Profit is the primary goal of all businesses, except those in the non-profit sector. To continuously increase profits and prepare for contingencies, a business must always know its accurate financial position. This understanding is even more important for small businesses, as their ability to absorb sudden shocks is much lower than for large corporations.
As a business owner, how can you know your exact financial position? With accurate bookkeeping.
In this article, we will cover bookkeeping basics, how you can implement it, and more.
What Is Bookkeeping?
Bookkeeping can be defined as the process of recording every business transaction, like income, expense, asset, and liability, to accurately understand the financial state of the business at any point. It is crucial to maintain the financial health of your business, as you will always know your income and expenses and can stay on top of your operations. Similarly, you can make informed decisions about your future. For example, if a new opportunity comes up, you can evaluate whether you have enough cash to leverage this opportunity. Such well-informed decisions are good for business growth and continuity.
Note that bookkeeping and accounting are often confused, but they are not the same. Bookkeeping is more focused on helping a small business understand its financial position and make informed decisions, while accounting focuses on financial analysis and reporting.
Why Bookkeeping Matters for Your Business
Small business bookkeeping is essential for operational success. Beyond compliance, it also helps businesses maintain a favorable cash flow position, make accurate tax calculations, and meet compliance requirements. Some key benefits of small business bookkeeping are:
- With bookkeeping, you can report income correctly, claim deductions, and compute accurate taxes for your business. As a result, you can avoid penalties and late filings.
- It tracks cash flows, so you can better plan for future expenses and avoid excess cash outflows.
- Detailed records of transactions with their supporting proof can make it easy to claim deductions. For example, small businesses can claim deductions on business travel, equipment purchases, etc. However, you need accurate records for the same.
- Bookkeeping is sometimes used by lenders and investors to better understand your financial position. Proper bookkeeping increases your chances of securing funding.
- Accurate records reflect your professionalism and build trust in the minds of your stakeholders.
- Helps identify discrepancies, errors, and frauds before they escalate into big problems.
Due to these benefits, bookkeeping is critical for the success of small businesses.
The Step-by-Step Bookkeeping Process
To make the most of the above benefits, you must have an accurate bookkeeping process. Here’s the step-by-step process of bookkeeping for beginners:
Step 1: Separate Business and Personal Expenses
Regardless of your business structure, it’s a good idea to keep your business and personal expenses separate. The advantage is that you will have better visibility over your business transactions and financial health.
The first step to keeping your finances separate is to have different accounts for your personal use and business transactions. Make sure to create a dedicated business bank account that will be used only for your business. Similarly, have separate credit cards for your business and never use them for your personal expenses. Stay on top of these credit card expenses to ensure accuracy.
Step 2: Choose a Bookkeeping System
Once you open the accounts, the next step is to decide on your business accounting and bookkeeping method. There are two types of bookkeeping: single-entry and double-entry, and you must decide which of the two is more suitable for your business.
Generally speaking, single-entry is simple and records only one entry per transaction, while in double-entry, every transaction affects at least two accounts, once as a credit and the other as a debit. As you can see, single-entry is easy to maintain and requires no specialized accounting knowledge. However, the downside is that it is hard to catch errors and works well only with limited cash flows. Depending on your operations and the volume of transactions, you can select the appropriate system.
For both systems, it helps to use bookkeeping software like QuickBooks or Xero, as they come with built-in features to automatically record transactions. This automation will save time and effort, and at the same time, maintain records even if you’re not an accounting expert.
Step 3: Choose an Accounting Method – Cash vs. Accrual
The next important decision is choosing between a cash vs. accrual accounting system. Again, understanding the differences is important.
As the name suggests, in cash accounting, you only record a transaction after money is paid or received. This is a straightforward system that works when you don’t operate on credit. The accrual system, on the other hand, is well-suited for businesses that offer or receive credit, manage inventory, or require a detailed view of their financial position. In this system, you record the transactions when they occur, regardless of whether cash is involved at the time of the transaction or not. For example, if you give products worth $100 to your regular customer on credit and they offer to pay it back in two weeks, you will record the transaction on the day when you give it to the customer and not on the day when you receive cash from the customer. Out of the two, the accrual system is preferred because it provides a long-term view of the financial health of a business. Moreover, the accrual system complies with the Generally Accepted Accounting Principles (GAAP).
Note that GAAP accepts the cash basis for small businesses, provided they meet specific conditions.
