Small business owners often have to deal with every facet of business to ensure its success. It makes sense to delegate some of the management tasks because it’s hard to keep track of everything yourself without hampering your business in the long run. However, delegating doesn’t mean staying out of the loop completely, especially when it comes to business finances, primarily accounting.
Accounting is the language of numbers. It shows the most accurate picture of the current state of a business and its future. So for a small business owner, it’s vital to understand accounting so they can understand their business and also be able to communicate with banks and investors.
In this article, we’ll break down small business accounting, the steps you need to take to set it up, and the best ways to deal with it that can help your small business grow bigger.
1. What is small business accounting?
2. Basic steps in accounting for small businesses
- Open a business bank account
- Go through business bookkeeping basics
- Track your small business profit and expenses
- Get to know small business tax obligations and procedures
3. Small business accounting software to help you stay on top of accounting
What is small business accounting?
Let’s start with defining what small business accounting is. In general, business accounting is the process of organizing and analyzing a company’s financial information to plan and advise on taxes, file tax returns, make forecasts, and help with data-driven financial decision making.
It’s necessary to distinguish between accounting and bookkeeping because people often confuse these two notions. Bookkeeping is a part of a business accounting system that focuses on recording and administering financial transactions. This information is used in accounting, the main priority of which is to analyze the financial health of your business.
Speaking of small business accounting, it includes bookkeeping, preparing and filing tax returns, and drafting financial reports.
You can choose how to deal with your small business accounting, several options are available:
- Employ a full-time specialist to cover your bookkeeping and accounting needs;
- Outsource accounting to an independent CPA or an accounting firm.
Each option has its pros and cons, but no matter which option you choose, it’s important to understand how accounting is handled. So let’s proceed to small business accounting basics.
Basic steps in accounting for small businesses
So you’ve started a small business and need to go on setting up your accounting system. Without an accounting or bookkeeping background, this task may seem daunting. The good news is that there’s a pretty straightforward list of steps to take, so you need to go through them one by one. And even if you already have an accountant at this point, being familiar with the process can give you more confidence in covering your bases. Let’s break them down.
1. Open a business bank account
You start by opening your business checking account. Depending on your business structure, a separate business bank account can be either legally required or not obligatory. However, it’s strongly recommended to have a separate account. This way, your personal and business records won’t mix up, and it’ll be much easier for you to prepare for the tax season, secure a loan or a credit line, and talk to investors.
To open a business account, you need a business name and a registration with your state or province. However, it’s better to check with the bank to find out what other documents they might require. Also, conditions and fees for managing business accounts can vary from bank to bank, so it may be wise to compare the offerings from several banks to see what will suit your needs best.
2. Go through business bookkeeping basics
Next, you’ll take some basic steps to set up your bookkeeping process and ensure that all your business finances are accurately reflected in your books and available for analysis. These basics include coming up with the bookkeeping method, organizing your general ledger and a chart of accounts, recording transactions, preparing financial statements, and balancing your books. Let’s look at them in more detail.
Choose your bookkeeping method
Choosing your bookkeeping method (or accounting method) is an important step that will define how you manage your books. You need to do it carefully because if you decide to change your accounting method in the future, you’ll be required to approve it with the IRS.
There are two bookkeeping methods: the cash method and the accrual method.
The cash or one-entry method involves recognizing transactions the moment they occur and reflecting each transaction as a single journal entry in the books. The biggest advantage of this method is the simplicity of maintenance: you can easily control transaction dates and know how much money you have in your business account at any particular point. However, it only suits small businesses with a really low number of transactions. Moreover, as soon as your annual revenue reaches $5 million, it becomes obligatory to use the accrual method.
The accrual or double-entry method involves recording two entries for every financial transaction. It means you reflect a transaction as a credit (increase) in one account and as a debit (decrease) in another account. It may seem a bit confusing, but accounts in this context have nothing to do with your bank account. They stand for different parts of your books or, in other words, general ledger (we’ll get to what it is a little bit further).
|A little example to illustrate how the double-entry method works.|
Imagine you have a retail business selling different goods online. When you sell something, you increase your revenue. At the same time, you decrease your inventory (pretty logical so far). Following the double-entry accounting method, you need to record the sale amount in your cash account as an increase (or debit) and as a decrease (or credit) in your inventory account.
The double-entry method is more accurate and less error-prone, as it provides a detailed view of how the money moves throughout your business. Also, if you’re planning to get a loan or looking for an investor, it’s preferable for you to manage your books following the double-entry bookkeeping method.
