LET’S GET STARTED
- 1 What is Bookkeeping?
- 2 What’s the Difference between an Accountant and a Bookkeeper?
- 3 Why Does Bookkeeping Matter?
- 4 How to Handle Bookkeeping for Your Small Business
- 4.1 Keep your Business and Personal Expenses Separate
- 4.2 Chose an Accounting Method: Cash or Accrual
- 4.3 Categorize Transactions Accordingly
- 4.4 Store All of Your Expense Receipts in One Place
- 4.5 Reconcile your Bank Account
- 4.6 Close the Month and Run Financial Statements
- 4.7 Organize your Tax Deductions
- 4.8 Accounting Software for Bookkeeping: It is Really Necessary?
- 5 Wrapping Up the Bookkeeping Basics
It’s certainly not easy being a jack of all trades as a business owner or entrepreneur. When deciding to take on the risk of starting a company, you probably did not plan on spending most of your time learning bookkeeping basics, payroll administration, financial statement preparation, and scrambling to meet tax-filing deadlines.
Spending too much time on these bookkeeping and accounting activities takes time away from tasks that are important to running and growing your business such as innovation, sales, customer service, and pursuing opportunities to expand.
Nevertheless, being your own bookkeeper helps you stay on top of key financial information about your company such as cash flow, and that knowledge that can help you make crucial decisions. To achieve that goal and achieve financial insight, it is necessary to maintain your own books.
Another plus of maintaining accurate books is that every transaction will be recorded and categorized for your CPA. That is important because if you can provide accurate information and supporting documents to your CPA on April 15, you may be able to claim additional deductions and possibly secure a larger tax return. Also, if you can maintain well-kept books, you can provide lenders or investors a complete view of your company’s financial status. Then, they will be able to make financial projections about your company’s ability to pay back a loan.
What is Bookkeeping?
Bookkeeping is the recording of a company’s financial transactions to describe where the money is being spent, where revenue is being generated, and which tax deductions can be claimed. That may sound straightforward, but it can be complex.
Transactions include purchases, sales, receipts, and payments by an individual, an organization, or a corporation. A tool called a chart of accounts helps organize your finances into five major categories: assets, liabilities, equities, revenues, and expenses.
The two major bookkeeping systems are single-entry and double-entry. Double-entry is more complex, but also more heavy-duty. Transactions are entered into a journal or ledger, and each item is entered twice, both as a debit and credit. Bookkeeping transactions can be documented by hand in a journal or the data can be entered into a spreadsheet program such as Microsoft Excel or a specialized bookkeeping accounting software program.
What’s the Difference between an Accountant and a Bookkeeper?
The bookkeeper’s role may seem similar or identical to an accountant’s responsibilities, but they are quite different. A bookkeeper enters all the company’s financial transactions into a ledger or software. The bookkeeping process includes several steps from writing original journal entries that credit and debit the appropriate accounts to posting entries to ledger accounts and adjusting entries at the end of each accounting period.
In contrast, an accountant reviews, interprets, analyzes, and reports financial information for the business. At year-end, the accountant also prepares financial statements and the proper accounts for the firm.
Over the reporting period, the accountant’s responsibilities are called the accounting process, a series of activities beginning with a transaction and concluding with the closing of the books. The year-end reports completed by the accountant must also adhere to standards established by the Financial Accounting Standards Board (FASB); these rules are called Generally Accepted Accounting Principles (GAAP).
Why Does Bookkeeping Matter?
Driving a car without knowing a city and/or not having a GPS will make it extremely difficult to reach your destination. The same principle applies to a business. Without robust and accurate bookkeeping, you just do not know how your business is doing and whether you are earning a profit. Tax time will also be difficult without a clear picture of the company’s results and a lack of proper documentation.
It’s Required During Tax Time
To prepare your taxes, you will have to show your bookkeeping records to an accountant or tax preparer. The records include journal entries, a profit and loss statement, and a balance sheet. Other documents should include last year’s business tax return, payroll documents, bank and credit statements, and depreciation schedules. You can print these items out or send the digital files.
Additionally, to make a thorough accounting of all income and expenses associated with your enterprise, it will help if you’ve saved as many documents as possible including gross receipts, checking and savings account interest, sales records, employee wages, insurance premiums, and office rent.
You’ll Want to Know Where Your Money is Going
Just as you need to take care of your personal health, there are steps you must take to ensure your company’s financial health. To properly chart your company’s finances, you must maintain financial statements, reports that summarize important financial accounting information. There are three main types of financial statements: the balance sheet, the income statement, and the cash flow statement.
Tracking expenses is an important part of creating a budget for your business and maintaining your financial statements. Keeping a daily record of your expenses by logging receipts, invoices and other outgoing expenses improves the financial health of your budget. In turn, a budget helps you monitor where your money is going, makes it easier to target problem areas, helps you pivot when necessary, and helps you reach your financial goals.
