Small Business Accounting Guide
As a new business owner, you need to understand accounting to manage and grow your business. It can be tedious, but understanding accounting will only make you a better business owner.
Essentially, accounting is keeping track of the money that flows in and out of your business. You'll record inflows and outflows to purchases, sales, liabilities, and other accounts. Even though accounting is a broad topic, small business accounting generally involves bookkeeping, creating financial statements, and filing tax returns.
Read on for more discussion of small business accounting below. We'll also show you how to get your accounting system started.
What Is Small Business Accounting?
Small business accounting is the process of gathering and evaluating the financial activities of your company. It involves recording transactions and producing financial statements. Your accounting method translates numbers into understandable information about the value and profitability of your business.
How to Get Started With Small Business Accounting
Here's a list of steps you can take to set up an accounting cycle for your small business.
Open a Business Bank Account
The easiest way to separate your business transactions from your personal finances is to have a dedicated bank account for your company. In most states, you'll have to register formally to get a business name before banks can grant you a business account. Don't be deterred: Having a business bank account will benefit you in several ways, such as:
- It makes tracking your business transactions easier.
- It makes records distinct and separate from your personal expenses.
- It helps you organize your revenue and plan for taxes.
- It establishes a financial history for your business, which you can use to apply for a business credit card, loans, or funding.
- It protects your personal assets in case of bankruptcy, lawsuits, or audits.
Develop a Bookkeeping System
Bookkeeping is the basis of accounting — the process of recording, classifying, and organizing business transactions. It also includes categorizing expenses, managing invoices, and reconciling bank statements. On the other hand, accounting builds on the information gathered through bookkeeping. It involves generating financial statements and making sure you're prepared for tax season.
One of the first decisions you have to make when setting up your bookkeeping system is whether to use a cash or accrual accounting system. Here's a quick differentiation between the two:
- Cash basis accounting: Revenues and expenses are recognized at the time they are received or paid. In short, you record transactions when cash changes hands.
- Accrual basis accounting: Revenues and expenses are recognized when the transaction occurs. Under this method, you're required to record account receivables and payables using the double-entry method.
To be effective at business bookkeeping, you also need to understand the basic accounting that composes your financial statements. Below are some accounting terms you need to be familiar with.
- Assets: These are anything of value that your business owns. You buy or produce assets to generate income. Examples include cash, accounts receivable, inventory, furniture, and real estate.
- Liabilities: These are the debts and obligations of your business. Examples include accounts payable, income taxes, wages, loans, and bills from utility companies.
- Accounts receivable: These are payments you expect from customers, clients, and other parties for the purchase of goods or services.
- Accounts payable: This is money you owe to creditors and suppliers.
- Double-entry accounting: This is a method where at least two entries (a debit and a credit) are made for each transaction. The two corresponding sides must be equal.
- Balance sheet: This is a financial report that shows your company's total assets, liabilities, and equity at the end of a specific period.
- Income statement: This reports a business's total revenue, expenses, and net profits for a specific period.
- Cash flow statement: This is a summary of your cash inflows and outflows from sales, expenses, and other transactions during a certain time period.
An option to help you manage your bookkeeping is Skynova's accounting software. Our accounting software will help you keep track of your expenses, let you choose between accrual and cash basis accounting, and ensure the accuracy of transactions through double-entry accounting.
Track Your Income and Expenses
Business income represents the total monetary value that you get from any activities that you do for profit. The term "monetary value" is used because if you barter with another person to provide a service in exchange for goods or another service, you still need to report the corresponding monetary value as income. Your revenue may include tips, commissions, and profits from business operations and investments.
Business expenses refer to ordinary and necessary costs incurred in the operation of a business. Examples of business expenses are rent, utilities, insurance, equipment or equipment rentals, furniture, and supplies. It's beneficial to track your business expenses to evaluate your profitability and because some expenses can count as tax deductions.
You'll need to establish how you'll record your income and expenses. You can use a spreadsheet, hire a bookkeeper, or use accounting software like Skynova. Just make sure you are tracking both accounts regularly.
Decide on a Payment Processing System
Whether you have a storefront or you're an independent contractor, you'll need a way to accept payments. With advances in technology, you have plenty of options. Having an efficient point of sale (POS) system can go a long way in making sure that your business operations are running smoothly and that you'll get paid for your hard work.
You may decide to use online payment, such as email money transfer or PayPal, get a cash register, or use a third-party payment processor like Square or Stripe. You can also try Skynova's invoicing and small business accounting software. It's easy to use and helps you keep accurate records of your income, expenses, sales taxes, and payments.
Create a Payroll System
If you have employees, you need an efficient payroll management system to pay wages and file employment taxes. Some of the work involved in managing payroll includes:
- Setting up a payroll schedule
- Time tracking of worked hours
- Calculating wages
- Withholding taxes and other deductions
- Printing and delivering checks or sending money through other processes
- Paying employment taxes
Take note that there's a difference between an employee and an independent contractor. You'll have to establish which one you'll be hiring because your responsibilities and the tax forms needed will vary for each.
Generate Financial Statements as Needed
Financial statements report the business activities of a company during a specific accounting period. They're also used as metrics to evaluate the financial position of a business. The three major financial statements are:
Be Mindful of What You'll Need for Tax Season
As a small business owner, you have to remember that you are responsible for paying all of your taxes. If you are a freelancer or are otherwise self-employed, you'll need to pay income taxes, self-employment taxes, and possibly estimated taxes every quarter. If you have employees or engage independent contractors, you'll also need to be aware of the tax implications of these relationships.
