What Is Small Business Accounting? A Beginner’s Guide
Small business accounting involves the process of tracking, recording and analyzing the financial transactions of your business. It translates numbers into a comprehensible statement about the profitability of your business.
Accounting may be a more tedious aspect of running a business, but it is also necessary to avoid cash flow snafus and piles of paperwork.
What this article covers:
- What Is Small Business Accounting?
- How to Do Small Business Accounting
- How Do You Keep Books for a Small Business?
NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.
What Is Small Business Accounting?
Small business accounting tracks the money that flows in and out of your business accounts, including purchases, sales, liabilities and payments. It is a massive topic, but for small businesses, it essentially boils down to:
- Bookkeeping (recording financial transactions)
- Creating financial reports
- Filing tax returns
Accounting helps you gauge the health and value of the company, to make better decisions about short- and long-term success.
How to Do Small Business Accounting
Here’s how to set up the basic accounting cycle for your small business.
1. Open a Separate Bank Account
Open a dedicated bank account to separate your business finances from your personal finances. A business checking account, as well as a savings account, will help you organize your revenue and allow you to plan for taxes at the year-end.
2. Record All Income and Expenses
Learning how to track and record business transactions is the foundation of a strong small business bookkeeping system. The source documents help you monitor your deductible expenses (tax deductions), prepare financial statements and tax returns and track the growth of your business.
It is important to note that only expenses pertaining directly to the business should be recorded. Examples include invoices, canceled checks, purchase orders and other business documents.
3. Select the Accounting Method
Before you establish a bookkeeping system, you need to choose a method of accounting for your business. There are two main methods of recording accounting transactions: cash vs. accrual basis of accounting. With cash-basis accounting, you record income and expenses when you receive or pay cash.
With accrual accounting, you use the double-entry method of recording transactions, which means you need to make two entries for every transaction. You record expenses and income when they are incurred, regardless of when the cash is exchanged.
4. Transactions to Trial Balance
When using a double-entry accounting system, the transactions are recorded as journal entries. The journal lists these entries in chronological order and records the amounts debited and credited, transaction dates and explanation of the transactions.
The balanced entries contained within the journal are then posted to the general ledger. Based on the past transactions and current balances, changes are made in the ledger, and the trial balance is prepared.
5. Create an Adjusted Trial Balance
If you’re using the accrual basis of accounting, adjusting journal entries account for periodic expenses and income. For example, when rent is paid for the entire year, a monthly adjusting entry should be made to recognize the expense incurred. This ensures that the income and expenses are matched accurately during the period represented in the financial statements.
After the adjusting entries are made, an adjusted trial balance is prepared to confirm that the debits and credits match the adjusted entries. An adjusted trial balance is the most accurate record of your financial activity.
6. Generate the Financial Statements
Once you’ve prepared the adjusted trial balance, you can now generate the financial statements of your business including the income statement, statement of cash flow, the statement of retained earnings and the balance sheet.
7. Reconcile and Close Your Books
The last step in the accounting cycle is to make post-closing entries. This is used to reset balances of temporary accounts back to zero and restart the accounting cycle. Income and expense accounts must be closed to capture the upcoming period’s transactions.
If you’re new to accounting and find the entire process too complicated, you could opt for a cloud-based small business accounting software, which automates these steps and makes the balancing of books much easier.
How Do You Keep Books for a Small Business?
It may look daunting but keeping books for your business is not that difficult when you consider the basic goals of accounting: To keep track of your expenses and collect financial information for tax filing.
This is broken down into three easy-to-understand steps.
- Keep the receipts of your business’s sales and purchases. These receipts will contain the amount, the date, and other information necessary to create summaries of your transactions.
- Post your receipts into a ledger. This is nothing more than a summary of revenues, expenditures, and whatever else you’re keeping track of.
- Create financial reports by combining data from your ledgers. The key reports include—the profit and loss forecast, the balance sheet and the cash flow analysis. These reports offer greater insights into the financial health of the business.
Once you have created your reports, take a step back and start streamlining systems. It might be time to set realistic expectations with your customers. Efficient bookkeeping helps you see a pattern and make the necessary changes in the way that you’ve been operating.