The better you understand the elements of your budget, the better you can stay on top of your financial health. Stated plainly, you must have solid financial information to prepare a meaningful budget.
Bookkeeping is Needed to Borrow Money and Obtain Financing
Cash is necessary to grow your business, but you first need to secure top-notch financing to obtain capital to grow your business or convince a venture capitalist to make an investment in your firm.
But before banks or investors are willing to dole out a business loan, line of credit, or other funding, they want to ascertain that your company is safe and reliable. For due diligence, they will examine your assets and liabilities, credit score, cash flow history, financial projections, business plans, and more.
How do you keep these critical financing factors in tip-top condition? With fundamental bookkeeping habits, of course.
To qualify for business financing, it is imperative to have the proper financial documentation. And even if you do have your finances neatly organized in a silver three-ring binder, the numbers must prove to lenders that you and your business are a worthwhile risk and you can pay back the loan. A banker may even want to look at some of your bookkeeping procedures and documents to verify if you are operating your business in a sound, professional manner. Fortunately, bookkeeping not only helps document and organize your finances, but it arms you with the information necessary to improve your business’s health and qualify for financing. After all, capital is the lifeblood of a business.
It Ensures Not Missing Out on Tax Deductions
As we all know, there is nothing certain except death and taxes. But fortunately, there are many legal ways to reduce your corporate tax bill. One of the simplest ways to reduce your income tax bill is to ensure that you are claiming all tax deductions available to your business. A tax deduction (or “tax write-off”) is an expense that you can deduct from your taxable income.
Essentially, tax write-offs allow you to pay a smaller tax bill. But the expense must fit the IRS criteria of a tax deduction. To claim these deductions, it is crucial to retain accurate records and keep up with your bookkeeping.
A correctly maintained set of books will correctly categorize all the transactions for your CPA. The more information and support documents that you can present to your CPA at tax time, The greater ability they have to claim deductions. If he can achieve that, you should receive a larger tax return.
The Importance of Catching Errors Long Before It’s Too late
Though rare, banks, credit unions or other financial institutions make mistakes from time to time. Unfortunately, it is difficult to discover these errors and check all your financial transactions if you wait until tax time when you are inundated with paperwork. Quite simply, if you wait to reconcile your transactions until year-end, it will be harder to reconcile an overcharge with your bank. For that reason, it’s best to conduct various reconciliations at month and year-end to detect many errors and to correct them.
There are other errors that can occur when recording financial transactions such as an error of omission. These errors occur when items such as an expense transaction are completely omitted from your company’s ledgers. Errors like these can be common but are difficult to detect. Therefore, it is necessary to enter these transactions on a timely basis before supporting documents such as a vendor’s invoice are lost.
How to Handle Bookkeeping for Your Small Business
Just as with any business, a small business has to establish a bookkeeping system, the day-to-day process of recording transactions, categorizing them, and reconciling bank statements. As a small business owner, you need to determine the best way to manage your books, accounts payable, and accounts receivable.
There are a few bookkeeping options. First is the do-it-yourself (DIY) route to purchase software like QuickBooks or Wave. Alternatively, you could employ a simple Microsoft Excel spreadsheet. Another option is using an outsourced or part-time bookkeeper that is either local or cloud-based. Finally, when your business expands into a large enterprise, you may decide to hire an in-house bookkeeper and/or accountant.
Keep your Business and Personal Expenses Separate
When starting a business, it may be daunting to establish new checking accounts and a line of credit, but to properly track your business finances you must separate them from your personal finances. There are a few reasons why it is imperative. If you are operating a corporation or limited liability organization without a clear distinction between personal and business finances, there is a possibility that a court or creditor could hold you personally liable for debts incurred by your company. In addition, reconciling bank statements will be extremely challenging because it will be tough to find receipts for business expenses.
Chose an Accounting Method: Cash or Accrual
The first decision you must make when establishing a bookkeeping system is should you select cash accounting or the accrual accounting method. The cash system may be best for a one-person, home-based company or even a larger consulting firm with just one employee.
If you operate your company on a cash basis, transactions are recorded when cash changes hands. In accounting, a cash account, or cash book, may refer to an account in which all cash transactions are recorded. The cash account includes both the cash receipts journal and the cash payment journal.
In contrast, with accrual accounting, you must record transactions right away, even if the cash does not change hands for a period of time. Firms frequently establish their business with cash accounting and switch to accrual accounting as they grow.
Categorize Transactions Accordingly
Unlike a personal checkbook, record keeping for a business is much more meticulous because every transaction your company makes has to be categorized at the time it is recorded in your business books. This helps your bookkeeper or accountant notice possible deductions and will help you if your company gets audited.
