Bookkeeping greatly differs from accounting. And as a small business owner, you’ll need to understand the difference.
In this guide, you’ll learn everything you need to know about what is involved in bookkeeping for small businesses and how to choose the right system for you, the essential terminology of basic bookkeeping, and more.
Understanding the basics of bookkeeping: What is bookkeeping?
Bookkeeping is the management process of documenting a company’s financial transactions. This is done to keep track of the money that comes into the business, what money leaves the company, what taxes are required, and what tax deductions may be claimed.
If you get compensated for your goods/services in real time, you can use a cash-based accounting system. When working with credit, you will need to use an accrual system of accounting.
Bookkeeping involves documenting and categorizing every financial transaction in your company. It keeps track of how much your company spends and how much it receives.
These duties were previously done by using journals and ledgers, thus the term “bookkeeping.” Initially, transactions were documented in daybooks and cash books before being moved to a ledger. But now, bookkeeping software has mostly eliminated the necessity for paper books.
Each financial transaction is documented based on supporting paperwork. That paperwork might be an invoice, receipt, purchase order, or any sort of financial record confirming that the transaction happened.
The bookkeeping procedure will allow the business’s accountant to prepare financial statements to report on the company’s financial results at the end of each year for income tax reasons.
The importance of bookkeeping for small businesses: Why do small businesses need bookkeeping?
Bookkeeping for small businesses is how you become a big company because having a well-organized and accurate account of your income and transactions affects everything your business can do currently. This is how you grow – growth through efficient financial management.
Some of the reasons why you need a bookkeeping system in place include:
- You can check to see whether you are earning more money than you spend.
- You will have accurate financial data for budgeting and planning purposes.
- You can predict and avoid a cash crisis by keeping track of when you’ll need to pay your suppliers and when you might expect payment from customers/clients.
- You’re more likely to come across improper payments (or even fraud), which might cost you money.
- You are capable of completing correct tax returns.
- Organizing your financial information makes it easy to collaborate with others, such as financial institutions, investors, and accountants.
What are the benefits of bookkeeping for business owners?
Once you’ve mastered the fundamentals of bookkeeping or have a well-structured system in place through outsourcing, you’ll begin to reap the rewards of a well-run business.
Some of the main benefits of bookkeeping for small businesses include the following:
- You can streamline your budget for spending.
- Better business projections and increased efficiency.
- Tax season is no longer a source of stress.
- You can monitor your progress and make plans for improved revenue and profit.
How do you set up a bookkeeping system? A guide to effective bookkeeping for small business
When establishing your bookkeeping system, one of the first considerations you must make is whether to employ a cash-based or accrual accounting system. If you are running a small business that deals with instant transactions and payments, cash accounting may be the way to go. You can read further below for a more detailed account of the difference between cash-based systems and accrual systems.
For effective bookkeeping management, there are 4 important practices you should always follow.
Record all transactions
Every sale and transaction must be recorded. Traditionally, this was once done in cash books or spreadsheets, but as technology has merged into everyday life – software and digital record-keeping is the most effective tool for recording transactions.
Sales and transactions are now usually downloaded onto the digital ledgers from their point-of-sale stations, and all invoices and sales records are migrated to a single space online. When you ensure every transaction is recorded and every purchase related to business expenses is noted, you will have proof of payment when/if you need to claim any expenses as tax deductions.
Whether your system is cash or accrual, you can use streamlined software that keeps these records stored through your bookkeeping software or via your outsourced accountant.
Reconcile all transactions
Reconciliation is done by frequently comparing your business records to your bank accounts to ensure that there is a match between the transactions and balances – and if there isn’t a match, determining why. Bank fees, interest payments, deposits, and payments that have not yet arrived in your bank accounts must frequently be accounted for.
Depending on the volume of transactions in your business, bank reconciliation can be daily or even monthly. But before you can file for any tax returns, you’ll need to ensure all your records are reconciled.
It’s important to ensure you regularly reconcile your transactions, because the sooner you discover any errors, the sooner you can correct the discrepancies.
