Your small business accounting essentials
As a business owner, it is important to follow some basic small business accounting essentials to help you succeed. It does not matter whether you are just starting off or you have been operating for a while.
The reality is that for many excited business owners launching a startup, it’s easy to relegate accounting to the bottom of the to-do list. And it happens a lot more often that you can imagine. However, adopting effective accounting practices early is one of the first small business accounting essentials to start with. It will give your business the best chance to thrive in the future.
Accurate accounting allows you to easily view your business’s cash flow and financial obligations to creditors, suppliers or workers. With this information you can also plan for the long-term by generating financial reports. Such reports comprise of balance sheets, income and cash flow statements as well as statements of retained earnings. These can help you determine which parts of your business are profitable and which are under-performing. This would allow you to make changes as needed.
Business owners who fail to take accounting and bookkeeping seriously could see their cash flows dry up unexpectedly. They may also face tax obligations that are higher than expected. However, you can easily avoid this by adhering to common accounting principles from your first day of business.
No matter what type of business you wish to start, it will follow the same basic accounting principles. You will need to create separate bank accounts for your business, choose the bookkeeping method and software most appropriate to your needs. Also, document all transactions, stay on top of customers to ensure payment and if you intend to hire workers, you will have to set up payroll with a provider and account for new expenses. Finally, you will need to keep track of your break-even point to know if your business is healthy or if it is heading for an emergency.
Most businesses aside from sole proprietorships are required to have their own bank accounts that are separate from those of their owners. It is also highly recommended for sole proprietors to have separate bank accounts for their businesses.
This helps to protect you from personal liability for your business’s financial obligations. It also provides business owners with the foundation necessary to institute sound accounting practices. It gives you an external record of payments, expenses, tax obligations and more which you can reference against internal records.
Many banks offer some kind of merchant account, but you should take the time to find one that is best suited to your business. Some banks charge higher fees for services others might offer for a lower price. Be sure to also bring any necessary paperwork with you when you are first setting up your business accounts.
Bookkeeping refers to the process of recording, categorizing and reconciling daily business transactions. Accurate bookkeeping can reveal a business’s current cash flow. It helps track sales, purchases, and payments on financial obligations such as bills or loans. You should use this information to cross-reference or reconciled with external sources such as bank statements.
In bookkeeping, timing is everything. Payment for goods or services can happen at different times than when a contract is completed. This leaves most businesses with two different ways they can keep track of revenues and expenses:
This option is available to small businesses with annual revenues under $5 million or inventory sales less that $1 million. With this approach, revenue and expenses are recorded once a business receives cash or pays it out. This allows a business to have an accurate view of its current cash flow. However, this can also obscure long-term trends. A spike in sales one month might actually be the result of payments for products you sold months ago. As a result, this can make it difficult to judge the long-term health of your business.
This approach relies on the matching principle.
What is the matching principle?
It is a methodology which holds that a business should record its expenses in the accounting periods in which they occur.
The date a transaction is agreed upon is more important than when a payment is made or received. There are times your business will agree to purchase a piece of equipment and not pay for it for several months. In such a case, you would still book the purchase in the period the agreement was made.
Likewise, you would credit a payment for services once your company delivers on a contract, even before receiving the payment it. This approach gives business owners a better understanding of the long-term health of their business. It can also allow them to take advantage of more tax write-offs, since expenses will be considered incurred within the tax year. However, this approach can lead to cash flow problems since some accounts receivable may become delinquent.
Accounting software can streamline bookkeeping and accounting and is an essential component of any modern business. Programs such as Quickbooks and Xero allow business owners to easily do their bookkeeping.
More sophisticated accounting packages offer features such as audit trails for fraud protection, automated bank reconciliation and easy integration with web-based services such as PayPal and Google Analytics.
Advanced cloud-based software packages offer further advantages over desktop applications. They include greater storage capacity, enhanced security and a higher potential for both scalability and customization. Netsuite and Microsoft Dynamics fall in this advanced category.
Accounts receivable refers to money that is owed by clients for goods and services your business has already provided. Many businesses will offer their goods or services to clients in exchange for future payment. A large accounts receivable may have a large proportion of delinquent or uncollectible accounts. Many companies suffer or close their doors because their owners counted on receiving payments that never arrived.
One way to reduce the potential for loss from accounts receivable is to demand upfront payments for your goods or services. Your business could also refrain from sending anything to clients until they pay off outstanding balances. You could also offer incentives for early repayment such as discounts or a longer payoff period.
Good accounting relies on complete and accurate information, so keep track of and organize financial documents relating to your business. These records can help you assess the state of your business, take advantage of tax breaks, and will also prove useful should your business be selected for an audit.
Some of the most common business expenses are rents and utilities, the cost of supplies, wages, taxes and insurance. However, capital depreciation, maintenance interest on loans or credit for your business, training for workers, and even meals and entertainment can qualify as expenses. Be sure to retain documentation for any payments your company receives as well. This will make bookkeeping much easier and will allow you to know the true state of your business.
When you start your business, you might be the sole employee of your company. However, if you decide to hire more help, make sure that you accurately classify your workers as employees or independent contractors for tax and accounting purposes.
You will need to create a payroll schedule for employees to ensure regular payment of their wages. You will also have to properly account for pay, withheld taxes and most fringe benefits as gross wages in your balance sheet. These expenses will help determine your liability for payroll taxes.
If you decide to hire independent contractors, you will need to keep track of their personal information and file a 1099 form. Misclassifying employees as contractors can lead to nasty penalties from the IRS. Be sure you do the right thing. Read more about Employees vs Contractors. If you are not sure, talk to your CPA or payroll company.
One of the best ways to monitor the health of your business is to follow its break-even point. This is the point at which profits are zero and revenues earned and expenses incurred during an accounting period are equal.
To obtain your business’s break-even point, divide your company’s total expenses by its gross profit percentage. The latter is simply equal to gross profit divided by sales and gives you the profit obtained from each units of goods or services provided.
Once you know this information you can determine if your company is ahead or behind on revenues and determine ways to close the gap if necessary.
It’s no secret that many small business owners dread accounting. AccountingToday.com states that according to a 2015 report by SCORE, a small business guidance organization, 40% of small business owners polled said the worst parts about owning a business were bookkeeping and taxes.
Nearly half of those surveyed said they spent over 80 hours preparing for taxes annually. It’s important to take accounting seriously from the start so you can cut down on the time you spend swimming through paperwork and instead focus on what you do best.
So, if you have a small business, or just starting off, keep these small business accounting essentials in mind. Success will follow you through your hard work.
This article was contributed by Larry of Larry L. Bertsch, CPA and Associates, a Certified Public Accounting firm. Larry has been offering quality accounting and tax preparation services to entire Las Vegas market since 2003.