The Complete Small Business Guide to Bookkeeping

No business can survive without bookkeeping, but few small business owners get excited about doing it. Instead, it’s one of those secondary considerations many entrepreneurs assume they’ll have to pick up along the way. 

And for many business owners, it continues to be an afterthought. You started your business because you had an idea and a vision to connect with an audience and create something. So why spend time looking at the numbers when you could be meeting customers or making a sale? 

However, when you fail to focus on bookkeeping, you undermine your business and put your company at risk. Take the time to learn more about bookkeeping and why it’s so important. 

What Is Bookkeeping?

Bookkeeping has to do with maintaining a consistent financial record of all the everyday transactions made by a business. It requires accurate records of all of the exchanges of money and all the company’s financial obligations. 

Bookkeeping needs to be quick and efficient to stay up to date and maintain an accurate and complete account of the company’s financial activities. 

Difference between Bookkeeping and Accounting

In a lot of ways, bookkeeping and accounting are two halves of the same coin. The difference between bookkeeping and accounting is that bookkeeping essentially has to maintain the records, while accounting is about reading and using that record. 

In accounting, you look over your history of transactions for patterns and changes. Accounting helps you plan efficiently for the future, address problems, and create financial statements and reports for investors. 

For accounting to be done well, it relies on effective bookkeeping. Bookkeeping is about keeping a complete record that reflects the basic facts of your company and its accounts. 

Why is Bookkeeping Important for Small Businesses?

It’s easy to underestimate how valuable good bookkeeping can be for a small business. But, with accurate and up-to-the-minute financial data, you can spot problems or inefficiencies before they grow out of hand. 

Entrepreneurs have to think on their feet, as a single decision in a crisis can put you on the road to success or failure. When thinking of the future and making the right choices for your business, you need to be as informed as possible about your business’s performance.

Beyond planning and troubleshooting, consistent bookkeeping will also help you with other regular practical chores and challenges your business will have to go through.  

Filing Taxes

One obvious benefit of bookkeeping is how it can help when the time comes for filing taxes. Effective tax planning includes good bookkeeping. Every year you need to report your income on your tax returns. Producing that record is another task of bookkeeping. 

Tax Records

Filing your tax return is going to be much quicker and easier if you have thorough and reliable financial records to draw on. With your records of the last year on hand, you shouldn’t have to go far for everything you need. Good bookkeeping also means keeping records of previous tax returns and all your tax payments.  

Tax Deductions

To fill out your tax return effectively and get the best result, you need to properly claim all the tax deductions you’re eligible for. There are numerous business expenses you can claim and remove from your taxable income, but you’ll need to have a record of all of those expenses. 

Proper bookkeeping means having precise numbers for all of those expenses and stored receipts backing up those deductions.  

Loans

Businesses take out loans all the time. Whether you’re investing in growth or simply trying to stay afloat during a crisis, there’s no shame in needing to borrow extra funds. However, bookkeeping is crucial when applying for loans. You need to be able to put together a coherent and confident report of your finances to prove that you deserve the loan. 

Reconciliation

Everyone makes mistakes. Errors are inevitable in business and bookkeeping, but with the proper time and effort, you’ll be able to catch every error that might have become a larger problem down the line. 

Reconciliation in bookkeeping lets you check the accuracy of your records and catch issues by comparing accounts. This is an essential bookkeeping task that businesses should frequently do. 

Bookkeeping Methods:

Bookkeeping is about keeping records of every business transaction. There are a couple of different ways of going about that. However, some different businesses use somewhat different systems. Here are the two principal methods of bookkeeping and the key differences between them. 

Single-Entry Bookkeeping

This is where most small businesses start out. Single-entry bookkeeping gives you the basic accounting essentials without extensive formal effort. 

For every transaction that occurs, you record it under the relevant account. Each separate transaction needs one single entry, whether it’s under revenue or expenses. This can be as simple as a two-column spreadsheet. 

Double-Entry Bookkeeping

Double-entry bookkeeping is a little more complex and time-consuming, but it’s the standard bookkeeping format for larger businesses. It gives you more reliability and makes it far easier to spot trends or errors and track profit and loss.

