Starting and running a small business is a massive undertaking. There are so many little tasks that will make their way onto your to-do list. Of course, you’ll also have the chance to celebrate plenty of achievements, as long as you make sure that you’ve got the right foundation in place.
One of the most important elements of this foundation is your accounting processes, which have a tremendous influence on the future of your business.
In this comprehensive guide, we’ll walk through everything you need to know to get started with small business accounting. Trying to figure it all out can lead you down many different roads. We’ve made it easy by compiling everything you need to know about accounting for your small business.
We’ll go over all the basics of small business accounting, including:
- Whether or not you’ll need to hire a professional
- How to go about bookkeeping for your small business
Do you Need to Hire a Professional?
The first question on your mind is probably whether you need to hire a professional.
As a small business owner, you might be used to doing everything yourself. When it comes to accounting, there are some things you can do yourself and some things that an accountant is better suited to do for your business. In the spirit of time efficiency, it isn’t wise to do everything yourself, but that doesn’t necessarily mean that you need to have a full-time accountant on staff.
So, the question remains: when exactly do you involve a professional? And, for what?
Starting to work with a CPA (Certified Public Accountant) early in your business’ growth can be highly beneficial for years to come. This way, you can get advice about financial strategy and reporting, tax planning, and legal matters. If you don’t consider the bigger picture when your business is small, you’re likely to encounter issues later on. Hiring a CPA for the initial setup of your business’ financial structure is crucial to safeguard against that risk while empowering yourself to make intelligent financial decisions at the most unique point in your company’s lifetime, which is the moment of founding.
“When you start you business, you’re very focused on the things you sell, the service you’re offering, the people you need to hire and the other thousand things necessary to kickoff your business. Too often, the accounting part stays on the back burner and that can cause issues downstream, especially because you don’t know ahead of time when your company will take off.
Having a professional on your team from the start safeguards you from any issues related to government notices, tax penalties, audits, and a variety of other surprises that could come in the way of your daily operations and cash flow.
As is the case for startups who record expenses and revenues haphazardly, surprises often spring up months later in the form of late tax payments, interest fee penalties and more.
As a small business operator, you want to focus on what you do best while having the peace of mind that your accounting is in good hands and up-to-date. In 99% of the cases, the up-front cost of hiring a professional far outweighs any penalties one might incur from an ill-prepared future.”
Should you defer hiring a CPA to later, we recommend involving an accountant again when it’s time for you to delegate some of your workload. As a small business owner, it can be tempting to save every penny and do everything yourself for as long as possible. However, this is actually not cost-effective at all! In fact, studies have shown that pushing yourself too far can lead to burnout and decreased productivity.
Picking the right moment to involve a professional accountant in your small business’ finances is tricky. If you hire one too soon, you may be paying too much for a service that you don’t really need. However, if you wait too long, you might get stuck doing way too much work yourself or finding mistakes in your financial reporting. It is recommended to hire a professional when you're going through major phases of the business like building a business plan, going through an audit or if your business is seeing a large expenditure in the near future.
Opening a Business Bank Account for Your Small Business
Before your business starts making money, you need a place for it to go.
Opening a business bank account is crucial to keeping its accounting processes organized. Although your small business is very personal to you, it must be kept separate from your personal bank accounts. This ensures that your business and personal finances don’t get mixed up. For legal and bookkeeping reasons, this is an important step.
When opening a bank account for your business, there are certain questions you should ask yourself in order to pick the right bank. Every bank has something slightly different to offer, and the little things can make a world of difference. There are some things you may not need to consider right at the beginning of your business journey, but they will certainly come into play later on. It’s best to consider the future and the possibility of growth for your business when selecting a bank to work with. Here are some interesting factors to keep in mind when prospecting banks for your small business:
- Fees. This is the first thing you’ll probably consider when you’re checking out what different banks offer. Be sure to inquire about monthly fees, transaction fees, and even assistance fees.
- Security. In the event that your bank fails, you want to make sure that your money is still safe! Go with a bank that is federally insured and backed by the U.S. government to keep your money as secure as it can be.
- Interest rates. Compare interest rates from bank to bank to ensure you are getting the lowest rate.
