Bookkeeping for Small Business – A Beginner’s Tutorial

In this article we’ll begin with the most frequently asked questions about small business bookkeeping that we discovered on Google – so that’s all the stuff you want to know. Then we’ll talk about the stuff you need to know in the simplest language we could come up with. We call it the Reader’s Digest version.

What Small Business Owners Want to Know – FAQ’s

If you want to be successful in your small business, understanding and tracking your finances is a fundamental skill that, like it or not, must be mastered.  We hope this article makes it at least a little easier.

Is bookkeeping necessary for a small business or the self-employed?

YES! That is an unequivocal yes. You must understand your bookkeeping system. You can delegate, but you must not abdicate. The risks of not keeping your bookkeeping up to date include, but are not limited to:

  • Missed tax deadlines
  • Over or underpaying taxes
  • Missed vendor invoices
  • Uncollected receivables
  • Poor cash flow
  • Undiscovered internal theft

We could go on, but you get the idea (we hope!).

What is the difference between bookkeeping (a bookkeeper) and accounting (an accountant)? 

We’ll answer these two questions together.

Bookkeeping vs Accounting

Bookkeeping

Bookkeeping, done by a bookkeeper, focuses on recording and organizing financial transactions. Accounting, done by an accountant, interprets and presents that financial information to business owners and investors.

Bookkeeping typically includes recording and maintenance of financial records and reconciling accounts. Including:

  • Reconciling accounts
    • Business Bank account(s)
    • Credit cards
    • Review bank statements
  • Accounts Receivable
    • Invoicing
    • Collections
    • Managing cash receipts
    • Credit reviews
  • Accounts Payable
    • Record vendor invoices
    • Pay vendors
    • Work with creditors (those you owe money to)
  • Payroll
  • Help prepare tax returns

Accounting

Accounting typically includes the interpretation and presentation of the information recorded and organized by the bookkeeper. Such as income tax planning, preparing documentation for bank loans, and preparation and interpreting of financial statements such as the:

  • Income Statement
  • Balance Sheet
  • Cash Flow Statement

So the bookkeeper will record the information while the CPA or accountant will tell you what it means for your business.

What is the difference between an accountant and a CPA?

While all CPAs are accountants, not all accountants are CPAs. The educational requirements are different. An accountant will typically have acquired a bachelor’s degree in accounting, while a CPA, or Certified Public Accountant, is earned after completing certain educational and work requirements and passing an exam specific to the state in which they are practicing.

Do I need an accountant if I have a bookkeeper?

To properly plan and file your taxes, you should probably have an accountant that helps you, at the very least, at the end of your fiscal year. If you need financing, an accountant would be more helpful than your bookkeeper – though (s)he will need the books to be up to date and accurate to provide you with the best results. 

How long should my bookkeeping take to complete each month?

The amount of time needed to keep your books up to date will depend on the number of accounts and transactions that have to be managed and the complexity of those transactions.

Generally speaking and assuming very little complexity, for every 100 transactions you need to record, you can assume approximately 60 to 90 minutes.

How much should I pay for bookkeeping?

The average hourly wage for a bookkeeper in the US is $22 per hour. According to the NSA (the National Society of Accountants), the average is $180 per hour. Accountants and CPAs range from $125 to $400 per hour.

While these fees may seem high, the cost of doing it yourself can be even higher. Filing your own taxes can be stressful and time-consuming. Errors are costly and frequent if you don’t know what you’re doing. Tax laws for the self-employed and small business owners are more complicated than for an employee. Here is an excellent article on the benefits of using an accountant https://lili.co/blog/cost-of-tax-preparation-by-cpa

What about software?

5 Reasons to choose an accounting software rather than manual bookkeeping or Excel

1. Automation

One of the biggest advantages of using accounting software is that it automates many of the tasks that you would otherwise do manually. This includes things like invoicing, tracking payments, and generating reports.

This saves you a lot of time and means that you can spend more time on other aspects of your business.

2. Accuracy

Mistakes happen!  But they happen less frequently and are easier to find when using accounting software. The software does the calculations for you, so there is less chance of human error.  

3.  Search

When you need to find a transaction it’s easy to search your accounting database.  Not so much when all your transactions are in a manual ledger.

4. Save money

Accounting software can save you money in the long run, by helping you to avoid late fees and interest charges, and it can also help you to get paid faster.

5. Better decision making and peace of mind

When you have accurate financial information, it allows you to make better decisions about your business. For example, if you know that you are not making a profit, then you can take steps to change this.

Finally, using accounting software can give you peace of mind. This is because you will have a better understanding of your financial situation and will be able to see where your business is heading.

Which accounting software should I choose for my small business bookkeeping?

Honestly, this is a big question and one we’re not prepared to answer in this article.  Know that likely to have to live with this decision for several years, take your time and choose wisely.  Here are a couple of links to articles you can read to start your research.  

