The Definitive Guide to Small Business Bookkeeping

How much should a small business pay in quarterly taxes? In sales taxes? Can it afford to upgrade its technology? Is it on pace to expand? Important questions such as these demand accurate answers, and getting those answers requires accurate bookkeeping. A strong bookkeeping system is an essential part of any small business.

Bookkeeping records all of the financial transactions of a business, from income to payroll to all business-related expenses. The strength of small business bookkeeping can make the difference between the success and failure of a business.

Bookkeeping is the process of organizing and storing the financial and accounting documents of a business. Without accurate bookkeeping, there is no physical proof of where a business stands financially. It’s a critical function for both the financial management of a small business and for potentially keeping the business out of legal trouble. 

Financial data such as income statements, balance sheets, and cash flow statements can provide a look at the financial health of a business and can offer a look at where a small business can improve its financial situation, such as cutting unnecessary spending. Bookkeeping can also keep a business compliant with Internal Revenue Service (IRS) tax regulations.

In addition, tracking incoming revenue against outgoing expenses can help a small business plan its strategy for the future. Accurate bookkeeping can also can a business respond quickly and effectively to potential audits, or inquiries from the IRS.

How Does Bookkeeping Help a Business?

Simply put, proper bookkeeping helps a small business grow and prosper. It does this in a variety of ways. Here are a few small business bookkeeping examples that emphasize its importance to small businesses:

• Overview of Business. Bookkeeping provides small business owners with an overview of their business through bank statements, income statements, and balance sheets. This information helps business owners better understand the strengths and weaknesses of their business and develop short-term and long-term plans accordingly. Of course, the better the information available, the better these decisions are likely to be.
• Accurate Recording of All Financial Transactions. Bookkeeping helps small business owners quickly understand details such as how much the business spends on overhead such as utilities and office supplies, or how often certain product offerings need to be ordered.
• Filing Taxes. Being a small business owner can be stressful enough without having to worry about the preparation and filing of taxes. Proper bookkeeping organizes all of the relevant documents and paperwork to make filing tax returns easier and less time-consuming.
• Business Analysis. A huge benefit of bookkeeping is that it allows business owners to quickly analyze their expenses, income, and cash flow. As a result, spending can be adjusted if necessary. More emphasis in terms of time and funding can also be placed on those portions of the business that are more profitable. Budgeting also is easier with well-kept books
• IRS Compliance and Audits. Accurate bookkeeping makes it less likely for a small business to run afoul of IRS compliance. But, in those cases where the IRS may have questions about expenses, tax deductions, and other tax-related questions, good bookkeeping can also provide thorough answers in a timely manner.
• Meeting Legal Requirements. Keeping financial records of a business is a legal necessity. Breaking this law can result in a business being shut down.

How Do I Keep Books for My Small Business?

While many small business owners may be experts in their field, they can be novices in the how-to of small business bookkeeping. As such, an often-asked question is, “How do you do bookkeeping for a small business?” With that in mind, here are some small business bookkeeping basics to organize a business’ books.

Understand Business Accounts

In bookkeeping terminology, an account is actually a category of a certain type of category or transaction, such as income or sales. There are five standard types of accounts:

1. These are the funds the business has on hand, and any resources owned by the business, such as inventory and real estate. Accounts receivable are also considered an asset.
2. These are the debts and financial obligations the business owes. Loans and accounts payable are considered liabilities.
3. The terms revenue and income can be used interchangeably. This is the money generated by the business.
4. Payroll and rent are prime examples of expenses. They are funds paid by the business for necessary services or products.
5. Assets minus liabilities equals equity, which is the owner’s interest in the business. Dividends are an example of equity.

For the next step in small business record keeping, books must be established to set up business accounts. Gone are the days of large books called general ledgers. The vast majority of businesses today use small business bookkeeping software to keep their books. While the physical books may no longer exist, the electronic file is still called the general ledger.

How to Set Up Digital Bookkeeping

The first step in setting up a bookkeeping system for a small business is to establish a dedicated bank account for the business. Mixing personal and business funds can unnecessarily complicate the bookkeeping process and may even lead to increased scrutiny by the Internal Revenue Service (IRS). Filing taxes will be easier with a separate business account, and the personal assets of the business owner will be better protected.

For businesses structured as a Limited Liability Corporation (LLC), a separate business bank account takes on added importance since the company’s expenses pass through the personal taxes of the business owner.

There are three basic software programs for creating an electronic business system. These are:

• Spreadsheet software;
• Desktop accounting bookkeeping software; and 
• Cloud-based bookkeeping software.

Of these, spreadsheet software is the least expensive, but the potential for error is great. Excel is an example of spreadsheet software.

Desktop bookkeeping software normally has a high fee one-time fee upfront, while online cloud-based bookkeeping software, requires a monthly subscription fee. That monthly fee, however, can be more cost-effective than the fee charged by desktop software.

QuickBooks Desktop is an example of desktop bookkeeping software, while QuickBooks Online is a cloud-based bookkeeping software program.

Small Business Bookkeeping Services

Small business owners can also pay for an independent accountant, bookkeeper or accounting company to oversee their books. To find a local option for bookkeeping and accounting services, simply enter “small business accounting services near me” into the search bar.

