Small Business Accounting 101: Everything You Need To Know

Although small business bookkeeping and accounting responsibilities may seem overwhelming at first, they can be more manageable with the right approach.

This guide will provide you with essential information to help you organize and maintain your small business financial records.

What Is Small Business Accounting?

Starting a small business also means learning accounting basics. Managing your finances might not be fun, but it’s essential for long-term success. Small business accounting involves tracking, recording, and analyzing financial transactions, which creates a clear picture of your business’s profitability and financial position.

Accounting helps small businesses manage finances, track income and expenses, ensure compliance with tax obligations, and make informed business decisions.

Setting up a profitable company isn’t easy. If you are still deciding which venture suits you best, read our guide on the best businesses that run themselves.

Small Business Accounting Vs. Bookkeeping: What’s The Difference?

Small business accounting and bookkeeping are different, even though people often confuse them. Basic bookkeeping tracks everyday financial transactions, such as sales, purchases, and payments. It’s focused on ensuring that financial records are accurate and current.

Accounting for small businesses includes bookkeeping but goes further. It involves analyzing and explaining the financial data recorded by bookkeepers. Accountants create essential financial statements and provide insights that help business owners make smart decisions about their money.

If you are thinking about purchasing a business, review this due diligence checklist.

Basic Accounting Terminology

Understanding the following terms can help business owners interpret financial statements and make informed decisions.

• Assets: These are valuable resources the business owns, such as cash or equipment.
• Liabilities: Debts or obligations the business owes to others, like loans or unpaid bills.
• Revenue: Income generated from selling goods or services.
• Expenses: Costs incurred while running the business, such as rent, utilities, and salaries.
• Equity: The owner’s interest in the business, calculated as assets minus liabilities.

These terms can help you to effectively manage your business finances and communicate confidently with financial professionals.

Different Types Of Financial Statements

Financial statements report on the financial position of your business. There are three kinds: a balance sheet, income statement, and cash flow statement. These, together with retained earnings statements, will give you a transparent picture of your business’s financial health.

• Income statement: Also known as the profit and loss statement, this details revenue and expenses over a specific period and shows whether the business made a profit or incurred a loss during that time.
• Balance sheet: Provides a snapshot of what the business owns (assets) and what it owes (liabilities) at a particular moment.
• Cash flow statement: This statement tracks cash movement in and out of the business, helping business owners understand how well they manage their cash resources.
• Statement of retained earnings: Also called a statement of equity, this report demonstrates business growth and performance potential by showing how much money the entity retains once all costs and payments, including dividends, have been accounted for. A business might retain earnings to pay debt, reinvest in the business, or keep as backup for a rainy day.

When applying for business loans, small business owners are often required to provide accurate record-keeping and financial statements to qualify for funding.

How To Do Accounting For Small Businesses: A 15-Step Guide

Select an appropriate accounting method and consistently track business transactions to manage your small business and prepare for taxes effectively. Follow these 15 steps to create a robust accounting framework that supports your business growth and financial health.

Step 1. Establish A Legal Structure

Choosing the proper legal structure for your business affects your taxes, liability, and operational flexibility. Some standard options include:

• Sole proprietors: Simple to set up and require minimal paperwork, but offer no personal liability protection;
• Limited Liability Company (LLC): Provides some legal protection for personal assets and tax benefits and
• Corporation: This framework is more complex but can raise capital and reduce liability.

When deciding on a system, consider your business goals, potential risks, and future growth.

Step 2. Open A Business Banking Account

Opening a different small business bank account will help you maintain financial clarity. When you keep your personal and business finances separate, you can easily track income and expenses.

A business bank account simplifies reconciliation of bank statements for tax preparation and provides a clear view of your finances. A dedicated account improves your professional image and can help you obtain financing, as lenders often prefer businesses with established banking relationships.

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Step 3. Build Your Credit Score

A strong credit score supports your small business’s financial stability. It can help you secure loans, better interest rates, and favorable supplier payment terms.

To improve your credit score, pay your bills on time, manage your credit utilization ratio, and consider using a business credit card for purchases.

Monitor your credit report regularly to spot and address any discrepancies. Maintaining a solid credit score can reduce financial risk and set a strong foundation for future growth. Implement POC and POV to learn more about effectively managing your finances and reducing financial risk.

Step 4. Choose Your Accounting Method

When choosing the best method for your business, consider its size, industry, country regulations, and financial reporting needs. A well-structured website can also support financial management by integrating accounting tools and efficiently tracking transactions.

The cash basis accounting method records business transactions only when cash changes hands, making it simpler and easier for many small business owners to manage. This method is beneficial for businesses with straightforward cash flows.

The accrual basis accounting method (used mainly by larger entities) records business transactions when they occur, regardless of when the cash exchange happens. This system provides a more comprehensive view of your financial performance, but it can be more complex to manage and track cash flow.

Step 5. Develop An Accounting System

To implement a small business accounting system, select reliable accounting software that meets your needs. Ensure the system easily categorizes transactions, generates financial reports, and offers invoicing, income and business expense tracking features.

Create a regular schedule for updating your financial records, whether weekly or monthly, to maintain accuracy and avoid last-minute scrambling during tax season. Develop a filing system for receipts and important documents.

A well-organized accounting system helps you make informed decisions, monitor cash flow, and maintain compliance with tax regulations.