- Branches. Does the bank you’re considering have physical branches nearby? If there are online banking limitations, or you think you may need financial advice often, it may be worth it to work with a bank that is physically near your small business.
- Minimum balance requirements. Check if there are any regulations requiring you to maintain a minimum balance. You may get stuck paying penalties if you don’t check beforehand.
There are so many questions you could ask yourself about what kind of banking would be ideal, but it’s important to focus on what’s most important for your small business in particular. If your business has a POS system, you may want to research banks that are compatible with the system you use. For example, Shopify retailer payouts are typically direct-deposit to bank accounts. If you have business partners, it would be important to check out the options for having multiple users or multiple cards associated to your account as well.
No matter what business you’re in, bank fees can start to add up and be a burden. Be sure to look out for any hidden fees. Some businesses have specific offers for small businesses and entrepreneurs which can help you avoid as many fees as possible.
What Kind of Business Account Should You Open?
Once you’ve settled on the right bank for your small business, you need to decide on what type of account to open. Right away, you should be opening both a business savings account and a business checking account.
Most of the day-to-day operations and revenue management should take place in your business’ checking account, but a savings account is important to set aside money to re-invest, to pay taxes, or even just for emergencies.
Additionally, having cash on hand in a business savings account can make it easier to obtain a loan in the future.
Should You Get a Business Credit Card?
There are plenty of pros and cons to getting a credit card for your small business.
Relying too heavily on credit is never a good idea, and credit cards are known for having very unfavourable interest rates. However, this doesn’t mean that your small business cannot or won’t benefit from having a credit card.
As long as you’re sure to pay your bills on time every month, a credit card can help you build up credit, earn special benefits like cash-back or extended warranties, and see your expenses broken down annually.
If you are able to stay financially organized, why not take advantage of these bonuses and make use of a business credit card?
Bookkeeping for a Small Business
You’ve worked with an accountant, gotten all the right accounts opened… now what?
When your business starts running, things can get hectic pretty fast. It’s essential to not only have solid bookkeeping strategies in place, but also to actually follow them.
First, you should decide on a bookkeeping system and stick with it. Having one system in place will not only help you stay organized, but it will also ensure that everyone is on the same page if you have more than one business partner or in the event that you hire more employees.
Not only is bookkeeping important for the organizational structure of your small business, but it’s also a key element of its financial success. It covers everything: invoices, payroll, transactions, expenses… Every side of your business is affected by the quality of your bookkeeping.
Examples of popular accounting systems include Quickbooks, Xero, Zoho Books, Freshbooks, and Sage. As the profession becomes more digital, platforms provide additional advantages by their ability to effortlessly connect to other applications you use every day.
Your bookkeeping system is what creates financial statements to hand over to your CPA. When you file your taxes or make long-term financial decisions, it’s these financial statements that are used! Now you can see why bookkeeping is so important.
A small error or oversight could end up causing confusion, legal issues, or strategic missteps. It is therefore worth the initial effort for a lifetime of organized benefit.
There are two different types of accounting that you have to consider for your business. It’s important to pick the right one, because whichever one you use when filing your first tax return is the one you’ll have to use on all your tax returns from then on.
Let’s go over the two methods and how to pick the best one for your small business.
In a nutshell, cash accounting doesn’t use accounts receivable (AR) and accounts payable (AP). It’s pretty straightforward, counting money as revenue when it is actually received, and expenses when they are actually paid.
Many small business owners choose this type of accounting because it’s easy to make sense of: either the money is there or it isn’t.
When using the cash accounting method, it’s also very easy to understand where you stand in terms of cash flow. All you need to do is check your bank account to see what kind of cash you have available to work with.
Cash accounting does have its disadvantages. For example, because the accounting isn’t documented until an exchange of money takes place, this can make future and past performance analysis quite difficult. It hurts your ability to plan ahead and make adjustments based on your performance.
On the other hand, accrual accounting necessitates the use of accounts receivable (AR) and accounts payable (AP). It counts both revenue and expenses regardless of when the actual money is received. As soon as the revenue or expense is incurred (for example, an invoice being sent out to a customer), accrual accounting records it.
