Your online small business selling gourmet coffee is taking off, with sales through coffee-club memberships doubling in the past year. You’re a bit giddy with the success, but you’re behind on paperwork. Your desk is cluttered with sales invoices and expense receipts, and you haven’t reviewed the business’s accounts or bank statements in three months. It’s time to get serious about accounting and bookkeeping. Here are some tips to do just that.
What is accounting?
Accounting is the process of assembling and presenting a business’s financial data. It’s used to analyze a company’s financial health, track operations, and make decisions on whether to expand, hire, reinvest profits, borrow, or seek investors.
Bookkeeping provides much of the material used in accounting. It is the process of collecting invoices, receipts, payroll, and tax payments, and recording the financial data in those documents. Accurate and up-to-date bookkeeping and accounting increase the odds of a small business succeeding.
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10 accounting tips for small businesses
Advice about accounting for small business owners could fill a book; the following small business accounting tips are a good starting point.
- Separate business and personal expenses
- Use bookkeeping software
- Create a budget
- Keep detailed records
- Understand sales tax laws
- Manage cash flow
- Stay organized, clean up the books
- Choose an accounting method
- Automate invoicing
- Plan ahead for taxes, stick to deadlines
1. Separate business and personal expenses
Set up a separate business bank account to avoid the confusion that comes from mixing personal funds and business transactions. This makes it easier to gather and verify business expenses for tax deductions, and keeping business funds separate helps limit the owner’s potential legal liability from business debts. Sole proprietors can use their Social Security numbers to open business accounts, while owners with employees can use employer identification numbers (EIN), to do the same.
Avoid using your personal credit card on business expenses and get a business credit card. That can help plug temporary cash shortages and establish a business credit score, while ensuring that your personal credit score is not affected by your business’s finances.
2. Use bookkeeping software
Keeping proper track of income and expenses is essential for good accounting. Bookkeeping and accounting software can automate many time-consuming and tedious manual activities, such as sending and tracking customer invoices, sorting expenses, and paying employees. Software also helps reduce errors.
3. Create a budget
A small business owner should have a budget for projected revenue and expenses, then check it periodically against actual results. Budgeting helps small businesses analyze operations to improve cost efficiency, as well as find possible opportunities for expansion.
It’s important to create a budget and businesses that do generally report better financial results, according to various government and Federal Reserve studies. Those without a budget may not see a problem until a cash crunch arises.
4. Keep detailed records
Accurate records increase a small business’s chances of success. Records also are critical at tax time, when a business must document any tax-deductible expenses. Internal Revenue Service rules require businesses to maintain records for at least three years; accountants recommend seven years.
As a first step, a small business can create folders for paper receipts based on expense type, vendor, or supplier. Some business software services let users electronically scan receipts with mobile devices, then sort and categorize them in the business’s online bookkeeping system.
5. Understand sales tax laws
A business owner must stay on top of sales tax laws in the states where they operate or sell. Sales taxes apply in 45 states and the District of Columbia; in addition, 38 states collect local sales taxes.
Generally, if a business has a physical presence in the state—a store, office, or warehouse—it must collect sales tax. Online sellers in multiple states may or may not have to collect sales tax, depending on whether they sell directly or through a fulfillment service such as Amazon, which may add the sales tax on its end.
Small business owners, particularly ecommerce businesses that operate in many states, may want to consult an accountant or tax attorney about setting up a program that meets state laws.
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6. Manage cash flow
A business’s cash flow indicates liquidity—how much money there is to immediately pay expenses. Many small businesses fail because they don’t produce enough cash flow.
A small business can create a cash flow statement so that it can gauge the timing of money coming in against money going out. Some ways to improve cash flow might include:
- Timing. Shorten customer payment terms, for example from 60 days to 30, while stretching supplier payment times, from 30 days to 60.
- Wiggle room. Build in a margin of error in cash flow projections.
- Rainy day funds. Establish a cash reserve for times when cash flow fluctuates.
- Credit line. Obtain a business credit line or credit card to use in a cash crunch if needed.
7. Stay organized, clean up the books
Organized accounting and bookkeeping mean less time spent searching for records instead of building the business. They also mean easier analysis and decision-making for the business when considering expansion or hiring.
8. Choose an accounting method
A small business must choose one of two accounting methods: cash or accrual.
- Cash-based accounting usually is simpler for a startup or young business: sales and expenses are recorded only at the time of payment.
- Accrual accounting is more complicated. A sale or expense is recorded at the time it’s incurred, even though payments may not happen until weeks or months later. The accrual method encompasses a longer-term view of the business across multiple periods, and it’s the standard among larger companies and financial institutions.
Accounting standards also are important. Publicly traded companies in the US and Canada must use a set of standards called generally accepted accounting principles, or GAAP. Although privately held companies don’t have to adhere to these rules, they can be useful in communicating with accountants and bookkeepers. The rules are monitored and enforced by government regulators. Most other developed countries use the International Financial Reporting Standards (IFRS). Unlike GAAP, the IFRS are guidelines, recommended but not enforced. China and India, among other countries, don’t adhere to IFRS.
9. Automate invoicing
Sending invoices automatically can streamline billing and save time and resources. For example, you could set up a program using invoicing software to automatically send an invoice within 48 hours of a sale, followed by timed payment reminders and overdue notices if needed.
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10. Plan ahead for taxes, stick to deadlines
A small business should estimate its income taxes during the year based on its growth and projected pretax income. Small businesses, including online businesses, usually make quarterly estimated federal tax payments if they expect to owe more than $1,000 for the year. Late payment or underpayment of estimated taxes can result in fines and interest charges on overdue taxes.
Accounting tips FAQ
How can I stay compliant with sales tax laws?
You should make sure you’re aware of the sales tax laws in your home state and for each state where you sell by obtaining copies of tax rules from a state’s department of taxation or revenue. You can also use software specializing in sales tax collection for small businesses, particularly ecommerce businesses that sell in many states.
How can I manage cash flow?
Some ways to manage and improve cash flow include:
- Stay current. Review and analyze expenses weekly.
- Timing. Synchronize expense payments with customer payments.
- Incentives. Give customers who pay early a discount or a first month free on subscription sales.
How often should I reconcile my bank account?
Reconciling is when you square up your business’s records with its bank account. Doing this at least once a month makes sense because monthly bank statements aid in the reconciliation process. Reconciliation lets you verify cash flow, spot discrepancies or missing funds, and prevent fraud.
What are some common tax deductions for small business owners?
Many expenses may be deductible from federal income taxes, in whole or in part, depending on your business’s circumstances. Common deductions include office rent and utilities, computers and software, office supplies, depreciation of machines, business phone and internet bills, business-related car expenses and mileage, business travel, local property taxes, and business and health insurance costs.
Is it necessary to hire a professional accountant for my small business?
Often, a small business owner can manage accounting and bookkeeping on their own, depending on the simplicity and scale of the business. Bigger, more complex businesses, however, almost always hire professional accountants.