Step 6. Compile A List Of Accounts

Creating a list or chart of accounts categorizes all the financial transactions your business will encounter, making it easier to track income and deductible expenses.

Start by dividing your accounts into main categories: assets, liabilities, equity, revenue, and expenses. Under assets, you might include cash, inventory, and equipment, while liabilities could encompass loans and accounts. Then, move on to further categories like accounts receivable and accounts payable.

A well-structured list helps you stay organized and simplifies financial reporting and tax preparation. Review and update your chart of accounts regularly as your business grows and changes.

Step 7. Track Your Income And Expenses

Documenting income and tracking expenses help you determine the financial status of your business. Start by noting every money-related activity, such as sales and purchases. To stay organized, you can use accounting software or a simple spreadsheet.

Regularly check your income to find patterns to help you set better prices or improve your marketing. Capturing your business expenses enables you to identify areas where you can save money. Make it a habit to update your records consistently to stay accurate and ready for tax time.

Step 8. Choose Payment Methods

Selecting the proper payment methods for your specific target audience enhances customer satisfaction.

Offering multiple payment options to accommodate different preferences can help increase sales and build trust for repeat purchases. Consider various payment options, including credit and debit cards, electronic funds transfer, digital wallets, pay-on-delivery, and Buy Now, Pay Later services.

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Step 9. Implement A Payroll System

When your small business starts expanding, you might wonder how to manage payroll effectively. Setting up a payroll system will help you manage employee compensation without constant headaches.

You should start by choosing whether to handle payroll in-house or use an external payroll service. An efficient system helps pay employees on time, correctly calculates benefits, and deducts taxes.

A small retail store might use software like Gusto or Sage to automate payroll calculations, tax withholdings, and direct deposits. This approach saves time and reduces the risk of errors. When implementing a payroll system, regular reviews and updates to employee information help maintain accuracy and compliance with labor laws.

Step 10. Learn About Tax Responsibilities

Know your tax responsibilities to run a successful business. Different taxes apply to income, sales, and payroll, depending on your business structure and location.

Stay informed about local, state, and federal tax regulations to ensure compliance and avoid penalties. To simplify the tax process, consider using automated tax solutions that provide live, accurate tax rates for your online customers at checkout.

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Step 11. Determine Your Gross Margins

To determine your business profitability, you must calculate your gross margins. To do this, subtract the cost of goods sold (COGS) from your total revenue.

This figure shows how much money you retain from sales after covering the direct costs of producing your products or services. For example, if your business generates $100,000 in sales and your COGS is $40,000, your gross margin will be 60%.

Analyzing your gross margins allows you to identify pricing strategies that maximize profits, assess operational efficiency, and make informed decisions about cost management. Regularly reviewing your margins helps ensure your business’s long-term financial health.

Step 12. Maintain Inventory Stock Levels

Keeping track of your inventory stock levels helps you meet customer demand and avoid overstocking or stockouts. Monitor your inventory regularly using software or manual systems to ensure accurate counts.

Efficient inventory management helps optimize cash flow, reduce storage costs, and make informed purchase decisions, improving customer satisfaction and business profitability.

Step 13. Review Accounting Practices

Review your accounting processes regularly. Set aside time to evaluate strategies, identify areas for improvement, and ensure compliance with regulations.

This process may involve updating accounting software, managing your website, refining your chart of accounts, or consulting with a financial advisor. Continuous improvement enhances efficiency, supports informed decision-making, and strengthens your business’s financial position.

Step 14. Hire An Accountant For Help

Engaging a certified public accountant can benefit your business and free your time for other responsibilities. They offer expertise in tax regulations, financial reporting, and compliance, allowing you to focus on core operations.

An accounting professional can provide valuable insights to optimize finances, enhance profitability, and ensure your business stays on track. They can also help file tax returns.

Step 15. Train Staff On Practices And Software

Proper staff training on accounting practices and software boosts their efficiency and reduces errors, ensuring smooth operations. Ensure they understand how to use the tools effectively and are familiar with best practices for maintaining accurate financial records.

Best Small Business Accounting Software

When managing a small business, the right accounting software can streamline financial processes, from tracking income and expenses to generating reports.

These software options offer various features to meet the needs of small businesses, such as user-friendly interfaces, cloud-based accessibility, and robust reporting capabilities.

• QuickBooks
• Xero
• FreshBooks
• Wave
• Zoho Books

Invest in the right accounting software to simplify your financial management and focus on growing your business.

Small Business Accounting Tips

Effective small business accounting is a key part of your financial success.

• Start by organizing your finances with a clear chart of accounts and regularly tracking income and expenses. Utilize accounting software to automate processes and improve accuracy.
• Establish a routine for reviewing financial reports to gain insights into your business’s performance.
• Think about allocating a percentage of business income to a savings account for estimated taxes.
• Consider using tools like Friday, which provide essential features to streamline your accounting tasks.

For those just starting, check out our small business startup checklist to ensure you cover all the necessary steps for effective financial management.

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Summary

In this article, we’ve explored how utilizing technology, establishing transparent processes, and knowing when to seek professional advice in small business accounting can improve financial management and overall business success.

With Friday, you can create a website with user-friendly tools and resources to streamline your accounting practices, ensuring you stay organized and focused on growing your business.