Although accrual accounting offers many benefits, it is not the most common choice for small business owners. Because it offers more details, it also requires more resources, which you may not have!
It provides a better view of your business’ long-term finances, but can also make it difficult to analyze the short-term, something that is very important to keep a handle on when you’re a small business.
When using accrual accounting, you must also use the double-entry method, making two entries for each transaction. In the double-entry system, the left side corresponds to “debit” and the right to “credit.” Every transaction affects both sides. For example, your cash may decrease, but your assets increase.
Bookkeeping plays an integral role in every part of your business, from both an accounting and operations standpoints, since bookkeeping allows you to keep track of your customers, transactions, and essentially every action and interaction that your business plays a part in.
As a regular person, you may not think twice when tossing your receipts. As a small business owner, it’s essential to hold onto all of them! For proper bookkeeping, you’ll not only have to keep a record of every receipt, but also tax returns, financial statements, invoices, bills, canceled checks, bank or credit card statements, and more.
Essentially, any evidence of a financial action, be it a credit, deduction, or income, must be preserved. As a small business, you will also need to consider what expenses can be deducted from your tax return. Things like travel, meals, entertainment, and even home office or vehicle-related costs may be available as deductions.
This amount of documentation and considerations can seem overwhelming, especially when every document has different guidelines for the minimum amount of time it must be held. When your business starts to grow, and the amount of documents along with it, many people opt to work with professional bookkeepers to save time, avoid mistakes and reclaim focus.
As a small business, it’s likely that spreadsheets or a bookkeeping software could do the trick. Before deciding on which option is best for you, it’s a good idea to ask yourself some questions. Consider how much time and money it would take to work with a bookkeeper as opposed to doing it yourself, as well as the level of risk if you’re not totally confident in the processes.
Creating a Budget
Budgeting as a small business can be especially difficult to get right, especially in the early days of your company. Your income may vary quite a bit from month to month in the beginnings of your business, and that can lead to difficulties budgeting with confidence. However, budgeting is one thing that should definitely not be skipped over. Without it, your small business will be unable to scale, and may even face big cash flow issues. It’s also important to help you:
- Understand your finances in order to make more informed decisions and strategize optimally
- See where your money is going and identify both opportunities for growth or areas where you may need to cut down on costs
- Have the opportunity to get funding and apply for loans, both of which normally require a detailed budget
Luckily, there are a few steps you can take to make this process easier, reap the rewards of proper budgeting, and avoid running into a financial disaster.
Step One: Calculate Your Fixed Expenses
First off, start by knowing your fixed expenses. You should never forget this number!
Calculate the fixed costs (expenses that don’t change) of running your business. Fixed expenses are the recurring costs that you’ll have to pay for no matter how your small business is performing. This includes things like rent, utilities, equipment, loan payments, website hosting fees, etc.
Knowing the total of your fixed expenses is crucial for small business because it serves as a benchmark of the minimum amount you need to make in order to break even. Even if your income varies, you’ll have a general idea of the revenue floor you cannot go under to keep things running.
Step Two: Calculate Your Variable Expenses
Variable expenses, as the name suggests, vary month to month depending on certain things.
As income grows, so do variable expenses. Even though variable expenses can be hard to predict beforehand, it’s still necessary to include in your budgeting.
As a small business, especially if you’re just starting out, it can be hard to get a sense of why and how these expenses are changing. However, if you’re on top of your budgeting, and consistently take a look at your variable expenses at the end of each month, it will become easier and easier to understand what’s going on.
Unlike fixed costs, you may be able to cut variable costs during times when cash flow is low. Furthermore, being diligent about monthly reconciliations helps you identify patterns in your spending that you may end up being able to budget and prepare for, strengthening your ability to plan and act without surprises to your cash flow.
Step Three: Consider One-Time Costs
What other types of expenses are there aside from fixed and variable?
Many small businesses will have to spend on resources that are not recurring. These are one-time costs, and they are easily forgotten when it comes to building your budget.
If you have any upcoming purchases, it’s important to factor these into your budget as well. This often includes things like equipment, but it could also cover something as small as a company phone.