Set up a general ledger
Though the name may sound a bit unfamiliar, the general ledger is just another name for your books. It’s a place where you record all your transactions. Be it a sale, invoice, bill, etc. – everything goes to your general ledger as a separate journal entry.
To set up your general ledger, you need to create accounts for different types of transactions. These accounts typically fall into five types:
- Asset. These accounts reflect all the resources your business owns, such as cash, property, inventory, investments, equipment, vehicles, etc.;
- Liability. The accounts that reflect all your business debts and financial obligations, including monthly rent payments, loans, etc.;
- Revenue/income. Here, you record all your business earnings, like sales, service revenues, fees earned, interest revenue, interest income, and more;
- Expense/expenditure. The accounts that comprise transactions where cash goes out of your business: employee salaries, monthly utility payments, costs of goods sold, etc.;
- Equity. This type of account records a business owner’s held interest in the business, like stock shares, for example.
Organize your chart of accounts
Apart from setting up necessary accounts to record transactions in the appropriate categories, bookkeeping also requires easy navigation between all of them. And that’s why you need to organize your chart of accounts.
If you imagine your general ledger being, literally, a book, your various accounts can be seen as chapters, then a chart of accounts would be like a table of contents listing all the accounts you have.
Accurately record financial transactions
Now, having organized your bookkeeping structure, you can go on to record your transactions. It’s probably the most challenging bookkeeping task because it involves identifying which accounts to debit and credit. Let’s look at how it works.
Imagine that your customer purchases a blender that costs $150 with an obligation to pay for it in, say, seven days. You invoice the customer waiting to receive payment at the end of the week. Now, you need to record this transaction in your general ledger correctly. So you credit (or decrease) your sales account to $150 and debit (increase) your accounts receivable account to the same amount.
As the customer pays the invoice, the money enters your bank account. So this time, you debit your cash account and credit your accounts receivable.
This way, you can see how the money moves through your business, ending up in the bank account.
The biggest challenge in recording transactions into your general ledger following the double-entry bookkeeping method is putting them into the correct category and not confusing what accounts to debit and credit. And the more transactions you have monthly, the more complicated the task feels. If a mistake occurs, you’ll recognize it by stumbling upon a discrepancy in balancing your accounts at the very end of the accounting cycle. So you’ll have to spend extra time looking for missing entries and correcting them.
|A side note about the accounting cycle. It’s a step-by-step process that accountants go through to ensure that all financial transactions are properly recorded during a given period (a day, week, month, quarter, or year). Starting from the initial financial transaction that occurs during this period, it comprises all the steps such as recording transactions and putting them into the general ledger and ends at the point of balancing and closing the books for this period.|
We’ll get to how you can ensure accurate recording and categorization of your transactions a little bit later, but for now, let’s move to the next step.
Balance and close your books
Balancing and closing books mark the end of the accounting period and the beginning of a new one. It’s the last step in basic bookkeeping that involves several steps, such as:
- Preparing an unadjusted trial balance. At this point, you list all your general ledger account balances, showing a debit or a credit balance. You tally them up to ensure they match. And if they don’t, you’ll have to go through all your entries again to spot errors.
- Making adjusting entries. At this point, you make entries to record any unrecognized income or expenses for the period. You need it, for example, if a transaction started in one accounting period and ended in a later period.
- Running an adjusted trial balance. After correcting the errors and putting in adjusting entries, you can run a final adjusted trial balance. It helps you update all of your general ledger accounts balances.
- Closing the books. To end the current accounting period and start a new one, you need to zero the balances of your revenue and expense accounts.
Prepare a cash flow statement and other financial reports
Done with balancing your books, you can proceed with generating financial statements for the accounting period to look at the performance of your business during this period. The basic financial statements for small businesses include:
- Balance sheet. A small business balance sheet is an overview of your business accounts, such as assets, liabilities, and equity, so you can have a general view of your money and measure your cash flow.
- Profit and loss (income) statement. A profit and loss statement breaks down the revenues and expenses of a company during a particular period.
- Cash flow statement. A cash flow statement aggregates information about all the cash inflows from a company’s ongoing operations and external investments. It also displays all the cash paid by a company for its activities and investments during a given period.
These statements are significant because they’re a source of truth about the company. Your accountant can use these for forecasting, advice for financial development, and more. That’s why these statements must include accurate and up-to-date information.
3. Track your small business profit and expenses
Small business owners use the gross profit margin to measure the profitability of a single product. A gross margin calculation is quite simple:
Gross Profit Margin = Total Revenue – Cost of Goods Sold (COGS)
Your pricing model may go up or down. After determining the target goal of the gross profit margin, you can see how much markup should be applied in order to get the revenue you want.
