For many new small business owners, the thought of accounting is the stuff of nightmares! Luckily, this fear doesn’t need to be a reality. If you want the tools to start doing your own small business accounting, you’ve come to the right place. In this simple, guide you learn how to do accounting for a small business. We’ll go over the basics of small business accounting like how to create financial reports and how to track business expenses.Table of Contents:
- What is Small Business Accounting?
- How to Do Accounting for Small Business
- How to Keep Books for a Small Business
What is Small Business Accounting?
Small business accounting allows you to record, track, and gain useful insights into your company’s financial transactions. In turn, it becomes easier to determine the business’ profitability. Accounting helps you counteract cash flow snafus and chart a viable path to sustained growth and greater success.
Businesses of all sizes need to track cash flows in both directions of operating accounts. An accounting system tracks sales, payments, expenses, and liabilities. It enables you to create reports, file tax returns, and record financial transactions (bookkeeping). You can count on your accounting system to evaluate the business’ overall financial health and value.
How to Do Accounting for Small Business
Small business accounting entails keeping track of various aspects of your business transactions. To do so, you open bank accounts, record all transactions, select an accounting method, generate financial statements, and reconcile your books. You can handle these tasks using one of two accounting methods: cash basis or accrual accounting.Steps to do Accounting for your Business:
- Open a Business Bank Account
- Record Income and Expenses
- Select an Accounting Method
- Transactions to Trial Balance
- Adjusted Trial Balance
- Create Financial Statements
- Reconcile Books and Finalize
Open a Business Bank Account
Separating personal finances from the business is a vital step that allows you to analyze and plan more effectively. Having a separate bank account for your business helps improve tax planning and keep business finances well organized. In addition, to helping your accounting, having a designated business bank account helps prevent the co-mingling of personal and business expenses.
Without having a separate business bank account you can risk “piercing the corporate veil” by co-mingling expenses. If the corporate veil is pierced the owners of an LLC or Corporation can be held personally liable for business debts and legal liabilities.
Keep a Comprehensive Record of Income and Expenses
A robust small business accounting system simplifies the process of keeping a detailed record of transactions. The records allow your team to monitor a wide selection of expenses, such as tax returns. You can also generate financial statements, which play a critical role in determining your venture’s growth trajectory.
When it comes to recording day-to-day transactions, you should focus on recording expenses directly linked to business operations. Some examples of expense instances you should record include canceled checks, invoices, and purchase orders.
Select an Appropriate Accounting Method
Depending on your bookkeeping requirements, you need to pick the ideal accounting method for your commercial venture. Your business can either use the cash basis accounting method or the accrual system. These two options recognize income and expenses at different points. With the cash basis accounting, the system tracks transactions instantaneously. Conversely, the accrual concentrates on anticipated transactions.
Method 1: Cash Basis Accounting
This method simplifies bookkeeping as it records transactions whenever you receive payments or pay third parties. It comes with pros and cons, which you should consider. While the cash basis method does not match the accrual system in terms of accuracy, it is undoubtedly easier to handle.
You can rely on the cash basis approach to track the cash flow of your business more conveniently. On the downside, this method may overstate the financial status of the business. As such, it does not provide the analytical benefits needed to determine the profitability of the business. Accuracy is critical when it comes to planning and presenting financial statements to potential investors.
Method 2: Accrual Accounting
This method employs the double-entry system to record entries more accurately. Hence, each transaction appears twice in the records. You record a transaction once an expense or income instance occurs even before funds exchange hands. This approach differs from the cash basis method, which only records cash exchanges.
Publicly traded companies rely on this system as it ensures accuracy. This selection is due to the inclusion of accounts receivables and payables. The accrual accounting method’s disadvantage is that it does not track your company’s day-to-day cash flow. Thus, the bookkeeping system may not highlight a short-term cash deficit. This anomaly can occur even if your company’s long-term profitability is looking great.
If you are looking for a detailed breakdown of the primary accounting methods we suggest you check out his great article by Bench.co: Cash Basis Accounting vs. Accrual Accounting
Transactions to Trial Balance
The double-entry system records expenses and income in the form of journal entries. It organizes the entries in chronological order and displays essential information, such as dates and descriptions of the entries. The journal includes a comprehensive list of amounts credited and debited.
The balanced entries listed in the journal also appear in the general ledger. Subsequently, you compile the trial balance in tandem with changes that took effect in the ledger. Current balances and historical transactions determine the changes.
Adjusted Trial Balance
When it comes to the accrual accounting method, any adjustments you make in the journal track periodic income and expenses. For instance, the system ensures that rent paid annually still features in the records monthly. Thus, the method accounts for monthly expenses incurred by your business.
This approach ensures consistency and accuracy for periods covered in the financial statements. Unlike the steps involved in the cash basis method, the adjusted trial balance guarantees the accuracy of your company’s financial records.
Create Financial Statements
Once you complete preparing the adjusted trial balance, you are ready to create the financial statements. At this stage, you can prepare a cash flow statement, balance sheet, an income statement, and retained earnings.
Reconcile Books and Finalize
In the final stages of the small business accounting process, you need to compile post-closing entries. This aspect plays an integral role in resetting the balances of your organization’s temporary accounts. After resetting them back to zero, you can kickstart a new accounting cycle. This approach allows you to record the upcoming period’s entries after closing the income and expense account.
How to Keep Books for a Small Business
The best part about accounting processes is that they are simpler to handle, even for novices. To keep track of your business’ day-to-day transactions, you need to familiarize yourself with three crucial aspects: tracking business receipts, post transactions to the ledger, and creating financial reports.
- Track Business Receipts: Maintain a record of your company’s sales and purchases. The receipts contain vital details like transaction date and amount.
- Post Transactions to the Ledger: This stage involves shifting journal entries into the ledger. In turn, you compile a summary of your company’s income and expenses.
- Create Financial Reports: These reports cover critical aspects of your business’ finances, including the profit and loss forecast, the cash flow analysis, and the balance sheet.