What is it? Why is it important? Need tips to getting started? This is bookkeeping 101 for small business owners.
Today, I am going to share with you small business bookkeeping tips and tricks to getting your business finances in order!
We just saved a client over $31k in ONE MONTH because of bookkeeping!
This client improved their profit by over $31,000 after ONE month of working with me and prioritizing her bookkeeping.
Now I know what you might be thinking. You may be thinking:
- “But I can’t afford a CPA to work with on a monthly basis”
- Or “I want to do this myself”
- Or maybe you just want a better grip on your small business bookkeeping so you can make decisions to grow your business
Either way, you cannot avoid doing your books. If you don’t, you’re not going to be able to file your business taxes. And even worse, you won’t be able to run your business because you won’t know what’s going on financially.
So to prevent this, in this post we’re going to explain Bookkeeping 101 for small businesses.
Specifically, we’re going to breakdown:
- What is bookkeeping?
- Why bookkeeping is CRITICAL & NECESSARY in your business?
- How it works?
- Tips on getting started and growing your business.
Bookkeeping 101: What is bookkeeping?
Bookkeeping is the process of tracking your income and expenses.
Most people like to believe it is more than that. Normally, they are just intimidated by numbers but honestly it’s simple. Bookkeeping is just tracking your income and expenses.
Now, how you use your bookkeeping to grow your business is the game changer.
Bookkeeping 101: Why is Bookkeeping important?
Bookkeeping can dramatically improve the bottom line of a company.
Here are the main reasons why bookkeeping is important and necessary in your business?
#1: Bookkeeping helps you budget.
When you’re properly tracking your business income and expenses, it makes it easier to manage your financial resources.
Budgeting creates a financial roadmap for your business so there aren’t any surprises.
#2 Bookkeeping is necessary for tax preparation.
In most cases, your business has to file a tax return every year. And every year, it’s a hassle. Sound familiar? The tax filing process can be made more efficient by simply having bookkeeping within your company.
Bookkeeping is important for filing your personal tax return too. As a business owner, a large part of your income comes from your business. In order to know what you earned, you have to know what your business earned first.
#3 Bookkeeping helps you make business decisions.
Bookkeeping is important because it helps you make better business decisions by first understanding your financial performance. Remember, the client I referenced in the beginning that saved $31,000 through bookkeeping?
The product of bookkeeping is financial statements. Financial statements should be regularly prepared and used for decision making.
While reviewing your financial statements, you can track your cash inflows and outflows and overall profitability.
This is what you want as a business owner…. Profits.
And the only way to improve profits is through useful information. Useful information is derived from bookkeeping. That’s bookkeeping 101.
Bookkeeping 101: How exactly does bookkeeping work?
Think of bookkeeping for your small business as a cycle.
It starts with a transaction. You could either be the buyer or seller in this transaction. It doesn’t matter because, at the end of the day, ALL transactions impact your bookkeeping.
As a result of the transaction, there should be some type of source documentation.
This could be a receipt, invoice, note payable, etc. This documentation serves as sources of information bookkeepers use to record transactions.
Now, if you’re like most business owners, you might find it tedious to keep up with every little receipt so having your monthly bank statements would be a great alternative.
The next part of the bookkeeping cycle is determining the financial effects of the transactions.
This part can be tricky and is usually where the expertise of an accountant or CPA is needed.
In general, all transactions fall into 1 of 5 categories:
- Sales Revenue
- & Equity
Revenue is what you made from selling your product or service. Revenue is also commonly referred to as Sales.
Expenses are costs incurred related to running your business. For example, your advertising and office rent costs are expenses.
Assets are resources that are owned by the company with a measurable future value. For example, if you prepaid your rent, this would not become an expense until after each rental period. Until then, is considered an asset.
Another example of an asset is inventory. When you buy inventory, that is an asset because it will have future value when you sell it. It is used to produce future revenue.
Liabilities are what the company owes to creditors. For example, loans or credit cards, are considered liabilities. An easy way to think of liabilities is to just think of debt. Debt payments are not expenses.
Finally, there is equity. Equity is the degree of ownership in your business. Owner distributions from the company or contributions to the company will typically impact the equity balance in your business.
It is very important to correctly classify each of your business transactions so that you can accurately interpret the financial performance of your business.
Classifying transactions correctly is bookkeeping 101 in a nutshell.