For every transaction you make, you will record it twice. You record it once in the relevant debit column and once in the relevant credit column. Debits and credits ensure balance and help you track where your money goes as you receive it. 

When you go to pay a repair bill, for example, you would debit money to the relevant expense account and credit money to your accounts payable. This makes double-checking through reconciliation much easier, as all of the numbers should line up.  

Accounting Methods:

There are two different methods of measuring and accounting for revenue as well. There’s the cash basis and the accrual basis for reporting revenue. 

Cash

The cash method is most frequently used for small businesses and personal finances. Using this basis, you measure revenue based on when cash changes hands. You don’t record the transaction until the money is being exchanged. 

This keeps it simple for small businesses, and it helps you to quickly assess how much cash you have at a given time. If you desperately need to buy more raw materials now, it doesn’t help you to know a customer owes you money next week. You need to know how much cash you have available now. 

Accrual

The accrual method is used by all corporations and larger businesses and many more established small businesses. According to the accrual basis for accounting, revenue is reported when it is earned, which can come long before the cash changes hands. 

The revenue has not yet become cash that you can spend, but it’s still important to know it’s coming. The accrual method includes accounts payable and accounts receivable that include money earned or owed before the actual transaction occurs. 

This presents a more comprehensive picture of your company’s assets and liabilities, and it can make financial planning smoother and less unpredictable. Potential investors will expect to see this kind of detail in your formal financial statements. 

Bookkeeping Statements:

There are three key bookkeeping documents you may need to produce at times while running your business. Each statement showcases different core aspects of your finances and will help you to assess your situation and chart a path forward.  

All of these documents are important to investors, auditors, and accountants helping you to evaluate and improve your business. 

Cash Flow Statement

A cash flow statement is a report on the immediate liquidity of a business. It gives you a picture of all the in and out-flows of cash within a particular period. This is an essential tool for managing cash flow and ensuring you have the cash you need precisely when you need it for paying bills, buying inventory, and taking advantage of sudden growth opportunities. 

This is a collection of data that says a lot about your company. An accountant or investor can glance over a cash flow statement and get a quick sense of how stable and sustainable your business operation is. 

Income Statement

An income statement is a basic bookkeeping document that focuses on a company’s overall revenue and expenses in a given time period. Also known as a profit and loss statement, it aims to give you the bottom line about the overall profitability of a company during the period in question.

For the quarter or year under consideration, the income statement reports revenue, expenses, gains in other assets, and financial losses outside of basic business operations. It aims to be a comprehensive statement of a company’s profits and losses. 

Balance Sheet

The third primary financial document is the balance sheet, which focuses on everything that a business owns and owes at a given point in time. Instead of reporting on flows over a longer period, it records the current state of a company. 

A balance sheet outlines a company’s assets, liabilities, and equity. It is called a balance sheet because these accounts should be balanced. Assets are listed on one side, while liabilities and shareholder equity is listed on the other. These two sides should be balanced, as all assets must have been paid for either through debt (liabilities) or investment funding (shareholder equity). 

Small Business Bookkeeping Basics:

There is a lot of specific language used in bookkeeping, and it can take a while to learn it all. Here are some of the common bookkeeping terms you should be familiar with and will need to understand in order to support your business. 

Accounts

An account can refer to a bank account, but more generally, it refers to any specific category, stream, or record of transactions. A business may have a chart of accounts that describes each separate account and collects the information in one place.

Separating your company’s finances into different accounts helps you to keep your finances organized and easily understandable. Here are the primary accounts every business has.  

Assets

An asset is any resource or capital that holds value for a company. This includes cash but also many other resources that are less flexible than cash. This is a large category of accounts that includes inventory, stocks, property, equipment and more.  

Assets are usually categorized according to the time frame in which they’ll deliver on their value. Current assets are those that are liquid or will be liquid in the near future. Most inventory will be current assets, as you expect it to be converted to cash in the short term. Fixed assets are those that offer value over the long-term. 

Liabilities

Liabilities are the opposing counterpart to assets. This umbrella category includes every debt and financial obligation a company has. Any loan agreement, regular expenses, or bill payments will fall under liabilities. 

This category can similarly be split into current liabilities and non-current or long-term liabilities. Current liabilities include all of the money that is owed within the next year. 