Ensure business and personal expenses are separate
For small business owners, it can be difficult to keep business and personal expenses separate. You may feel overwhelmed when it comes to these requirements, but it is always better to have a separate account and ensure all goods bought for the business are not done through your personal account. Your life will also be far more simple when you’re required to submit your tax returns.
A business account will let you keep track of your finances and allow for smooth organization and budget allocations, and thus, bookkeeping will be made efficient as all your financial records originate from one location.
Assign a category to every transaction
Bookkeeping categories are especially important when filing and recording your business transactions. This will help you manage and keep track of where your money is going and what money is coming in.
There are 5 main account types for bookkeeping categories:
Choosing the right bookkeeping method: Cash-based systems or accrual systems
There are 2 types of bookkeeping accounting: Cash-based systems and accrual systems.
In cash-based systems, you record every transaction in real time as they are made from goods and services. And in accrual systems, purchases and sales are recorded even if payment is made at a later stage. For small businesses, cash-based systems are often used initially and then converted to accrual or used in conjunction with the accrual system as your business grows.
When you start accepting credit and staggered payments from your customers, you will have to use an accrual system to ensure you have accurate management and record of your transactions.
The best way to avoid conflicting records and financial statements that will result in non-compliance issues, it’s highly advantageous to consult with an accounting firm to iron out the best systems and bookkeeping management for your business.
What are the basics of bookkeeping? Understanding the essential terms and elements of bookkeeping for small businesses
Understanding the basic terminology and definitions of bookkeeping is a crucial part of running your business. Even if you decide to outsource your bookkeeping to an accounting firm, it’s important to understand how the fundamentals work.
The most important bookkeeping categories that track cashflow are broken down into 5 main account types:
- Assets (this includes inventory, accounts receivables, cash, buildings, and equipment)
- Liabilities (this includes accounts payable, salaries/wages, and loans)
- Equity (The investments and shares in the business, by you as the business owner, and other investors)
- Revenue (Income made from business through the sale of its products or services)
- Expenses (All money spent to keep the company running)
What is the difference between accounting and bookkeeping for small business?
While accounting and bookkeeping are often mentioned together, they are not the same. Bookkeeping falls under the larger umbrella of accounting. But it is no less important.
Business accounting is the process of evaluating complicated financial data and applying it to generate reports and predictions to better understand a company’s financial health and performance.
While bookkeeping is the process of keeping track of all the money that goes into and out of a company. Bookkeeping activities include collecting and maintaining financial records such as invoices, receipts, and bank statements, in addition to tracking all revenue and outgoings. Paying bills and employees, reconciling bank accounts, data entry, and filing taxes are all part of the job.
The accountant then creates the company’s year-end financial reports and statements based on the information the bookkeeper has prepared and managed. The accountant’s year-end reports must comply with the rules of your country’s financial regulators, so it’s crucial to ensure you have a professional to handle these important procedures.
Doing your own bookkeeping vs outsourcing to professional accountants
Setting up and operating an effective bookkeeping system may be extremely challenging if you don’t have a background in accounting or financing.
Some of the functions of bookkeeping involve:
- Keeping track of business taxes and ensuring VAT compliance
- Managing cash flow statements
- Recording and reconciling transactions
- Managing profit and loss accounts
- Tracking business finances
- Managing the balance sheet
- Strictly managing and tracking late payments
A small firm may not be able to afford an accounting department staffed by trained and certified accountants, which calls for the need to outsource to reliable financial service providers.
Professional bookkeepers also assist with financial reporting, like cash flow reports, balance sheets, profit and loss accounts, and assessing business performance.
It’s so important to have good bookkeeping practices in any business environment. While larger firms have robust bookkeeping systems, most small businesses don’t, and this has a detrimental impact on their operations.
Maintaining your records also helps with things like analyzing company performance, recruiting investors, tax considerations, and securing funding.
A strong bookkeeping practice is necessary to avoid defaulting on your tax duties or incurring a financial loss owing to tax-related concerns.
Thus, many small businesses outsource to accounting firms that offer bookkeeping services. After all, this is not something you want to underestimate and under-prioritize as you focus on growing your business.