  1. Best Accounting Software – Investopedia
  2. Best Accounting Software for 2022 – Prospect Tax
  3. Best Accounting Software for 2022 – Nerd Wallet

What Small Business Owners Need to Know – A Beginner’s Tutorial

We’ve gone over what you want to know, now let’s talk about what you need to know (at least in our opinion). To successfully manage your small business finances you’ll need to begin with a couple of fundamental decisions.

Cash or Accrual Basis?

The first of those decisions is whether you will record your transactions on a cash basis or an accrual basis. If you have inventory, are a C-Corp or are doing $5 million or more in annual revenue the IRS requires you to use an accrual method, but for most small businesses, a cash basis is the easiest way.

The main difference between cash and accrual basis accounting is the timing of when transactions are recorded.

Using the cash method you record income when you receive payment and expenses when you pay for them. This method allows better cash flow monitoring, which is critical in most small businesses.

Using the accrual method you record income and expenses in the same period and when they occur as opposed to when cash is exchanged.  So when you create an invoice, whether or not it is paid and when you pay an expense, not when you receive the bill.

The cash basis method generally results in lower taxes in the current year. However, this can create problems in future years if insufficient cash is available to pay the taxes owed. The accrual basis method results in higher taxes in the current year but can provide a more accurate picture of a business’s financial health. Ultimately, the best method of accounting depends on the individual business’s needs.

For smaller businesses, it’s possible to use the accrual method during the year but still file your taxes using a cash basis. Which you choose is beyond the scope of this article and a brief discussion with your accountant is probably a good idea.

Double-entry or single-entry?

This is the second fundamental decision you’ll need to make.  Here are the basics and some pros and cons.   

Single Entry

If you’ve decided to work on a cash basis a single entry system might be the simplest and easiest way to keep your books. Single entry means you’ll enter each transaction one time, subtracting expenses from total sales.  

Each transaction should have a date, description, amount or value, and a running total. You might keep these records in a manual journal or cash book, or you can use an Excel or Google sheets file. If you maintain a spreadsheet, I’d recommend one file per year and one tab per month.  

Double Entry

Double entry accounting is a bit more complicated. For each entry, incoming or outgoing, you’ll need a second offsetting account or entry. So every debit (always entered in the left-hand column) will have a credit (always entered in the right-hand column).  

The two entries must always match for your books to be balanced.  

It sounds more complicated than it is. Most if not all accounting software is double entry. Once you’ve set up your chart of accounts, the software does most of the work for you. 

Man meditating

Debits and Credits (The confusing part)

This is where it can get a little confusing but once you’ve worked with it for a while it will all start to make sense.  Debits and credits are the two basic types of entries in accounting. Here are three key things to remember about debits and credits:

1. An increase in assets or expenses is recorded as a debit (on the left)

2. An increase in revenue, liabilities or equity is recorded as a credit (on the right)

3. The debits and credits must always balance.so that the books remain balanced.

Five Financial Areas to Maintain and Measure

Sales and Revenue

We rarely need to remind small business owners to track sales, no matter how little they know about basic bookkeeping. But most companies, even small ones, have more than one revenue stream. If you’re not accurately tracking your revenue streams, you’re missing an opportunity to understand and grow your business.  

 So what exactly is a revenue stream? I’ll use my own company as an example; I have several revenue streams:

  • Accounts receivable collections 
  • Bad debt collections
  • Collection support products
  • Back office support
  • Educational products and services

You might have revenue streams from sales of products, services, or advertising. Revenue streams can be one-time events, such as a product sale, or recurring, such as a monthly service fee.

Tracking revenue streams is essential for any business owner who wants to grow his business and understand its financial health. Tracking revenue streams helps a business owner understand where his revenue is coming from and how it is generated. You can then use this information to decide how to grow the business, what products or services to offer, and how to allocate resources.

Don’t overdo this.  Figure out your revenue channels but don’t get crazy about it, you don’t want to delay your reports with overcomplicated reporting requirements.  Most businesses can break this down to 2 to 5 revenue streams.  

To easily track your revenue streams you’ll need to adjust your chart of accounts to reflect each one.  Then your bookkeeper will be able to easily post each sale to the correct revenue channel.  

Expenses

Business expenses include everything you spend in your business to generate sales and revenue and to operate your business. Do not include personal costs in your small business accounting records! It’s essential to keep them separate for several reasons:

  1. It helps to ensure that business expenses are tax deductible.
  2. It helps to maintain accurate financial records.
  3. It can help to protect your assets if your business is sued.
  4. It can help you to avoid personal liability for business debts.
  5. It can make it easier to get business financing.

Avoid headaches later by keeping personal and business expenses separate.

