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Running a small business comes with many responsibilities—and keeping accurate financial records is one of them. Bookkeeping might seem intimidating at first, but it's essential for your business's success. It helps you track your income and expenses, keep an eye on your financial health, and make informed decisions. Plus, it's a legal necessity for tax compliance.
To shed light on this topic, we talked to an accountant and a senior financial analyst. Here's their best advice on basic bookkeeping.
Bookkeeping 101: What is it?
Think of bookkeeping as the detailed management of your business finances. It involves systematically recording all financial transactions. Whether you're making a sale, paying bills, or transferring money between bank accounts, bookkeeping keeps track of every financial move.
By recording these transactions, you gain a crystal-clear picture of your business's financial health. You can see how much money is coming in (income), how much is going out (expenses), and what's leftover (profit). This information is crucial for several reasons:
- Tax time triumph: Come tax season, you'll be a filing pro with all your financial records neatly organized. No more last-minute tax scrambling.
- Smart business decisions: You can identify areas to cut costs, track sales trends, and make strategic decisions to grow your business.
- Financial fitness tracker: Just like a fitness tracker monitors your health, bookkeeping tracks your business's financial well-being. You can monitor cash flow, identify potential problems early on, and keep your business on solid financial footing.
Bookkeeping vs. accounting: Understanding the differences
While bookkeeping and accounting are closely related and often used interchangeably, they serve different purposes in managing a business's finances. Understanding the distinction between the two is crucial for small business owners.
Bookkeeping involves the day-to-day recording of financial transactions, which includes documenting sales, expenses, payments, and receipts. Bookkeepers ensure that every financial transaction is accurately recorded in the business’s books, keeping an organized system to track financial activities.
Accounting, on the other hand, takes the information provided by bookkeeping and analyzes it to provide insights and reports. Accountants interpret, classify, analyze, report, and summarize financial data. They also handle financial statements, file tax returns, and advise on financial strategy.
Bookkeeping: How to do it right in 6 simple steps
Now that you understand the basics, it’s time to put your knowledge into action. Here's our easy-to-follow guide to bookkeeping for beginners.
1. Set up your bookkeeping system
The first step is choosing a system that works for you. The main options are:
- Manual bookkeeping: Pen, paper, and a calculator—the old-school approach. While perfectly functional for some micro-businesses, manual bookkeeping can be time-consuming and prone to errors.
- Bookkeeping software: “They improve accuracy and time management,” says Michael Schmied, a senior financial analyst. “Tools like QuickBooks, Xero, and FreshBooks streamline tax preparation, making that time of year a little less stressful, and provide real-time financial insights.”
2. Choose an entry system
The next step is to decide between single-entry and double-entry bookkeeping systems.
- Single-entry bookkeeping: Imagine this as a checkbook register for your business. It tracks income coming in and expenses going out, but it doesn't account for liabilities (what you owe) or assets (what you own). This method can work for basic bookkeeping, for freelancers, or micro-businesses, but "if you need to track liabilities and assets, double-entry is the way to go," Schmied says.
- Double-entry bookkeeping: This method provides a 360º picture of your finances. Every transaction is recorded twice—once to debit (record a decrease in an asset or increase in a liability) an account and once to credit (record an increase in an asset or decrease in a liability) another account.
It may seem complex at first, but it ensures accuracy and shares insights into your financial health. "For most small businesses, I'd recommend this option, given its precision and ability to capture nuances like assets, liabilities, and equity," says Mark Pierce, an accountant, attorney, and Certified Public Accountant.
3. Select an accounting method
Here, you have two options available:
- Cash basis accounting: This is straightforward and easy to understand. Income is recorded when cash is received, and expenses are recorded when they are paid. This method is often used by small businesses and freelancers because it gives a clear view of cash flow.
For example, if you receive payment for a service in January, you record the income in January, even if the service was provided in December. Similarly, if you pay for office supplies in February, you record the expense in February, regardless of when you actually used the supplies.
- Accrual basis accounting: This is more complex but offers a more accurate picture of your business’s financial health. Income is recorded when it is earned, and expenses are recorded when they are incurred, regardless of when the cash is received or paid. It's preferred by larger businesses and those looking to get a better understanding of their financial situation.
For example, if you provide a service in December but don't receive payment until January, you record the income in December. Similarly, if you incur an expense in January but don't pay for it until February, you record the expense in January.