No matter how large or small the one-time expense- the more you have on your budget, the more effective it will be.
Step Four: Calculate Your Income
Income is yet another variable in your budget. It is unlikely to be the same number every month, but it’s still important to consider.
What’s crucial here is to understand where your money is coming from. Your business may have different streams of income, for example, online sales and physical store sales. When you’re calculating your monthly income, figure out the income received from each stream, and then add them all up to see your total income overall.
Step Five: Bring All the Numbers Together
Now that you have information about all the money coming into your business, and all the money going out, you have all the right ingredients for a basic budget.
However, it’s important to know how to put it all together and analyze it in order to get the most out of your budget. Here’s the most important equation to remember:
Total Income - Total Expenses = Total Net Income
Step Six: Analyze Your Budget
Your total net income is the amount that your small business is earning after all expenses.
This is the amount you’re left to save, invest, and use to grow your company even more. But, before making big financial decisions, sit back and consider the numbers.
If your total net income is low, or even negative, you may need to cut costs and focus on boosting your income. If your total net income is high, you may want to consider an investment or growth opportunity.
Step Seven: Always Be Saving
For a small business, saving money is one of the most important things you can do. Small businesses tend to deal with a lot of risk and fluctuations, so it’s always better to be prepared rather than caught off guard.
Budgeting with no room for emergencies or low cash flow can be difficult and risky, so be sure to set money aside just in case. How much money should you be putting into savings? It’s a good idea to settle on a realistic percentage of your net income that you can save each month. You can apply and save a similar amount for reinvesting into the business, the rest of which can be pure take-home profit or dividend.
When it comes to taxes, ignorance is anything but bliss.
In your personal life, you may be very comfortable and at ease with your tax obligations and what to do when tax season comes around. But now that you’ve started a business, things are a little more complicated and time consuming. It won’t come as a surprise then that good bookkeeping will save you countless hours during tax season!
As a small business owner, understanding at least the basics of your tax obligations will ensure that you are in compliance with the law and don’t run into any bureaucratic confusion.
Let’s go over the basics of taxes for small businesses:
Types of Taxes
First of all, there are a number of different types of taxes that you may have to deal with.
- Income Tax: This is the tax that your business pays based on the amount of profit it makes. The way income tax works is all based on the way your business is legally structured.
- Employment Tax or Self-Employment Tax: If your business has any employees, you’ll have to pay employment tax. It’s important to be aware of this tax throughout the year, since it affects your payroll. Even if you’re self-employed, you must pay a self-employment tax, which essentially covers the same things as employment tax.
- Sales Tax: This is one of the most difficult types of tax to understand, simply due to the amount of different rules and exceptions that exist.
No matter what type of taxes your business has to pay, this is one area where it’s certainly important to take your time and work with a CPA. Tax obligations can change, and it’s important to consider them year-round, not just when tax season rolls around.
Setting up Payroll
If you’re planning on hiring even just one employee, you’ll need to have a payroll system in place.
Automated payroll solutions can help take a lot of the hassle out of this activity! Payroll has to take into account everything from employment tax and insurance to worker’s compensation and how your employees are classified.
If payroll is done incorrectly, it could not only result in some unhappy employees, but also in problems with the IRS. This is all true whether you have a single employee or dozens of them! Here are some tips to keep in mind when setting up your payroll:
- Pick the right system: Popular systems include Gusto, Wagepoint, and Paychex.
- Check your state and federal obligations:
- Don’t overlook the paperwork:
The Importance of Invoicing
The king of all records is undoubtedly the invoice. Although all documents are important, invoices are how you get paid, how your customers know what they’re paying for, and how you keep track of transactions. Learning how to manage invoices as a small business owner is a skill that you must continually work on developing.
First off, ensure that you understand how to properly make an invoice. It may seem like something completely straightforward, but even the smallest omission could throw a wrench into your operations! When you start creating your first invoice, you should select a template and a system that you will stick with. This way, recurring clients know what they’re in for, and your invoicing can be automated as much as possible.
