Profit is the most important aim for all businesses, with the exception of those that are in the non-profit industry. To continue to increase profits and be prepared for the eventuality the business needs to be aware of its financial situation. This knowledge is especially crucial for smaller businesses because their capacity to handle sudden fluctuations is lower than large corporations.
If you are a business owner, how do you determine your financial situation? With accurate bookkeeping.
In this article, we’ll discuss the basics of bookkeeping and how to implement it, and more.
What is bookkeeping?
Bookkeeping is the process of recording every business transaction, such as the expense, income, asset and liability, in order to precisely assess the financial health of the company at any point. It is vital to ensure the business’s financial health, because you’ll know the amount of income and expenditure and be aware of your activities. Additionally, you are able to make informed decisions regarding your future. If, for instance, you discover a new opportunity and you want to know if you have enough money to make the most of this chance. These well-informed decisions are great for ensuring continuity in your business and growth.
Keep in mind that accounting and bookkeeping can be confusing, but they’re not the same. The primary focus of bookkeeping is helping small businesses comprehend its financial standing and make more informed decisions, whereas accounting focuses on financial analysis and reporting.
Why bookkeeping matters for your business
Bookkeeping for small businesses is crucial to ensure the success of operations. In addition to compliance requirements, this helps companies maintain a healthy cash flow, perform precise tax calculations and meet the requirements of compliance. A few of the advantages of small business bookkeeping include:
- By using bookkeeping, you are able to properly report income as well as claim deductions and calculate accurate tax rates for your company. This means you’ll be able to stay clear of penalties and late tax filings.
- It monitors cash flows to help you better plan your future expenses and avoid excessive cash outflows.
- Complete records of transactions and the supporting evidence will make it easier for you to get deductions. For example, small businesses are eligible for deductions for business travel, equipment purchases, etc. For that, you must keep accurate data of the same.
- It is often utilized by investors and lenders to assess your financial situation. A good bookkeeping practice can increase your chance of securing funding.
- The accuracy of your records reflects your professionalism and establishes confidence in the minds of your clients.
- Helps to identify errors, discrepancies and frauds before they turn into major issues.
With these benefits, the importance of bookkeeping is crucial to the growth of small companies.
The Step-by-Step Bookkeeping Process
To reap the advantages above, you should have an efficient bookkeeping system. This guide will show you how to do bookkeeping for beginners:
Step 1: Separate Business and Personal Expenses
Regardless of your business’s structure, it’s a good idea to keep your personal and business expenses separate. This will mean that you’ll have more control over your business’s transactions and your financial health.
The first step in keeping your financial affairs separate is to have different accounts for personal and business use. Be sure to set up a separate business bank account which is used exclusively for business. Also, you should use separate credit cards specifically for your business and never utilize them for personal expenses. Keep track of these expenses on your credit cards to ensure accuracy.
Step 2: Choose a Bookkeeping System
After you have opened the accounts, then the second step to take is to choose the business accounting and bookkeeping strategy. There are two kinds of bookkeeping: single entry and double-entry. You need to choose which one is best suited to your business.
The majority of the time single-entry is a simple process that is able to record only one entry per transaction. In double-entry, each transaction impacts at minimum two accounts, one as a credit, and the second as debit. As you can see, single-entry is very easy to manage and doesn’t require special accounting expertise. But, one disadvantage is that it’s difficult to spot errors and functions effectively only for small cash flow. Based on the nature of your business and the amount of transactions, you will be able to choose the right method.
In both systems, it’s recommended to utilize software for bookkeeping like QuickBooks or Xero because they come with built-in functions to automate the recording of transactions. Automating your accounting will help save time and effort as well as, maintaining the records even if you’re not an expert in accounting.
Step 3: Select an accounting method – Cash vs. Accrual
The next crucial decision is to make a choice between cash and accrual accounting method. Understanding the distinctions is essential.
Like the name implies, with a cash account, just note a transaction when the money has been paid or received. It’s a simple system that is effective when you don’t work on credit. The accrual system, on other hand, is ideal to businesses that offer or accept credit, control inventory, or need the detailed view of their financial situation. With this method, 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 provide $100 worth of goods to your regular customer by credit and they promise the opportunity to repay it within two weeks, you’ll record the transactions on the date you deliver it to the customer, not the day you receive money from the client. Out of the two methods, the accrual method is the most preferred since it offers an over-the-long term view of the financial health of a business. Additionally, the accrual method is in compliance with Generally Accepted Accounting Principles (GAAP).
It is important to note that GAAP recognizes the cash basis for small businesses, as long as they meet certain requirements.