Types of Expenses

Businesses have a variety of expenses that they must incur and track to keep operations running smoothly. These can be broadly categorized into four main categories: 

  1. Cost of goods sold – (COGS) The cost of goods sold includes the direct costs associated with producing and selling a product or service. They can include:
    1. Raw materials
    2. Items purchased for resale
    3. Freight-in costs
    4. Purchase returns and allowances
    5. Trade or cash discounts
    6. Factory labor
    7. Parts used in production
    8. Storage costs
    9. Factory overhead
  2. Operating expenses – Operating expenses are those necessary for the business’s day-to-day running, such as:
    1. Rent
    2. Payroll & Salaries
    3. Utilities
    4. Insurance
    5. Repairs
    6. Office supplies
  3. Capital expenditures – Capital expenditures are funds used to purchase long-term assets, such as buildings or machinery. 
  4. Debt service – The payments made on loans or other forms of financing. 

The cost of goods sold is perhaps the most important expense category for businesses to track. This is because it directly affects their bottom line; the more a business spends on producing and selling its products or services, the less profit it will make. For this reason, businesses must always strive to keep their cost of goods sold as low as possible. There are a variety of ways to do this, such as negotiating better deals with suppliers or streamlining production processes.

Because it directly affects their bottom line, the cost of goods sold is perhaps the most critical expense category for businesses to track. The more a company spends on producing and selling its products or services, the less profit it will make. Always strive to keep COGS as low as possible. There are various ways to do this, such as negotiating better deals with suppliers or streamlining production processes.

Each type of expense is important in its own way, and businesses must carefully track all of their spending to ensure profitability.

Why Track Expenses?

2 Reasons to track expenses

  1. Track expenses to manage cash flow and ensure profitability. Sales and revenue are exciting and fun to track if we’re doing well. Expenses, not so much. But, if we don’t know what it costs to generate our revenue, we don’t know enough to run our business profitably.  Your expenses must be lower than your revenue – if you’re not tracking expenses, you’re very likely to spend too much. If costs exceed income, we’re not profitable; if we’re not profitable, we go out of business. 
  2. TAXES! Many business expenses lower your taxable income. That means you pay taxes on less of the revenue you generated. April 15th comes every year folks; track those expenses so you can keep more of the money you earned.

How to track expenses?

You can do this the simple way or the easy way. The simple way is to maintain your check register and deduct what you spend from what you earn. The easy way is to choose bookkeeping software and an accounting system, as discussed above, and diligently enter all your business transactions.

Cash Flow

Cash flow is the lifeblood of any business, so it’s important to keep a close eye on it.

3 Reasons to monitor cash flow

  1. Watch your cash flow to avoid running into cash flow problems. By forecasting cash flow, you can identify potential shortfalls and take steps to address them.
  2. A cash flow forecast can help you make better use of your money. By knowing how much cash is coming in and going out, you can make sure you’re using your money in the most efficient way possible.
  3. A cash flow forecast can help you plan for the future. By forecasting cash flow, you can make sure you have the money you need to grow and expand.

There are several ways to forecast cash flow, but one of the easiest and most effective is to use a cash flow forecast tool.

A cash flow forecast is a tool that businesses can use to predict how much cash they will have coming in and going out over a specific time period.

Most software packages have a module or option for forecasting cash flow. How to do it will depend on the software package you’ve chosen.

Profitability

What is it?

Profit is the difference between what you earn “revenue” and what you spend “expenses.”  There are three ways to measure profit:

  • Gross profit  (Revenue – Cost of Goods Sold or COGS)
  • Operating profit (Gross Profit – Operating Expenses)
  • Net profit (Operating Profit – Taxes)

Net profit is what we’re looking for when everything is said and done.  In the end, it all comes down to one thing – did you earn more than you spent?

Why?

Generating profits is the purpose and primary goal of all business ventures.  If there are no profits there is no cash.  If you have no cash you can’t invest in your business, hire help, or borrow money.  That’s right you’ve got to have money to borrow money.  It doesn’t sound right but it’s the way it is nevertheless.  Ultimately if you aren’t profitable, you’ll have to close the business.  

How?

How to calculate profit is simple – I gave you the formulas in the section above.  How to make a profit in a small business is a big subject and is beyond the scope of this article.  But I strongly recommend you do some reading!

Here are a couple of must-reads, “Profits Aren’t Everything, They’re the Only Thing” written by George Cloutier and “Profit First” written by Mike Michaelowicz.  And here is a good article to get you started.  https://www.tonyrobbins.com/career-business/make-a-profit/.  We particularly like this one out of the many we reviewed because it starts with “understand your financials”.

But in the end, it all comes down to one thing – did you earn more than you spent?

Summary

So, what have we learned? First and foremost, it’s important to understand your small business finances. This means tracking revenue and expenses, understanding your cash flow, and monitoring your profitability. 

You can best accomplish this by choosing a software package that you can manage. 

If you’re still feeling lost don’t be afraid to ask for help. . Nearly 60% of businesses fail within their first five years, in part because they didn’t have a firm understanding of their financials. That’s why it’s so important to take the time to learn.  Leave your comments below or give us a call at 800-201-2274 we’re happy to help you set up your bookkeeping so you can keep up.

 

 

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