Take note that tax obligations also vary depending on your business structure. Popular business types are sole proprietorships, partnerships, and limited liability companies (LLCs).
Here's a list of what you'll want to keep track of for tax season:
- Business income: Keep invoices and records of your income from all sources of revenue.
- Business expenses: Keep receipts and records of all expenses you incur from starting and operating your business.
- Self-employment taxes: You must pay self-employment tax if your net earnings from self-employment are $400 or more. The self-employment tax rate is 15.3%, with 12.4% going toward Social Security insurance and 2.9% going toward Medicare.
- Estimated taxes: The Internal Revenue Service (IRS) requires that taxes must be paid as you earn or receive income throughout the year. If you expect to owe $1,000 or more when your return is filed, for instance, you must make quarterly payments or you'll incur penalties.
- Sales taxes: If you operate in a state that has a state income tax, you must set up a system to collect sales tax from your customers. Then, you'll need to report and remit payment to your state's Department of Revenue.
- Property taxes: If your business owns real estate, you'll receive a notice to pay property taxes to the city or county where your property is located.
- Employment or payroll taxes: You'll need to withhold, report, and remit the following for each employee: federal income tax, FICA taxes for Social Security and Medicare, and federal unemployment (FUTA) taxes. The federal income tax will come from withholding alone, FICA taxes include employee contribution and employer contribution, and unemployment taxes are paid by employers only.
Reconcile and Close Your Books
To reconcile and close your books means verifying that all of the information is correct for a specific accounting period. Closed books allow for accurate financial statements. Accurate reports, in turn, help you make better-informed decisions for your business.
At a minimum, you'll need to close the books annually when you file an income tax return and prepare annual financial statements. If you have large volumes of transactions and you need to submit sales tax reports, it may be easier to close your books at the end of each month.
This last step in the accounting cycle involves closing income and expense accounts and making post-closing entries. This is also the part where bank transactions are reconciled and financial statements are created. Closing entries reset the accounts and the balances are transferred to the owner's equity account.
4 Tips for More Effective Small Business Accounting
Bookkeeping and setting up an accounting system for your small business don't have to be complicated. The goal is simply to keep track of your income and expenses and collect financial information for tax time.
Below are tips on how you can save time and reduce the stress of recordkeeping and tax filing.
Consider Using Additional Help During the Initial Stages
Even though you may want to manage your own bookkeeping and accounting, enlisting the help of professionals while you're still learning the ropes can be a good idea. It may even save you money: When it comes to taxes, even innocent mistakes can cost you.
Consider outsourcing some bookkeeping or accounting tasks. The following accounting professionals can offer some help:
- Accountant: An accountant can offer you advice on many business facets like structure, licenses, and permits. You'll also have access to accounting services, such as business planning and payroll services.
- Certified public accountant (CPA): In the unfortunate event that you get audited, a CPA is the only person who can legally prepare an audited financial statement.
- Bookkeeper: A bookkeeper does the day-to-day management of your business accounts, including reconciling and closing your books.
- Tax preparer: A tax preparer fills out necessary tax forms and may file them on your behalf.
Calculate Your Gross Profit Margin & Identify Ways to Improve It
Your gross profit margin is a key benchmark in determining your business's profitability. The gross profit margin represents the portion of each dollar of revenue that your company retains after deducting the cost of goods sold (COGS). The COGS refers to direct costs incurred to produce the goods or services. Raw materials and direct labor are examples of direct costs.
To calculate your gross margin, the formula is:
To illustrate, assume a jewelry-making business has $100,000 in revenue and COGS of $35,000. The company's gross margin would be 65%. This means for every dollar of income, the company retains $0.65, which would be further reduced as it pays taxes, salaries, wages, etc. That's why a higher gross margin means higher overall profitability for your company.
Use Accounting Software to Keep Your Financial Records Organized
Although you can use spreadsheets to set up your small business accounting, the process can be time-consuming. Manual accounting is also prone to errors. Thankfully, you have options if you decide to tackle accounting yourself.
Consider using online accounting software, like Skynova's accounting software for small businesses, to simplify the process. It saves you time and it makes tracking your income and expenses more manageable. Accounting software also allows you to manage your accounts and transactions in real time.
Reevaluate Your Accounting Methods as Needed
As your business grows and you learn to navigate the ins and outs of accounting and taxation, you'll need to reassess what your business needs and adjust accordingly. Maybe you've handled accounting for your business since you started but you've expanded and need advanced methods. Or you've learned a lot and are now comfortable handling bookkeeping on your own. It's always good to check how you're doing and if your processes are still working for you and your business.
Let Skynova Help You With Your Small Business Accounting Needs
With small business accounting, your goal is to accurately track your income and expenses and collect the financial information necessary for tax filing. Accurate records help you make better-informed decisions on running and growing your company. Tracking your expenses also allows you to monitor the growth of your business.
Save time and reduce the stress of managing your business; use Skynova's all-in-one invoicing and accounting for small businesses. The software allows you to generate reports, like profit or loss statements and balance sheets, whenever you need them. You can also get an accurate view of your company's financial health by tracking your revenues and expenses with journal entries.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional for specific and individual accounting advice.