Jeff Wiener, an entrepreneur, shared his 19 easy ways to increase profit margins for your small business, where you can find some interesting ideas on how to make your business more profitable.
Collecting expense receipts in a bookkeeping system is necessary so that when tax season comes, you won’t have to look at a pile of receipts, wondering whether they were personal or business related. Also you’ll be able to track your cash flow and know what you spend money on and which expenses should be reduced.
4. Get to know small business tax obligations and procedures
For a business owner, it’s crucial to understand your business tax obligations. Here, a lot depends on your industry, business structure, and activities, but, in general, business taxes fall into three types: federal, state, and local. It’s true that the tax system is a bit complicated and requires time and effort to understand. However, it’s an investment that pays off. Let’s go through the basic federal taxes for small businesses including:
- Income tax. It’s a tax filed and paid on any income earned or received during the year.
- Self-employment tax. It’s a tax paid on a self-employed person’s income. It’s not the same as the income tax but a separate 15.3% tax that applies to some business owners, such as sole proprietors, LLC members, or general partners.
- Employment tax. It’s a set of taxes, including Social security and Medicare taxes, federal income tax withholdings, and federal unemployment tax (FUTA), that you, as the employer, file and pay for your employees.
- Excise tax. It’s a set of taxes imposed on various goods, services, and activities, including, for example, tax on coal, sports wagering, indoor tanning services, heavy highway vehicle use, and more.
- Estimated tax. It’s more the method used to pay tax on income that isn’t subject to withholding, including earnings from self-employment, interest, dividends, rents, etc.
|To better understand what taxes apply to your particular business, we strongly recommend you consult with your local tax authorities.|
Check our articles if you want to learn more about:
🧷 Payroll tax filing
🧷 IRS audit red flags
🧷 Tax season 2023
🧷 Income tax
A worry-free tax experience is possible with up-to-date bookkeeping and by following the next procedures regularly:
- Every single transaction should be recorded and categorized.
- Keep an eye out for any discrepancies that occur between your bank account and bookkeeping records and try to spot them right away.
- Each and every transaction should be accounted for in your books.
- Filing income tax reports and contractors and employees tax reports, as well as your small business tax rate, will depend on your business structure (LLC, S Corp, C Corp, sole proprietor) and which country and state you’re based in, so obtain more specific information on your local regulations.
- Find out whether you’re eligible for any tax deductions.
Small business accounting software to help you stay on top of accounting
You’re about to set up an online business or you’ve just launched one and accounting seems to take up a lot of space on your small business owner’s plate. The good news is that while you need to know how to do small business accounting, you don’t actually need to do it. Having accounting software to automate some processes, and a bookkeeper and accountant for the rest means you don’t need to do it all yourself.
Accounting software helps automate a significant part of the process. There are so many options in the market, and all you need is to wisely choose the solution that would cover your specific business needs in the best way possible.
Here are some options tailored for small businesses that you might be interested in trying.
1. QuickBooks Online
QuickBooks Online is an accounting software that lets you track all the business transactions from all of your gateways, such as credit cards, Stripe, PayPal, IntegraPay and others. This software will enhance your business and optimize your time usage.
Xero is an accounting software that connects your bank and other business apps. This software provides precise and safe reconciliation, and advanced automatic bookkeeping.
|A helpful tip. You can drastically streamline your experience with any of these solutions by combining them with Synder Sync. It enables you to automatically sync all transactions from 25+ sales and payment platforms, like Shopify, Amazon, WooCommerce, Stripe, PayPal, and more, to your accounting software. It’ll save you considerable time on processing transactions and reconciliation each month.|
3. Synder Books
Synder Books is an easy-to-use accounting software for small businesses, especially those working in the e-commerce industry. Apart from automatically capturing transaction data from 25+ e-commerce and payment platforms, accurately categorizing it and facilitating reconciliation, it has specific e-commerce features allowing for inventory management, multi-currency compatibility, and many more. It also offers comprehensive reporting on sales, products, and customers, providing a deep analysis of your business for informed strategic decision-making.
Accounting done right is the key to a successful and smooth business workflow. It may seem daunting but understanding the basics of accounting helps you keep control of your business finances and see the ways for your business growth. Investing in the right accounting software will get your finances in order and make it easier for your business to function.
Synder can help you avoid inevitable human errors in your small business bookkeeping and instantly track your business performance.
Start with a free trial and free demo access to see if it fits your business needs.