Revenue

Revenue is the cash earned by normal sales of your company’s goods and services. This account includes all your regular business earnings. How you measure revenue will depend on whether you use the accrual or cash method of accounting. 

When considering business earnings, it’s important to consider your sales revenue separate from any money you earn from irregular one-time and not sales-related events, like lawsuits or selling off investments.  

Expenses

Expenses are the opposing category on the other side of revenue. These are the transactions made by your business that see cash flow out of your company. Many expenses are regular and recurring, while some may be one-off singular events. 

A company has to spend money in order to make money. Tracking your expenses compared to revenue helps you to ensure you’re getting a reasonable return on your investment. If you’re making significant expenses that don’t seem to lead anywhere productive, you might want to reconsider those costs.  

Equity

For corporations, equity refers to the value of stocks held by the shareholders. For most small businesses, however, there is one single owner of the business. Equity represents the total value of the business to you after all debts are settled. 

If your business was closed down and sold off at any given moment in time, your equity would be the money leftover after all your assets were sold and your debts were paid. 

Accounts Payable

Accounts payable are expected or planned expenses. These are accounts and liabilities that have yet to be paid. This will include all sorts of short-term payments for bills, debts, and inventory. This functions as a subcategory of your liabilities.

Loans Payable

Another specific account under liabilities on your balance sheet should be loans payable. This is the category for loans that will eventually need to be repaid. Any interest payments you make should be filed elsewhere, but the principal remaining on your loan will be filed here. This is usually a long-term liability.  

Inventory

Inventory is an account under assets, and it is one of the most important accounts for managing the everyday operation and growth of your company. You invest money in producing your inventory and then use that money to drive your sales. 

A healthy business needs a consistent flow of cash and inventory. If you’re not selling and converting your inventory, you’re not making money. However, if you sell that inventory faster than you can replace it, you’ll similarly stall your business without any products to sell. 

Cash

Cash is the lifeblood of your business. This is the liquid asset that gives your company flexibility and helps you to adapt, buy new inventory, and pay off outstanding liabilities. Just like inventory, this is an account that should see a lot of turnover. You should be regularly spending cash and seeing more flow in, and managing that flow effectively is crucial for sustaining your growth. 

General Ledger

The general ledger is the central bookkeeping document of a company. It contains the chart of accounts and financial records that cover the whole history of the company’s life. 

All of your reports and statements will be produced out of information collected in the general ledger. Most of these statements will focus on data from particular time periods, unlike the general ledger that includes everything. 

Double-Entry Accounting in the General Ledger

This is where double-entry accounting becomes essential. Every transaction entered into the general ledger should have two equal and opposing parts, a debit and a credit. This allows you to periodically test your general ledger and check for errors with a trial balance, ensuring that the accounts are fully balanced.  

Journals

Many small businesses may use journals as temporary documents for collecting the raw, initial record of transactions. It should describe both the credit and debit parts of the transaction. Once inputted into the general ledger, each transaction is also known as a journal entry.  

Basic Accounting Equation

Every account in the general ledger should be balanced with the others. That balance means adhering to the basic accounting equation: Assets = Liabilities + Equity. The entirety of a company’s assets is equal to the total of all its liabilities and the owner’s equity. 

Double-entry bookkeeping relies on this equation. When you make a sale, you lose inventory and gain revenue, and the account stays balanced. When you take out a loan, your liquid assets increase, but your loans payable increase as well.  

Why Use a General Ledger

Using a general ledger puts all of the records for a business together in one place. It makes it easier to reconcile and find relevant data for financial statements, and it even makes the basic bookkeeping process simpler. 

Getting Started with Small Business Bookkeeping:

If you’re just getting started establishing your business, setting up your bookkeeping system can be an intimidating process. Here are a few basic steps to start you out on the path to success. 

1. Open a Business Bank Account

The first thing you need is an actual bank account specifically for your business. There’s already a lot of work involved in organizing and assessing your company’s finances. You’ll make that even harder if you put personal and company finances together in a single account. 

2. Choose a Bookkeeping System

Before you get started, you need to know what your objectives are with your bookkeeping process. Are you prepared to start with double-entry bookkeeping, or will you use a single-entry system to keep track of transactions?

