Millions of small business owners and start-up entrepreneurs are masters at creating great products and services, building awesome teams, or winning over customers. Many of them, however, would probably flunk basic bookkeeping. Let’s face it, most business owners don’t know the first thing about double-entry bookkeeping, and quite frankly, they really don’t want to know.
But if you’re running a business, it doesn’t matter whether you’re an independent contractor or a growing company, managing your accounts and staying organized are critical to efficient and accurate bookkeeping. Even if you hire a professional to do the majority of the work, you should still have an idea of the basics of managing your finances so your business can thrive. If you don’t have an accurate grasp of your financial situation, your plans will be based on little more than guesswork.
We want you to learn the basics of keeping your business accounts in order. We’ll go through the fundamentals of double-entry bookkeeping, and explain how to set up a chart of accounts, balance the books, and prepare financial statements.
Though you won’t be a fully qualified accountant, of course, you will at least have a basic grasp of how to keep a set of business accounts. You’ll be armed with some practical steps you can take to make sure you’re recording the right things, and will be able to keep your business on solid financial ground.
Step 1: Understand Double-Entry Bookkeeping
This step is important, so don’t skip this step! The point of double-entry bookkeeping is to give you a rounded picture of where your money is going, and to help you avoid making mistakes. Every transaction is recorded in at least two places. It makes sense, because every business transaction is an exchange of one thing for another. The double-entry system shows exactly how that exchange took place, and what the results were.
Let’s look at an example.
Say you run a café, and spend $500 on a crate of the finest coffee beans. If you look only at your cash balance, it would seem as if you’ve lost $500, because your account has gone down by that amount. In reality, of course, that coffee has a value—you’re adding it to your supplies (inventory), and will use it to brew drinks to sell to customers. So in the double-entry system, you’d make two entries:
Cash account: – $500
This records both the loss of cash and the gain in inventory, giving you a more accurate picture of what’s happening in your business.
Step 2: Keep Your Receipts
Each of your business’s sales and purchases must be backed by some type of record containing the amount, the date, and other relevant information about that sale. You’ll use these to create summaries of your transactions.
From a legal point of view, your method of keeping receipts can range from slips kept in a cigar box to a sophisticated cash register hooked into a computer system. Practically, you’ll want to choose a system that fits your business needs. For example, a small service business that handles only relatively few jobs may get by with a bare-bones approach. But the more sales and expenditures your business makes, the better your receipt filing system needs to be.
Step 3: Set Up A System
If you want to have a rounded picture of how your business is doing, you’ll need to set up several different accounts. What that means is that for each key area of your business, you track each transaction that affects it, and adjust the balance accordingly. Whether you are using a traditional spreadsheet or an online accounting program, you’ll need to start collating all your receipts, credit card expenses, and incoming bills from suppliers and enter them into your system.
Aside from cash and inventory, here are some other key accounts to track:
Accounts Receivable (money due from customers).
Accounts Payable (money you owe to others).
Sales (the revenue you make from selling products/services).
Purchases (supplies you buy for your business).
Payroll Expenses (staff salaries and other costs).
Owners’ Equity (the amount you or other owners put into the business).
Retained Earnings (the profits you’ve accumulated).
For spreadsheet users, you’ll need to set up your file to capture the following line items:
Expense type (e.g. office supplies, raw materials)
Date the invoice was received
If you’re not sure whether to make the move to an automated program, as a general rule, if you’re receiving more than two bills a day, or your expenses are racking up, then it’s a good idea to look into automation as an option to help you keep track of your bills. Many of these tools are free or available on a trial basis.
As your company grows, the number of accounts can multiply rapidly, so it’s essential to set up a chart of accounts from the start: basically a list of all the accounts you maintain, with a number for each one. Don’t forget to keep and securely store paper copies of all your documents too.
Step 4: Balance the Books
You’ve probably heard about companies balancing (or sometimes failing to balance) the books. In this step, we’re going to look at exactly what that phrase means, and how you can balance your own books effectively.
A completed ledger is really nothing more than a summary of revenues, expenditures, and whatever else you’re keeping track of (entered from your receipts according to category and date). Later, you use these summaries to answer specific financial questions about your business, such as whether you’re making a profit and, if so, how much.
Post receipts on a regular basis. On some regular basis — like every day, once a week, or at least once a month — you should transfer the amounts from your receipts for sales and purchases into your ledger. This is called posting. How often you do this depends on how many sales and expenditures your business makes, and how detailed you want your books to be.
Your posting schedule depends on your sales numbers. Generally speaking, the more sales you do, the more often you should post to your ledger. A retail store, for instance, that does hundreds of sales amounting to thousands of dollars every day should post daily. With that volume of sales, it’s important to see what’s happening every day and not to fall behind with the paperwork. To do this, the busy retailer should use a cash register that totals and posts the day’s sales to a computerized bookkeeping system at the push of a button.
A slower business, however, or one with just a few large transactions per month, such as a small website design shop, dog-sitting service, or swimming pool repair company, would probably be fine if it posted weekly or even monthly.
Step 5: Creating Basic Financial Reports
Financial reports are important because they bring together several key pieces of financial information about your business. Think of it this way: while your income ledger may tell you that your business brought in a lot of money during the year, you won’t know if you turned a profit without measuring your income against your total expenses. And even comparing your monthly totals of income and expenses won’t tell you whether your credit customers are paying fast enough to keep adequate cash flowing through your business to pay your bills on time.
That’s why you need financial reports: to combine data from your ledgers and sculpt it into a shape that shows the big picture of your business. The key reports you need to create regularly are a cash flow analysis, a profit and loss forecast, and a balance sheet. Most accounting software can provide these regular reports, however, this may be best handled by a professional bookkeeper.
Step 6: Get Professional Help When You Need It
It’s never too late to get help. This is true whether you are just starting a business, looking to improve your existing one, or you are simply a responsible accountant trying to offer the best service possible to all of your clients.
In business, keeping accurate accounts can be a complex process, especially as your business grows. A single transaction can involve multiple entries in several different accounts, and when you have hundreds or even thousands of transactions to record, it can quickly become overwhelming.
Technology helps, of course. Accounting systems like QuickBooks or others are much easier to use than the old-fashioned system of recording every transaction in physical ledgers. But still, a time will probably come when you need to hire a professional. Even when you use software, it’s easy to make mistakes. And the time it takes to enter all that information could probably be better spent elsewhere.
You can start by employing a bookkeeper and accountant part-time or on a freelance, hourly basis, and progress from there. When your business grows to have more than 30 employees, or more than $1 million in revenue, it’s probably time to consider hiring full-time staff.
Bookkeeping is a complex area, and there’s a lot more to learn. But we’ve now given you the basic tools you need to be able to keep accurate records, and ensure your business is in a good state of health. If you still need help, don’t hesitate to hire a professional bookkeeper or accountant to help make sense of your finances so you can keep focused on your business.