There are several fundamental guidelines to small business accounting. Most entrepreneurs and business owners have many other priorities don’t go into business for the joy of keeping their books. Accounting is likely the last thing on your list of priorities. However, it is essential to keep track of your income and expenses to stay in business. According to studies, almost a third of small businesses fail because they run out of cash. Some entrepreneurs like to do everything themselves, but others outsource all of their financial matters to experts. Most are somewhere in between. Whichever path you choose, understanding the basics of accounting gives you a deeper line of sight into the performance of your business. Read on to learn about the most important fundamental guidelines for small business accounting.
What’s the difference between bookkeeping and accounting?
These terms are often used interchangeably, but they have slightly different meanings. Accounting is the overall process of recording, summarizing, and analyzing business transactions to create financial statements. Bookkeeping is the first step in that process. Bookkeepers gather information, record, and organize transactions to produce a record of the financial interactions between a business and the outside world.
Accountants take the output of bookkeepers and use it to prepare tax returns and the financial statements that banks and other investors need to see before they provide funding. A great accountant will also give you advice on how to grow your business, and tell you how you’re doing in comparison to industry benchmarks.
However, in practice, the boundaries between the two professions are fuzzy. Many bookkeepers give business owners advice on how to improve their businesses. Many accountants do the basic bookkeeping work in addition to preparing tax returns and financial statements for clients. Working with a Certified Public Accountant (CPA) or an Enrolled Agent (EA) can give you the assurance that they’re competent, knowledgeable, and professional.
What Is The Accounting Process?
Accounting sorts your sales and purchase transactions into accounts so you can track where your money came from and where it went. Accounts are like buckets that you use to divvy up the flow of money through your business. There are several key accounting terms you need to know. First, revenue is the tally of the sources and types of income that a company brings in by selling goods or services. Next, expenses refer to the costs of providing those goods and services. Breaking expenses further into meaningful categories helps business owners understand how business resources are spent.
Assets are essentially what you have. Every business has cash, and depending on your operations, you may also have inventory, equipment, or real estate. If customers have not yet paid you, you may also have accounts receivable. Importantly, liabilities are what you owe. This includes loans that you take out to fund operations or to purchase equipment. Accounts payable is where you summarize what you owe to vendors. Furthermore, equity is where you track the cumulative investment in your business and the overall gains and losses generated by your business. Importantly, private equity usually refers to capital investment that’s made into companies but are not publicly traded. Knowing these terms is essential to understand the basics of small business accounting.
What Is Double-Entry Accounting?
At first, you might be able to get by with just tracking income and expenses in a spreadsheet. But, as your business grows, you’ll need a more complete picture of your business transactions. You’ll need to use double-entry accounting. As the name implies, double-entry accounting records each transaction in two (or more) accounts using journal entries. Each journal entry is balanced across at least two accounts by having an equal number of debits and credits. Depending on the nature of the transaction and the type of account, debits and credits either add to or subtract from the cumulative balance in that account. For example, if you pay someone $500 to design a logo for your business, that decreases the balance in your bank account by $500 and increases your advertising expenses by $500. The journal entry to record that will have a debit to advertising expense of $500 and a credit to cash of $500.
Double-entry accounting lets you see the movement of cash and resources through your business. You can see how much you’ve made in sales, what your expenses are, how much is owed to you by customers, and how much you owe to outside parties.
Most business owners don’t need to know much more about double-entry accounting than these basics because accounting software does the heavy lifting for you.
What Are Financial Statements?
After transactions are recorded, they are further sorted by the type of account to result in financial statements. The most basic financial statement for a small business is the income statement. This is the summary of your total revenues and total expenses over a specific period. Net income, which is the difference between income and expenses, is generally on the bottom line of the income statement. For a really small operation, the income statement might be the only financial statement you need. To get a more complete view of your business, you’ll need to add a balance sheet. A balance sheet is a snapshot in time of the overall performance of your business. It shows the balance between your assets, liabilities and equity on a specific date. A successful business has more assets than tax liabilities, and shows a positive amount of equity. Negative equity results when a business has more liabilities than assets, and can be a sign of impending failure.
How Do I Keep My Books?
Before we had computers, bookkeepers entered every transaction by hand using paper ledgers and pens. Some people start out by using a spreadsheet, but that can be a very tedious and error-prone method. A better choice is to use cloud accounting software, which automates the majority of your data entry. Today, accounting systems connected to your bank accounts and the apps you use to run your business pull in and record transactions in real time. Automating your bookkeeping with the best accounting software saves you time, and gives you numbers you can trust.