Whatever you choose, the point is to be clear and consistent. Single-entry bookkeeping can work fine for smaller operations, but you should consider a double-entry system if you’re planning on expanding. 

3. Choose an Accounting Method

How are you going to account for revenue? Establish for yourself and any other partners or employees whether you will be using the cash or accrual method of counting revenue. Using the cash basis is simpler, but the accrual basis gives you more detailed information for business planning. 

Again, the important thing is to be consistent. If you change between methods later on, you need to make that clear in your records. 

4. Manual vs. Bookkeeping Tool

Now you need to figure out your actual bookkeeping process. How are your transactions going to be recorded? Who will do it and how? 

The central choice to be made is between creating your own books manually on your computer or using a program to help you. 

a. Create a Bookkeeping Spreadsheet

An easy manual option is to create a simple bookkeeping spreadsheet. You can start a set of spreadsheets on a central computer or the cloud and use that for logging your financial data. If you take this route, you’ll want to clearly label and organize your spreadsheet workbooks.  

The key is to put in enough effort on the front end so that the data entry process is easy and simple to revisit. It doesn’t matter how many transactions you record if your spreadsheets are messy or unreadable.  

b. Use a Tool

The other option is to find a more automated program or tool to help you organize and input bookkeeping data. Even the smallest of small businesses can benefit from using specialized bookkeeping software to keep their accounts in order. Many tools can also automatically produce regular statements to report on the state of your finances. 

5. Categorize Expenses

Once you have a system and you’ve decided how you’re going to go about your bookkeeping, you can start working and filing transactions as you go. However, you’ll need to know how you’re categorizing various expenses. 

With a simple single-entry system, your books can start with just one column for assets and one for liabilities. All revenues will go in one column and all expenses will go in the other. In order to get more benefit out of your records, you’ll need to sort them so you can keep track of them. 

6. Keep Records

You can change your system and create new categories as you go if you need to, but the most important thing you can do is to keep records. As soon as you start to neglect the bookkeeping process and let a transaction or two stay off the books, your accounts start to be less helpful. 

If you want to keep control of your business and plot a course for success, you absolutely must keep records of everything. The records have to be clear and complete so that you can come back to them later and get accurate data. 

7. Practice Reconciliation

No matter how dedicated you are to your bookkeeping, you’re going to make some mistakes. Human error is inevitable. You might forget to log something or type in a number wrong. 

That’s why it’s crucial to take the time to go over your records for accuracy and reconcile your accounts to ensure they balance. You should practice reconciliation to keep your accounts reliable on whatever regular schedule works for your business, whether that’s every day, week, month, or year. 

8. Keep Up with Your Books

Now that you’ve got the system don’t hesitate to take advantage of it. Your bookkeeping effort won’t be worth much if you don’t use your records. Periodically take stock of your situation and consider the bigger picture among all the numbers. Sitting down with your books can help you improve efficiency and plan for greater growth in the future. 

9. Log Your Deductions

Of course, another great benefit of regular bookkeeping is the easy access to data when tax filing comes around. Many of your business expenses can be claimed as tax deductions, so make sure to log them appropriately in your accounts to make claiming and deducting business expenses straightforward when tax season comes around.  

Bookkeeper vs. DIY

As your business grows and your accounting needs grow with it, you might consider hiring a bookkeeper to work specifically with your financial records. At a certain point it may become too big of a task to handle on top of your other work as a business owner.

Whether you bring on a full employee or work with an external accounting firm, hiring a bookkeeper will take the bookkeeping work off of your plate and give you an experienced but neutral observer to offer advice. 

It may take time for a new bookkeeper to learn about your existing system and the particular issues of your field, but you may see a significant return on your investment once they do. It depends on the size of your business and your budget.   

When to Work with a Bookkeeper

If you’re struggling to set up your bookkeeping system, or you’re worried about making the right choices for your company, it might be time to get help and look into alternate bookkeeping options. 

Bookkeeping is essential, but it’s not what makes your business work, and chances are it’s not the reason you started your company. Fortunately, you don’t have to do it all alone. Working with a bookkeeper can give you more time and energy to focus on innovating and realizing your vision.