Step 4: Use the right tools for bookkeeping
When you are setting up your bookkeeping system, be sure to select the appropriate tools which simplify your work and help to achieve your goals over the long term. The first thing to consider is whether you’d like to make use of accounting software or just spreadsheets. While spreadsheets can be useful as well as cost effective, they may become a bit cumbersome after a certain point and they are not the best choice for recording complicated transactions. This is why an accounting software is a better flexible option that will accommodate the growing volume of transactions in your business. Additionally, It offers automated invoicing, expense tracking and reporting. This can certainly cut down on time and effort.
Step 5: Categorize your transactions
Another crucial step is to categorize your transactions into distinct groups for better visibility and calculation. The categorization of your transactions will improve the quality of the report. A few common categories to look at are utilities, rent, wages, office supplies, marketing and travel. If you track expenses in each category, you’ll be aware of how each category adds to your income and expenditures. Based on this information, you will be able to make better financial planning.
Step 6: Store your financial documents securely
In addition to keeping precise records, you should also ensure that you keep your documents in a secure manner. The loss of your records could affect your tax filing and the ability to assess your financial situation.
To prevent this, keep multiple copies of your receipts and invoices. Ideally, you should keep a physical copy in a safe locked cabinet, and keep multiple digital copies on various storage devices such as hard drives and cloud storage. Be aware that the IRS will require you to keep these copies for a period of three to seven years, or longer based on the nature of the document and the requirements of your business. Make sure you have adequate storage capacity to store the entire set of records.
Step 7: Keep track of tax deductions
Deductions are a crucial aspect of bookkeeping since they help you reduce your tax liability. If you know the tax deductions you qualify for, you will be able to do business expense tracking more efficiently. Some possible tax deductions, depending on your industry and turnover, are:
- Business meals
- Set-up cost for home office
- Office equipments
- Business loan interests.
- Depreciation
- Contributions to charities
- Education, if it’s in connection with business.
Be aware of the ones that are applicable to you and make a note of these in your bookkeeping. If you intend to file deductions, ensure you have supporting documents such as receipts and vouchers in a safe place.
Step 8: Make bookkeeping a habit
Finally, integrate bookkeeping into the business process. Be sure to educate your employees and utilize the right software to account for your transactions and enjoy the advantages as mentioned earlier. Set reminders every week or month to review your transactions and then reconcile the missing ones. Review your records regularly and cross-check them with bank transactions for greater accuracy.
By following these steps, you’ll be able to establish and manage a complete bookkeeping plan that provides long-term transparency while also making sure that you’re in compliance.
DIY bookkeeping vs. Hiring a professional
A crucial choice for small-scale business owners is whether to hire an expert who will manage their bookkeeping or take on the task by themselves. Here are some pros and cons for each alternative.
The DIY approach to bookkeeping
At first, Do-it-yourself bookkeeping might seem like the most efficient method since it can save money, however it is also crucial to realize that it is time-consuming and may divert an owner’s time away from the more important aspects of business.
Pros:
- It saves money
- Direct control over financial records
- Learn more about accounting and finance
Cons:
- Time-consuming
- Increases the chance of making mistakes, as the business owner may not be an expert on accounting
- Lack of knowledge on deductions could increase tax liabilities
- There involves a learning curve
In the end, DIY bookkeeping is ideal for solopreneurs and freelancers with limited transactions.
When to outsource bookkeeping to a professional
Engaging a bookkeeper, or a professional accounting company can provide entrepreneurs security and give them the opportunity to concentrate on their business. These experts are knowledgeable about the procedure and will bring maximum value to the company. The advantages and disadvantages to outsourcing include as the following:
Pros:
- Most accurate levels of accuracy keeping records and ensuring compliance
- The ability to leverage tax deductions
- Expert advice on strategy, and valuable insights
- It frees time for business owners
Cons:
- Costlier than DIY bookkeeping
- Owners might not be aware of everyday transactions
Outsourcing is a great option for businesses with complex or large volumes of transactions that make it challenging for the business owner to manage on their own. It also helps when the owner of the business does not have a solid understanding of accounting and requires external assistance.
Parr & Ibarra CPA firm in Keller, Texas is an experienced and trusted firm which handles bookkeeping for small companies. We also offer customized services such as account reconciliation, categorization of transactions, tax optimization, and preparation, in-depth financial analysis and creation of reports.
Final thoughts – Simplify bookkeeping for business success
Bookkeeping is crucial for all businesses because it gives you a clear overview of your finances at any given time. However, it can be a daunting task especially if you’re not familiar with accounting. Another option is to utilize software for bookkeeping that handles the accounting, however an alternative is to employ experts as they can go beyond accounting to offer strategic insights. If you choose to carry out DIY bookkeeping or outsourcing, ensure that you keep the correct records of your transactions.
If you’re in search of experts who can manage your bookkeeping needs, schedule an appointment for a free consultation with Parr & Ibarra CPA.