4. Create and maintain financial records
To keep your financial records, you'll need a chart of accounts—a complete listing of every account in your accounting system. These accounts are used to categorize all of your business’s transactions and are crucial for maintaining organized financial records.
Your chart of accounts should include accounts for assets, liabilities, equity, income, and expenses. It’s essential to record every single transaction, including details like date, amount, description, and the accounts affected.
Keep track of invoices sent to customers and ensure timely payment. These are your accounts receivable. Follow up on overdue invoices to avoid cash flow issues. Additionally, monitor your outstanding bills (accounts payable) and pay them on time to maintain good relationships with suppliers, avoid late fees, and manage your business’s credit rating.
5. Reconcile bank accounts
Reconciling your bank accounts is essential for having accurate financial records and ensuring your bookkeeping matches your bank statements. Regular reconciliation helps identify discrepancies, detect fraud, and avoid costly errors.
“I advise small business owners to reconcile their bank accounts at least on a monthly basis,” Pierce says. “However, if they engage in a volume of transactions, weekly reconciliations may be best.”
6. Generate financial statements
Don't underestimate the power of financial statements. These reports act like financial storytellers, giving you details about your business's health, performance, and insights for the future.
Three key statements make up the financial picture:
- Balance sheets: They give a snapshot of your financial position at a specific time, revealing what the business owes, what it owns, and its net worth.
- Income statement: Also known as the profit and loss statement, it summarizes your business's income and expenses over a period of time, showing your net profit or loss.
- Cash flow statement: It tracks the movement of cash in and out, helping you understand how you earn money and how you use it.
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How to bookkeep like a pro: Bonus tips
One of the easiest ways to simplify your bookkeeping process is to automate recurring transactions. By setting up automated invoicing, bill payments, and payroll, you can save a lot of time. “This reduces manual entry errors and ensures timely transactions, which are crucial for cash flow management,” Schmied says.
He also states the importance of protecting your financial information by backing up your data. “Keep digital backups of your financial records. Think of it as an insurance policy for your records.” Using cloud-based bookkeeping software can make this process easier, as it often includes automatic backup features.
Common bookkeeping mistakes to avoid
Steer clear of common mistakes like not keeping receipts, miscategorizing expenses, and mixing personal finances with business ones. “These can be avoided by maintaining meticulous records and using the right software,” Pierce says.
“Overlooking bank fees and inaccurate record-keeping” are also frequent pitfalls, Schmied says. Regular reviews and detailed tracking can help avoid these issues.
Consider outsourcing as your business grows
As your business expands, bookkeeping complexity may increase. When deciding whether to hire a bookkeeper or an accountant, consider your financial complexity and available resources.
“If your business needs help with daily financial transactions and maintaining records, a bookkeeper is your best bet,” Schmied says. “For more complex tasks like tax planning, financial forecasting, and strategic advice, you should hire an accountant.”
FAQs
What are the bookkeeping basics?
Bookkeeping is the process of recording all your business's financial transactions systematically. It involves tracking income, expenses, assets, liabilities, and equity. This data provides a clear picture of your financial health and helps you make informed business decisions.
How do I teach myself bookkeeping?
You can teach yourself bookkeeping in different ways (this guide gives you a solid start). Additionally, online courses (check Coursera and Udemy), workshops, and even free tutorials can equip you with the knowledge you need. You can also use bookkeeping softwares like QuickBooks, Xero, or FreshBooks to get hands-on experience.
How do I choose the right bookkeeping software for my business?
For small businesses, user-friendly software with essential features may be sufficient, while larger businesses may require more advanced features. Evaluate the cost of the software, including any monthly or annual subscription fees, and ensure it fits within your budget.
Look for important features to your business, such as invoicing, expense tracking, bank reconciliation, and financial reporting. Choose software that is intuitive and easy to use, with good customer support and resources for learning. Don’t forget to check if the software integrates with other tools you use.
When should I consider outsourcing bookkeeping to a professional?
As your business grows, your bookkeeping needs might become more complex. Spending too much time on bookkeeping tasks, struggling to understand your financial data, and needing help with tasks like tax planning or financial forecasting are important signs. Hiring a professional bookkeeper can free up time, ensure accurate financial management, and give peace of mind.