How Much Should a Small Business Spend on Bookkeeping?

Professional bookkeeping can cost between $1,000 – 5,000 per year. Accounting services for a specific purpose, such as preparing for an audit, can cost between $150 and $450.

The price for desktop accounting bookkeeping software can range between $250 and $350. An online subscription to cloud-based bookkeeping software is normally about $25 per month.

What Are the Basic Books in Record Keeping?

Transactions are recorded in books – either physical or digital – called journals, ledgers, and the trial balance.

The journal is the book where a business chronologically records a transaction for the first time. This entry records the date of the transaction, the amount, and the accounts debited or credited.

The ledger is a book that contains a compilation of accounts. Transactions entered into a journal are then classified into separate accounts and transferred into the ledger. These accounts are assets, liabilities, equity, income, and expenses. Keeping an accurate journal will help ensure the ledger is balanced at the end of the year.

The trial balance is a product of the entries compiled in the ledger. It serves as a test to see if the books of the business are balanced. Inaccuracies between debits and credits are easy to see on the trial balance.

Preparation of Financial Reports

Once the books are balanced, it’s important to understand what the books say about the financial health of a business. This is done by generating financial statements created from day-to-day entries to examine the company’s performance over a period of time. There are three main financial reports that every business must produce and understand:  the cash flow statement, balance sheet, and profit-and-loss statement. These three reports provide a picture of the financial situation of a business. They help identify areas for growth and potential problems,

1. Cash Flow Statement. This is a financial report that tracks the incoming and outgoing cash in a business. It demonstrates how well the business manages its debt and expenses. As a result, the cash flow statement allows business owners to see if the business is earning enough revenue to be a consistently profitable venture.
2. Balance Sheet. Balance sheets indicate how much value a business has by comparing what a business owes against what it owns. Balance sheets show the assets, liabilities, and equity of shareholders at a given point in time. They have the most value, however, when compared with balance sheets from other periods in time.
3. Profit-and-Loss Statement. This is also called the income statement. This statement shows the profitability of the business. Profit and loss are determined by a simple formula:  Revenue – expenses = profit/loss. The upper half of the profit-and-loss statement chronicles operating income and the lower half lists expenses.

Having accurate financial statements is critical to any enterprise seeking small business loans.

How Do Small Businesses Record Transactions?

Small business transactions are recorded in chronological order in a journal, typically using the double-entry bookkeeping system. This involves two accounts: debit and credit. Debits are normally recorded on the left side of the journal. Credits are on the right side. In double-entry bookkeeping, each transaction requires both a debit and a credit.

While single-entry bookkeeping is more basic and less challenging, double-entry booking helps ensure that the books of a business are balanced. In addition, most accounting software comes equipped with double-entry bookkeeping, which greatly reduces the degree of difficulty.

Choosing an Account Method:  Cash Basis or Accrual

For small business owners who choose to manage their own books rather than outsourcing the work, the next step is to decide whether to use the cash or accrual accounting method to keep their books. Both methods have their pro and con, so the key is to decide which is best for your business.

Cash Basis

Cash basis accounting is the method that’s commonly used by most small businesses to keep their books. In cash basis accounting, income is recorded when it’s received as opposed to when the invoice for the work is sent out.

Likewise, expenses are recorded when they’re paid, not when they are incurred. For example, should the business owner need to order furniture online and use a business credit card for payment, the expense wouldn’t be recorded until the date that the credit card bill is paid.

Since record-keeping is simple in cash basis accounting, professional accounting help isn’t required. Accounting software automatically tabulates income and expenses as they are received or paid and puts them into the appropriate categories.

Cash basis accounting also tracks cash flow. It registers bank transfers, check transactions, and credit card payments. This allows cash basis accounting to provide a valuable look at where a business stands cash-wise and how it may change.

On the downside, cash basis accounting can be deceptive. Recording income when received rather than when billed can make a slow month seem busy and vice versa. It also means that cash basis accounting can’t be used to track invoices that a business receives or sends. A separate tracking system is needed for invoices in order for them to be accurate on your balance sheet.

Accrual Basis

With accrual basis accounting, income is recorded when earned and expenses recorded when incurred.  This allows small business owners to better track the performance and profitability of their business

However, accrual basis accounting can make it harder to detect cash flow problems, since funds are being recorded that have yet to be received. This can lead to paying taxes on income the business has yet to earn. Accrual basis accounting is more labor-intensive since it requires all invoices and bills to be entered into the system before the end of each month.

What Records Will Be Needed for a Small Business?

The records that a small business needs to maintain go far beyond invoices and receipts. In addition to filing income taxes, small businesses need to comply with IRS and Department of Labor regulations that require documents to be kept for up to seven years. The IRS, for instance, can audit the financial records of a business up to seven years in the past and even longer if the business owner fails to file a tax return or is suspected of fraud.

The most common financial records that need to be kept are:

• All tax forms submitted to the IRS;
• Tax returns;
• Bank statements;
• Financial statements;
• Employee timesheets and pay stubs;
• Insurance documents;
• Customer invoices;
• Receipts;
• All contracts, including loans and mortgages;
• Depreciation schedules;
• Business registration documents;
• Legal files;
• And emails.

There can be other state-specific document retention rules on the state level.