Small Business Accounting Basics

What Is Small Business Accounting?

Small business accounting is the process of recording, tracking, and analyzing the financial transactions of a small business. This includes activities like bookkeeping and preparing financial statements such as an income statement, balance sheet, and cash flow statement. Together, these activities provide valuable insight into your business’s financial health.

One of the most important things about small business accounting is that it forces you to separate your business and personal finances. This not only allows you to get a clear picture of your business’s financial status but is also essential to shield you from personal liability if your business is ever sued. Accounting also simplifies tax preparation, making it easier to track revenue and expenses and distinguish deductible business expenses.

Why Is Small Business Accounting Important?

Small business accounting is important because it allows business owners to understand the financial health of their business. It also helps shield them from personal liability and aid in preparing tax returns. Additionally, if you ever want to sell your business or take on outside investors, reliable accounting practices are absolutely necessary.

Here are some examples of people who can benefit from strong small business accounting:

• Independent contractors: Independent contractors often have to manage their own taxes. By keeping separate records of all income and expenses, they can easily identify tax-deductible expenses and avoid overpaying on their tax returns.
• Freelance professionals: Similar to independent contractors, freelance professionals such as writers, graphic designers, and photographers need to keep accurate accounts of their income and expenses to ease tax filing and identify areas for potential growth.
• Small business owners: For small business owners, accounting helps in tracking income, expenses, and profitability. It helps in preparing and tracking employee withholding and aiding in strategic decision-making.
• Retailers and e-commerce business owners: Proper accounting helps these businesses track sales, manage inventory, and calculate gross margins, thereby improving their overall financial management.

How to Set Up Accounting for Your Small Business

A well-structured accounting system will keep your financial data organized, making it easier to compile and analyze financial reports, file taxes, and make informed business decisions. Below are the basic steps to set up an accounting system for your small business:

1. Decide on an Accounting Method

There are two primary accounting methods: cash-based and accrual-based accounting. Cash-based accounting records transactions when cash is exchanged. Accrual-based accounting recognizes income and expenses when incurred, regardless of when payment is made. 

Accrual accounting may be required in some cases – such as when businesses have $25 million in revenue over three years. Cash accounting is generally preferred in cases where it’s not required because it’s simpler.

2. Open a Business Bank Account

One of the most important aspects of business accounting is separating your personal and business finances. Opening a business bank account can help you track your business expenses and income more accurately, making it easier during tax time and helping to protect you from personal liability.

3. Choose an Accounting Software

There’s a wide range of accounting software available, from simple bookkeeping applications to comprehensive financial management systems. You should choose software that aligns with your business’s size, budget, and accounting requirements. We prefer QuickBooks because of its accessibility, ease of use, and ready access to licensed professionals.

4. Set Up Your Internal Accounts

You’ll need to set up an internal list of accounts your business uses to record transactions in your general ledger. It includes categories like assets, liabilities, equity, income, and expenses.

5. Record Your Transactions

This step involves recording all business transactions, including sales, expenses, and investments. Regularly updating your books ensures your financial reports are always up-to-date and accurate.

6. Prepare and Analyze Financial Statements

These statements provide insight into your business’s financial health and performance. Regular analysis can help you identify trends, manage cash flow, and make informed business decisions.

7. Stay Compliant with Tax Laws

Once you set up your accounting, use those records to prepare and file relevant tax returns and other reports. You can also communicate these records to a licensed accountant to help you prepare any necessary filings.

Small Business Accounting Tips

Here are a few essential accounting tips to help you manage your small business finances effectively:

• Stay organized. One of the keys to successful small business accounting is staying organized. This includes maintaining accurate records, keeping receipts, and categorizing expenses correctly. 
• Regularly review finances. Don’t make the mistake of only checking your finances at the end of the year. Regular financial reviews give you a real-time view of your business’s financial health. They can help you spot and address issues before they become significant.
• Use cloud-based accounting software. Cloud-based accounting software like QuickBooks can increase efficiency, reduce errors, and provide real-time updates. This software automates many time-consuming aspects of financial management, such as data entry and reconciliation, leaving you to focus on running your business.
• Stay on top of invoicing. Late and unpaid invoices can create serious cash flow problems. Make sure to issue invoices promptly and follow up on late payments.
• Keep business and personal expenses separate. Commingling business and personal finances makes it difficult to gauge the financial health of your business. It also makes things more difficult at tax time and can open you to personal liability if your company gets sued.
• Consider hiring a professional. If the burden of managing your business’s finances becomes too great, consider hiring an accountant or bookkeeper. They can help ensure that your finances are handled correctly and may provide audit protection if you’re ever scrutinized by tax authorities.