Accounting is the practice of recording, organizing, and analyzing a business’s financial information. Publicly traded companies must adhere to generally accepted accounting principles (GAAP), which are a set of standardized accounting best practices set by the Financial Accounting Standards Board.
Unlike publicly traded companies, most privately owned small businesses in the US are not legally required to follow specific accounting guidelines. However, keeping books in order is still needed to do routine financial things like preparing tax returns, applying for loans, and attracting investors. Here are seven key accounting best practices to keep in mind.
7 accounting best practices
- Organize financial statements and records
- Decide on an accounting method
- Budget and forecast
- Maintain internal controls and prevent fraud
- Ensure compliance
- Employ auditors if needed
- Use accounting software
1. Organize financial statements and records
Small businesses should keep accurate and consistent accounting records, as they are often required to use their financial statements and records to file their taxes, apply for loans, or seek new investments.
At a basic level, there are three main financial statements a small business keeps:
- Income statement. An income statement details sources of revenue and profit over a specified period of time, like a month or a quarter.
- Cash flow statement. A cash flow statement records all cash transactions, including investments and loans, over a specified period of time.
- Balance sheet. A balance sheet is a snapshot of a business’s assets and liabilities at a single point in time.
Keeping track of receipts, invoices, and bank account statements will make it easier to maintain these records accurately. If you would like more information on how to set up your financial records, you can follow this business accounting guide for small businesses.
2. Decide on an accounting method
During this process, you should also choose an accounting method and stick with it. There are two main types of accounting methods:
- Cash basis accounting. The cash basis accounting method involves recording all cash transactions a business receives.
- Accrual basis accounting. The accrual basis method requires businesses to record all products and services delivered, even if the business has not received cash for those services yet. Accrual basis accounting can give more detail on a business's anticipated future income than cash basis accounting can.
3. Budget and forecast
Budgeting and forecasting involve outlining your current business finances and predicting future needs. Creating realistic budgets and estimating future cash flow minimizes the risk of having to pay unexpected expenses in the future. If you do have sudden and unexpected costs you didn’t budget for, you may have to take out loans to pay them off. As such, accurate financial planning can save your business a lot of money in the long run.
4. Maintain internal controls and prevent fraud
Fraud occurs when one changes a business’s financial records to alter the appearance of a company’s financial health. This could include overstating revenue, undervaluing liabilities, and failing to record financial transactions, among other crimes. Fraud is illegal, even if it’s unintentional, and is one of the most costly issues a business can run into.
Businesses can minimize this risk by maintaining internal controls that are designed to prevent fraud. These controls may include, for example, reconciling bookkeeping with bank and credit card statements, creating a system of checks and balances so that no one person controls the entirety of a business’s accounting, and creating an authorization process for business expenses.
5. Ensure compliance
In accounting, compliance refers to following rules and procedures set by a business to ensure that its recordkeeping and accounting are accurate. This may include adopting GAAP and creating a clear set of written guidelines for bookkeepers. Note that if you adopt GAAP, your business will be required to use the accrual accounting method.
For companies considering expanding internationally, it may also be useful to adopt the International Financial Reporting Standards (IFRS), which is a set of accounting standards used by most companies that do business internationally.
6. Employ auditors if needed
Auditors are accountants who inspect financial reports prepared by other accountants. They double-check for accuracy and identify any potential fraud risks in a business’s accounting system. You can benefit from employing an auditor if you’ve noticed any inconsistencies or unrealistic numbers in your accounting or bookkeeping records. This is especially true if you’re hiring someone else to do the bookkeeping for your business, since it might be possible that fraud is happening without your knowledge.
7. Use accounting software
Accounting software helps a business automate parts of the accounting process. For most businesses, using accounting software can help speed logging expenses and income, reduce errors, and potentially reduce staffing costs. If you are struggling to choose between options, Shopify has compiled a list of the best accounting software for small businesses.
What are the 10 GAAP principles?
GAAP, which stands for generally accepted accounting principles, is a set of guiding principles adopted by the US Securities and Exchange Commission, used to standardize accounting throughout the US and in many other countries. All public companies in the United States are required to abide by GAAP. While private businesses are not required to follow GAAP, many choose to do so, because it makes it easier for outsiders to understand their financial records.
The 10 GAAP principles are:
- Principle of consistency. Businesses must use the same accounting standards across different years. This makes it easier to compare a business’s records from different time periods.
- Principle of permanent methods. Similar to the principle of consistency, this principle requires accountants for a business to use the same accounting methods and practices each year.
- Principle of non-compensation. Businesses must write down the value of all assets and liabilities, rather than simply using one to cancel out the other.
- Principle of prudence. All financial reporting must be based on facts. The value of an asset must be based on the price of that asset at the time of purchase, not estimates based on the worth of the asset today. This principle guards against overvaluation or undervaluation of assets.
- Principle of regularity. All accountants must follow all GAAP principles consistently.
- Principle of sincerity. Accountants must always be accurate and honest in their reporting of financial data.
- Principle of utmost good faith. Accountants should assume other parties are acting honestly and accurately.
- Principle of materiality. Accountants must disclose and not withhold all relevant information in financial documents.
- Principle of continuity. Accountants should conduct valuations based on the assumption that present conditions will continue in the future.
- Principle of periodicity. Businesses must keep track of financial records on a regular basis. Common intervals for recording transactions are daily, monthly, and yearly.
Accounting best practices FAQ
How can small businesses ensure compliance with accounting regulations and laws?
The best way to ensure compliance is to document all transactions and regularly review your financial records. You may also want to hire a professional accountant who has expertise in accounting regulations and laws.
What are the best ways to prevent and detect fraud in accounting?
In order to prevent and detect fraud, you should frequently double-check financial records and ensure that no single person has total control of your business’s accounting. You may also want to hire an auditor. Auditors are accountants who specialize in detecting mistakes in financial records.
How can businesses effectively use technology to streamline accounting processes and improve efficiency?
Businesses can use popular accounting software like QuickBooks and Xero to improve efficiency and speed up the accounting process. If you are running an ecommerce business, Shopify has an article with tips to improve ecommerce accounting.