No matter the size of the company, all businesses rely on accounting practices to tell the story of their financial health. While larger companies have entire departments dedicated to the practice, a small business may not even have one accountant on staff.
Small business owners and self-employed workers value efficiency. Proper accounting will keep a successful business humming along, and also wave red flags to signal potential issues.
So what are the appropriate steps in accounting? Let's look at our objectives first.
Why Is Accounting Important for Small Businesses?
Business owners constantly keep an eye on the bottom line. Efficient accounting practices benefit publicly traded companies just as they do mid-sized private firms and small mom-and-pop shops. Proper analysis of a small business’ financials enable its decision makers to identify:
- Trends — predictable outcomes based on past performance
- Areas for growth – new revenue sources or existing sources that might yield greater results through increased focus
- Potential trouble spots – parts of a business that cost too much time or money
Additionally, proper accounting is critical for smooth tax preparations and tax filings.
What Are the Basics of Small Business Accounting?
Here's the good news: You don’t need an accounting degree to understand the basics. But you also don't want to go in blind.
First and foremost, pay attention to bookkeeping.
Small business accounting begins with careful attention to bookkeeping, which is the overall organization of financial transactions.
Bookkeeping focuses on all transactions and lays the foundation for analysis. By categorizing, organizing, tracking, recording, and balancing the information, your business is on its way to better understanding its financial health.
With this information in hand, any small business can produce reports that analyze income and expenses.
A bookkeeping checklist can provide the foundation for your accounting practices and make sure that you have the right bookkeeping services in place. One way to organize your checklist is as follows:
- Daily — Track cash on hand and any incoming or outgoing transactions
- Weekly — Record all billings and payments; update payroll
- Monthly — Balance accounts; review and process payroll; account for payroll taxes; review month-end balance sheet
- Quarterly — Review profit and loss projections; make quarterly payroll payments and tax payments
- Yearly — Analyze year-end inventory; complete IRS and tax forms; review year-end financials
Depending on the size of the business and the scope of work, a small business could benefit from a bookkeeper’s services for 3-4 hours per month to organize all bank activity and reconcile the bank account.
If bookkeeping needs are more advanced, a small business can have enough work for 10-15 hours per week. In that case, a bookkeeper could manage billing clients, writing vendor checks, preparing payroll, and preparing sales tax forms.
Basic Accounting Tools beyond Bookkeeping
Sound bookkeeping is just the beginning of small business accounting. Some basic steps will ensure that small business owners are equipped with the financial understanding of their companies both today and in the future.
1. Establish a dedicated bank account.
By keeping your professional finances in a separate bank account, your monthly financial statements will require less manipulation, and your bookkeeping system will benefit. A business bank account will also protect the proprietor’s finances through personal liability protection.
2. Determine your payment policies and terms.
Will you require payment up front? Who will do your invoicing? Will you accept credit cards? Will you pass sales tax along to the consumer, or will you cover it yourself? Having a sense of these answers will help shape your accounting system and give you greater control over your own books.
These are also questions you should answer before determining which accounting method you plan to implement.
3. Establish a methodology for recording sales.
Recording sales is all about organization, bookkeeping, and basic accounting. Every sale has a paper trail, anything from a basic receipt to detailed information entered into your customer relationship management (CRM) software. Your ability to retain customers or clients is largely tethered to knowing who they are and what kind of tendencies and history they have.
Your recorded sales information can then be collected in a ledger that holds all transaction information. It will help you prepare income statements, gauge profitability, assist with inventory management if you are selling goods, and organize your financial information in advance of tax time.
4. Establish a system for recording revenues and expenses.
Both revenues and expenses need to be tracked carefully, regardless of record-keeping practices. You can track income and expenses by hand or with the right software — or you can elect to hire a CPA.
5. Understand cash flow.
Cash flow statements, which summarize all money from all sources both received, owed, and dispensed, are an invaluable resource for business owners because they are the most concise and thorough analysis of financial health.
Cash flow is calculated one of two ways, either by the direct method or the indirect method. Basically, the direct method focuses solely on net cash flow while indirect method considers non-cash revenue and expenses, such as purchases on credit.
6. Select an accounting method.
There are two ways of going about tracking and recording your finances: cash accounting and accrual accounting. The major difference between the two methods comes down to when you consider the money in or out of your possession.
Cash accounting records income and expenses only when the money is received or paid out. Payments owed both to and by your company will not be reflected in your account until the money exchanges hands.
Cash accounting provides the most accurate appraisal of cash-in-hand for a small business and can help avoid cash-flow problems.
Accrual accounting tallies all debits and credits regardless of when financial transactions occur. Typically, this method is suggested for companies that maintain inventory. It provides for a clearer big-picture perspective.
Service-oriented businesses may opt for cash accounting, while businesses that sell goods elect accrual accounting.
Small businesses that opt for accrual accounting do need to keep in mind that they may have to pay taxes on reported income that has not yet been received. Additionally, those businesses can claim expenses for tax purposes before money has left the company. That’s where the right accounting software or accountant is critical.
How Much Does an Accountant Cost a Small Business?
Your need for an accountant may not depend upon your comfort with financial information. At a certain point, you will need to spend more time on other areas of your business—elements that only you are qualified to handle.
Your time is money, and at a certain point you may find that your time is better spent in areas of your company other than bookkeeping and tax reporting.
Rather than waiting for tax season, you can bring a CPA on board earlier in the process of establishing your small business. An accountant can make sure you're in compliance with a variety of regulations. Don't wait for an audit from the IRS to call for help.
For companies that use a bookkeeper and have their finances in order, a CPA would only be needed for tax preparation. A small business owner should expect to pay about $1,200 - $1,600 for those services.
If an accountant needs to sort through a year’s worth of bank transactions, a small business should expect to pay an additional $800 - $2,000 in total for work that can take about 5-8 extra hours.
You should expect to pay between $150-$400 per hour for an accountant's services. The pricing will vary based on where you live, how experienced an accountant you want, and the nature of the project. A startup might want to consider an introductory consultation from an accountant to better understand overall needs.
Remember, leaving the accounting principles to an expert will free you up to focus on new business and other chores.
For small business owners looking to take on more accounting responsibilities, there's accounting software.
What Is the Easiest Accounting Software for Small Businesses?
Accounting software can give small business owners a head start on their tax filings. The right software helps them track accounts receivable and accounts payable.
Most popular accounting software:
- Sage 50
While size and scope of your business may dictate which accounting software works for you, QuickBooks is generally regarded as best in class. Even better, many accountants are already familiar with it, and QuickBooks offers scalability that suits freelancers and employers alike.
Xero is another popular option, better suited for very small businesses with fewer monthly transactions. They also offer a full-service payroll option.
The most popular small business accounting software options offer out-of-the-box solutions that save time and far exceed the general functionality of Excel.
The Next Step: an Accounting Plan for You
You pour too much energy into your business not to provide for the accounting support it needs. Whether you need to improve your small business bookkeeping, or you're ready to seek the services of an accountant, there's an accounting plan for every business.