Bookkeeping 101: How to Get Started with Bookkeeping
Here the 5 simple steps to help you get started with getting your business bookkeeping up and running.
#1 You MUST open a business account.
If you’re a sole proprietor, you’re not legally required to do this step. However, if you want clean and easy books, we highly recommend having a separate bank account for your business.
This is especially important for LLC or C Corp business types. If the IRS finds out that these types of businesses don’t have a separate account, this could mean the END of their business and grounds for termination by IRS standards.
Furthermore, consider the headache you’ll avoid at tax time by having a separate account. Instead of cycling through the year’s deposits and expenses and trying to remember what was personal vs business, everything will be centralized in your business bank account.
Most banks offer a business account option. You just want to make sure you have an EIN or employer identification number which you can request from the IRS.
#2 Set up a bookkeeping system.
Bookkeeping is an ongoing process for every business. This process should be completed at least monthly to stay on top of your finances.
One great way to establish a bookkeeping system is to invest in accounting software like QuickBooks or Xero. These programs allow you to perform monthly, weekly and even daily bookkeeping tasks.
The best part is that most of these programs enable you to connect your business bank account. This makes tracking income and expenses easier by eliminating the manual aspect of recording transactions.
In addition, setting up a bookkeeping system is knowing how you’ll classify your expenses. Remember the 5 categories of bookkeeping we mentioned earlier? It comes to play here.
As transactions are coming in, they’ll need to be placed in the appropriate category. Each transaction needs to be classified as an asset, liability, equity, revenue or expenses).
However, it is best practice to drill down even more into what each transaction is.
For example, perhaps you sell clothing online and made a big wholesale purchase of clothes. Instead of labeling this as inventory, you might find it more useful to label it ‘Summer Inventory’ or ‘Winter Jackets’
Let’s take another example. Perhaps you’re just starting out and are investing a lot into advertising. You might consider creating subcategories for Google Ads, Facebook Ads and print advertisements. This way you can track how much you’re spending in each category.
In accounting, we call this setting up your Chart of Accounts (or COA). This is basically your rubric to classifying transactions in your business.
#3 Reconcile your transactions
Reconciling your transactions is the practice of determining any difference between the balance shown on the bank statement and in your bookkeeping system.
You want to make sure that none of your transactions are missing or double-counted in your bookkeeping program.
Performing a bank reconciliation at least monthly will help you catch errors or even billing mistakes made by your vendors.
#4 Prepare your financial statements
Once everything is categorized and reconciled, you can prepare your financial statements.
Specifically, you should prepare your balance sheet, income statement (or P&L), and cash flow statement.
The balance sheet shows you your outstanding balance in assets, liabilities, and equity.
The income statement shows your profit or loss for a specific period.
The cash flow statement shows the movement of cash related to financing activities, investing activities and operating activities.
Each of these reports should be prepared and reviewed at least monthly. And don’t worry, the bulk of work has already been done once all of your transactions are classified and reconciled. Preparing the reports is usually the easy part.
#5 Start making business decisions
… There is very little point in doing all of these steps if you aren’t using this information to make better business decisions.
The textbook definition of accounting is centered around one major concept: business decision making.
As a business owner, you are faced with business deci sions day in and day out. And in any decision you make, there are considerations, mostly related to finances.
Intelligent business owners use their bookkeeping to determine things like:
- Would X add value to my company?
- Can I afford X?
- What are the financial implications of X?
These are just a few questions you might ask yourself.
Ultimately, the answers to these types of questions and more are found in your bookkeeping.
Bookkeeping 101 Recap
There you have it. You have just learned the basics of bookkeeping in your business or bookkeeping 101 as I like to call it.
To recap, here are the major items you need to know.
- What is Bookkeeping? Bookkeeping is simply the tracking of your income and expenses.
- Why is Bookkeeping important? Bookkeeping is important because it helps you budget, prepare taxes and make business decisions.
- How to Get Started with Bookkeeping? To start the bookkeeping process, you need to 1) open a business bank account 2) set-up a bookkeeping system 3) categorize and reconcile your transactions 4) prepare your financial statements and 5) use those financial statements to make critical business decisions.
If any of this sounds a bit overwhelming, you may want to consider engaging an experienced bookkeeper or accountant to help you tackle this process.
Until next time. Take care!