeping solutions for small business owners:

  1. Do it Yourself (DIY)
  2. Hire part-time / full-time support  

DIY – Excel

Cost: free

Best for:

  • Sole proprietors who are just starting out, with less than 30 transactions per month

Expert tips:

Plan for major expenses for the first year of operation, then account for growth of the business over milestone years such as 3 years, 5 years, and 10 years. Add a realistic percentage for unexpected expenditures. This is your budget for the year.

Track expenses by using a business bank account and business credit card for expenses whenever possible. Make sure you record any cash expenses in a timely manner. And always remember to keep your receipts!

Categorize expenses following the IRS guidelines. And don’t wait until the weekend before the tax deadline! Do this on a weekly or monthly basis while the transactions are still fresh in your mind. Most small business owners will only have a few major expense categories, so this exercise should become easier each time. 

Record money received for sales revenue, services/product, personal savings etc. into the business bank account. Proper record keeping ensures the business is not taxed for non-income. 

Maintain proper record of invoices. If invoices are inaccurate, unpaid, or late, accounts receivables will be negatively affected. Set invoice terms (net 30 days, 60 days, 90 days, or an exception).

Separate money for taxes. Set aside some of your budget to pay taxes, so you’re not surprised when taxes come due. For 2019, the average Small Business Tax Rate was 19.8% and a flat 21% for a C-Corporation. Businesses taxes vary based on entity type.

Tools / Resources

There are many free resources online that small business owners can leverage, especially when you’re just starting out. The simplest tool for DIY bookkeeping is Excel.

Here are some resources offering Excel templates that we like. They’re both 100% free:

1. Beginner Bookkeeping

Basic Excel bookkeeping templates that any small business can use. Most of these templates can be easily customized to your requirements.

What it provides:

  • Basic accounting / bookkeeping templates such as Income Statement and Balance Sheet
  • Additional business templates relevant to small business owners, such as Sales Invoice, Receipt, and Inventory

2. Bench.co

The bookkeeping software provider Bench actually offers practical Excel templates for basic financial statements and bookkeeping for free on their website.

What it provides:

  • Free Excel templates covering various topics and functions

The templates are free to download, but you will need to register. 

Bench does a good job explaining the basic accounting concepts that’s required to understand these templates and statements. The article also provides a helpful step-by-step guide on some of the functionalities in the templates, making it a great option for those of you who are not Excel wizards.

There are many other free templates available online that you can choose from. The important thing is not which one you use, but that you understand the purpose of each statement and the information it reveals about your business. 

DIY – Software

Cost: $0 – $60 / month

Best for:

  • Sole proprietors, freelancers, and small business owners with a few employees (5 or less)
  • If you’re not Excel savvy or if you prefer to use a software interface
  • If you want to have a source of support for accounting / bookkeeping questions when you need it 

There are many accounting and bookkeeping software options in the market that range in function and cost. Here is a good summary.

Hire part-time / full-time bookkeeper

Cost: $200 – $500 / month

Best for:

  • Small and medium business owners with more than 5 employees
  • Businesses that involve complex transactions such as inventory management or trading in foreign currencies
  • If you operate two or more separate businesses that have different business activities

Frequently Asked Questions

What’s the difference between a bookkeeper and an accountant?

Bookkeepers record and account for daily financial transactions. They invoice customers and pay the vendors. They also prepare payroll and make bank deposits. They ensure that the daily accounting operation is performed on a consistent and timely basis.

Accountants may also function as bookkeepers depending on the size of the business. But generally, an accountant works on more advanced, high-level functions than a bookkeeper.

An accountant obtains the trial balance for the business at month/year end and ensure that all accounts are accurately stated. That process may involve reconciling the account to other sources and/or researching the history that created the balance. There might also be a need to prepare adjusting journal entries to correct the balances to a more accurate amount. The accountant then also prepares the financial statements for the time period required.

Should I use single or double-entry bookkeeping?

To answer this question, let me first explain what they each mean.

Single-Entry

Single-entry bookkeeping is like keeping your own personal checkbook (in the old days). You keep a record of transactions like cash, tax-deductible expenses, and taxable income. It’s characterized by the fact that only one entry is made for each transaction, just like in your check register. In a single column, entries are recorded as a positive or negative amount. You can also choose to keep a two-column ledger, one column for revenue and one for expenses. It’s still considered single-entry because there is just one line for each transaction.

A downside of this type of bookkeeping is it doesn’t track accounts like inventory, accounts payable, and accounts receivable. 

Single-entry bookkeeping only works if yours is a small company with a low volume of transactions.

Double-Entry

Due to the shortfalls of single-entry listed above, most businesses use double-entry bookkeeping for accounting. Two key characteristics of double-entry bookkeeping are:

  1. Each account has two columns 
  2. Each transaction is located in two accounts

Each transaction should have two corresponding entries – a debit and a credit

If your company is of any size and complexity, or if you plan to reach a considerable level of size and complexity in the future, you will want to set up a double-entry bookkeeping system.  

About Zoey Wen

Content contributor and website admin @ Exper.

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