Step 4: Use the Right Tools for Bookkeeping
While setting up your bookkeeping process, make sure you select the right tools that will ease your work and make the process viable in the long run. One of the first things to decide is whether you want to use an accounting software or just use spreadsheets. While spreadsheets are convenient and cost-effective, they can get unwieldy beyond a point. Also, it is not ideal for recording complex transactions. This is why accounting software is a more scalable option that can accommodate your growing business transactions. Also, these software platforms offer automation for invoicing, expense tracking, and reporting, which can undoubtedly save time and effort.
Step 5: Categorize Your Transactions
Another important step is to categorize your transactions into different groups for better visibility and computations. This categorization will also improve the accuracy of your reporting. Some common categories to consider are rent, utilities, wages, office supplies, marketing, and travel. When you record expenses under each category, you can know how much each category contributes to your income and expenses. Based on this data, you can do better financial planning.
Step 6: Store Your Financial Documents Securely
Along with creating accurate records, you must also take measures to store them securely. Loss of your documents can impact your taxation and the ability to understand your financial status.
To avoid this situation, keep multiple copies of your invoices and receipts. Ideally, keep a paper copy in a secure locked cabinet and multiple digital copies across different storages devices like hard drives and clouds. Also, note that the IRS requires you to maintain these copies for a period of three to seven years or even longer, depending on the document type and your business requirements. Plan and buy enough storage space to accommodate all these records.
Step 7: Keep Track of Tax Deductions
Deductions are an important part of bookkeeping as they can reduce your tax liability. When you know what tax deductions you are eligible for, you can do business expense tracking better. Some possible tax deductions, depending on your industry and turnover, are:
- Business meals
- Home office setup and expenses
- Office supplies
- Interest on business loans.
- Depreciation
- Charitable contributions
- Education, provided it is related to the business.
Know which ones apply to you and account for them in your bookkeeping. If you plan to apply for deductions, keep the supporting documents like vouchers and receipts safe.
Step 8: Make Bookkeeping a Habit
Finally, integrate bookkeeping into your business process. Make sure to train your employees and use the appropriate software to account for the transactions and gain the benefits we discussed earlier. Set reminders weekly or monthly to go through your transactions and reconcile the missing ones. Review these records periodically and cross-check them with the bank transactions for better accuracy.
With these steps, you can create and maintain a comprehensive bookkeeping strategy that will provide long-term visibility while ensuring compliance.
DIY Bookkeeping vs. Hiring a Professional
A key decision for small business owners is whether they should hire a professional who can handle their bookkeeping or should they do it themselves. Below are the pros and cons of each option.
The DIY Approach to Bookkeeping
At first glance, Do-It-Yourself (DIY) bookkeeping may seem the best way as it saves money, but it’s also important to understand that bookkeeping is time-consuming and can take the owner’s attention from the core aspects of the business.
Pros:
- Saves money
- Direct control over financial records
- Understand finance and accounting better
Cons:
- Time-consuming
- Increases the chances of errors, as the business owner may not be an accounting expert
- Lack of knowledge about deductions can increase tax liability
- Involves a learning curve
In all, DIY bookkeeping is well-suited for freelancers and solopreneurs who have few transactions.
When to Outsource Bookkeeping to a Professional
Hiring a bookkeeper or a professional accounting firm can give business owners peace of mind and will open up the time to focus on their business. These professionals are well-versed in the process and can provide maximum benefits to the business. The pros and cons of outsourcing are as follows:
Pros:
- Highest levels of accuracy in maintaining records and meeting compliance
- Ability to leverage tax deductions
- Expert advice on strategy and insights
- Frees up time for the business owners
Cons:
- More expensive than DIY bookkeeping
- Owners may not know everyday transactions
Outsourcing is ideal when a business has complex or a large volume of transactions that make it difficult for business owners to manage independently. Also, it helps if the business owner is not an expert in accounting and needs external help.
Manay CPA is a trusted and experienced firm that handles bookkeeping for small businesses. It also offers tailored services like account reconciliation, categorization of transactions, tax optimization, and preparation, in-depth financial analysis, and creation of reports.
Final Thoughts – Simplify Bookkeeping for Business Success
Overall, bookkeeping is important for every business because it provides an accurate picture of your finances at any given time. But it can seem daunting, especially if you are new to accounting. One option is to use bookkeeping software that can handle the accounts, but a better way is to hire experts because they go beyond just accounting to provide strategic insights. However, whether to choose to do DIY bookkeeping or outsourcing, make sure to maintain an accurate record of all your transactions.
If you’re looking for professionals who can handle your bookkeeping, schedule a free consultation with Manay CPA.