Next, ensure that you have systems in place for after the invoice has been sent. A big mistake that many small business owners make is simply forgetting about the invoice as soon as it’s sent to the client. The truth is, that’s not where it ends. Invoicing is a step-by-step process that requires some attention, but once you’ve got the process up and running smoothly, it will make things so much easier!
Unfortunately, it’s highly likely that you will deal with customers not paying their invoices on time- around 60% of invoices are actually paid late. In fact, if an invoice sits unpaid for 90 days, there’s only an 18% chance that it will ever be paid! Having an automated invoicing system can help you handle this seamlessly and waste the least of your time possible.
Start off by having templates for your invoice emails and reminders to customers. There are many stages along the invoicing process where these templates come in handy. Did you know that sending a thank-you note along with your invoice can even help you get paid up to 5% faster?
Plus, when it comes time to remind a customer about their invoice, or inquire about a late payment, email templates minimize the amount of time you need to spend following up.
Invoices are also something that you’ll receive from your supplier. At this point, they can be considered a bill. But, you should understand how they affect your accounts payable and how best to pay the invoices that come to you.
Analyze and Optimize your Finances
Finances and accounting are ongoing processes, and there’s always room for improvement.
Whether you have an accountant working with you or not, it’s a good idea to build up your financial literacy so you understand the ins and outs of your numbers. Financial analysis is a tricky thing, so let’s go over the basics that every small business owner should know:
What’s a Balance Sheet?
A balance sheet is a document which shows your business’ equity, assets, and liabilities all in one place. This is an element of your financial statements, and a balance sheet is one of the most important documents when it comes to small business accounting. Understanding what’s on it, how to read it, and how to analyze it is crucial for every small business owner. A balance sheet is governed by one main formula:
Assets = Liabilities + Equity
Assets are what you use to run your company, and they are balanced out by the business’ liabilities as well as the equity invested into the company. A balance sheet uses these numbers to show the financial position of a business at a given moment.
What’s a Cash Flow Statement?
A cash flow statement helps you visualize your cash flow by projecting the money coming in minus the money that will be going out of your accounts.
Cash flow management is another important part of small business accounting, and many small businesses struggle with it. Up to 82% of small businesses in the U.S. even fail because of this very struggle. A cash flow statement can help you analyze the operations of your business, and is an especially important tool to keep an eye on when margins are low.
If your cash flow goes negative, this could leave you struggling to deliver to your customers and unable to grow your business.
Calculating a Sales Forecast
To create a cash flow statement and estimate the amount of money that will be coming in, you first need to have a sales forecast. A sales forecast estimates future sales, which can help you make financial decisions and create more accurate budgets.
Forecasting sales can be tricky, since sales can be influenced by a number of different factors. However, it’s not necessarily about predicting the future, and is more so another way of staying on top of your finances.
Consistently reviewing your sales forecasts will help you understand how to make them better and how you can make financial decisions for your small business in the future.
How to Calculate Your Gross Margin
Your company’s gross margin is an important element in measuring its profitability. This is one of the key performance indicators, or KPIs, that you should understand and know how to calculate yourself.
What exactly is a gross margin? It shows the percentage of your revenue that is higher than the cost of your goods sold. This is an important indicator of your business’ profitability, comparing your revenue with the actual cost of production.
Understanding Financial Reports/Statement
When it comes time to check out a financial report or statement, the sheer amount of numbers can be overwhelming. What should you be checking for? What are some good signs to look out for? Bad signs to look out for? Every time you have a financial document, there should be a handful of things that you know to check off your list.
One of the most important things that you can calculate based on your financial reports and statements is the actual value of your business. There are so many different financial documents that show different perspectives on the financial status of a business, but how can you calculate its value. Calculating the market value of a business is something that can help you understand the big picture and get an idea of how far your business has come. Valuation takes into account a number of different factors:
First off, the value of your business’ assets: everything your business owns minus debts or liabilities. This is the value of your assets, and it is the first step in determining the value of a business as a whole. Next, things such as revenue, earnings, and cash flow can be taken into account.
Small business accounting can seem daunting, there’s no arguing that. But, equipped with the right information and the right professional assistance, every small business owner can ensure that their finances are kept in order.