The categories you select depends on what type of business you operate and its industry. Overall, transactions can be placed into five account types: assets, liabilities, equity, revenue, and expenses. Individual line items are further broken down into subcategories that are called accounts.
Store All of Your Expense Receipts in One Place
At tax time, the onus is on you to provide proof of your business transactions so it is important to properly store supporting documents such as cash receipts and records is crucial. A good habit is making a small note on the receipt of its business purpose. You can jot the note down immediately or set aside time at regular intervals, i.e., the end of the day, week, or after a group of purchasing is completed (such as at the end of a business trip). Either way, it’s best if the purchases are fresh in your mind when you write the note so you can label the receipts correctly.
Luckily, the IRS accepts digital records so receipts can be stored on cloud-based systems such as Dropbox, Evernote, or Google Drive. Another option is using an App like Shoeboxed, which is designed for receipt tracking.
Reconcile your Bank Account
The next important step is bank reconciliation. This task ensures that your books are up-to-date and accurate. Reconciling your bank statement entails comparing it to your bookkeeping records for the same period, and then identifying every discrepancy. Then, you make a record of those discrepancies so you or your accountant can ascertain if there is money missing from your business. This process is important for your company’s financial health.
Accounting software can make the process easier because you can link your bank accounts to your software. The software then allows for daily or weekly reconciliation, and, in turn, it makes the month-end process much smoother.
Close the Month and Run Financial Statements
After your bank accounts are reconciled and adjustments were made in your recording tool, it is time to close the month and print financial reports. At month-end, you need to complete a report to keep your accounting statements updated. The month-end report adjusts your ledger for monthly transactions and financial records. This includes recording loan payments, reducing the value of business assets by their depreciation, writing off any bad debts, and recording entries for prepaid expenses.
After the financials are prepared, the month-end adjusting and closing entries are recorded (journalized) and posted to the appropriate accounts. After those entries are made, a post-closing trial balance is run. The post-closing trial balance verifies the debits equal the credits and that all beginning balances for permanent accounts are in place. If your accounts do not balance, the month-end report is a time to correct any accounting errors. The month-end report is also used to review the past month’s transactions and make sure everything has been properly recorded.
Organize your Tax Deductions
Accounting for tax purposes one of the most important reasons for accurate bookkeeping. Whether your business is a sole proprietorship, partnership, or corporation, you must file an income tax return and pay income taxes.
Most entrepreneurs understand that deductible expenses help to offset many of the costs of running a business. But not every expenditure is fully tax-deductible. Understanding which expenses can effectively reduce your taxable income will not only help you estimate your tax obligation for the coming year, it will also improve your business planning. Eligible expenses also tend to change from time to time, as IRS tax regulations evolve. The IRS has compiled a comprehensive guide of business deductions.
With good records, preparing an accurate tax return will be easier and you are more likely to complete it on time. Poor records may result in underpaying or overpaying your taxes and cause you to file your returns late (and also paying penalties).
If your accountant prepares your income tax return, poor records will almost certainly result in your paying higher accounting fees. If your business is a partnership, not only will you have to prepare a partnership tax return, but partnership return amounts will pass directly to the tax return of each partner. In this type of business, recordkeeping will directly affect the tax return of each partner.
Accounting Software for Bookkeeping: It is Really Necessary?
Small business bookkeeping transactions can be entered by hand in a journal or keyed into a spreadsheet program like Microsoft Excel. The majority of companies now use specialized bookkeeping software programs to record financial transactions. Accounting software can vary widely in scope, with some programs designed for simple, small business bookkeeping and some developed to manage the finances of large corporations.
The benefits of accounting software benefits include increased accuracy by reducing or eliminating human errors in calculation. Manual bookkeeping processes involve making a lot of mathematical calculations by hand. An incorrect calculation early in the process could have a great impact on the end balance. Most accounting software can help you generate several important reports including a chart of accounts, an income statement report, a balance sheet, a cash flow statement, and several others.
Wrapping Up the Bookkeeping Basics
Most likely, you’d rather spend your time selling your product or service and expanding your business. As a result, you may find it’s difficult to devote enough time to take care of all your company’s complicated bookkeeping duties. When you reach this juncture, it may be the right time to hire a professional.
At Punch Financial we can provide you with a modern accounting experience. Instead of hiring an in-house CFO and accounting team at great expense, you can outsource your bookkeeping to an experienced team with proven results for a fraction of the cost.
We are a U.S.-based team of accountants, bookkeepers, and CFOs, who specialize in QuickBooks Online and partnering with high-growth companies. At Punch, we manage your day-to-day accounting and are an extension of your team. Each account is assigned a staff accountant, a Director, and a CFO.
Our mission is to help you streamline your back-office and to provide you with actionable data to make you a more-prepared business owner. Please click here to learn more about Punch Financial.