Small Business Accounting: The Basics

Accounting is an essential part of any business, whether you’re a mom-and-pop retailer or a large corporation. Business accounting enables you to track all the transactions, assets and liabilities, inventory and other aspects of your regular operations, and to have the figures needed to prepare the regular filings required by state and federal taxing authorities.

In small business accounting, there are tasks that need to be done daily, weekly, monthly, quarterly and annually to keep things running smoothly. Even small business owners who’ve earned a business degree may find tackling the bookkeeping and accounting responsibilities challenging at times. Business accounting software, however, has made the various tasks in the accounting process more manageable. 

To help you get started in small business accounting, there are some regular business terms you should familiarize yourself with. Think of these items collectively as a compass that will help you get your bearings as you navigate your businesses’ finances:

These two accounting basics help you determine what you owe, and what is owed to you. Accounts payable is money that you owe to others, like vendors, suppliers and creditors, and are listed as liabilities because you are obligated to pay them. Accounts receivable is money that is owed to you by your customers, for the goods or services you’ve sold them. These items are listed as assets because the customers are obligated to pay you.

Accrual and cash-basis accounting are terms that designate when a sale is recognized by the business. In accrual-basis accounting, businesses recognize revenues and expenses at the time a sale is made. In cash-basis accounting, businesses recognize a sale when a payment is made.

Assets are anything your business owns that has value. This may include the money you have in the bank, accounts receivable, inventory, furnishings and equipment or real estate. Liabilities are items that detract from the value of your business, such as anything considered a debt or financial obligation. These could include accounts payable, wages and taxes, and small business loans.

A balance sheet is a financial report that acts as a snapshot of your company’s financial position at the end of a specified period, listing your business’s assets, liabilities and shareholder’s equity. Your balance sheet can give you an accurate indication of how you’re handling your business’s assets and liabilities when compared with the numbers from an earlier timeframe and can help you identify trends in your financial performance. 

The cash flow statement indicates how well a company manages the inflow and outflow of cash through operating activities, investing activities and financing activities, and supplements the balance sheet and income statement.

The profit and loss statement, or P&L, is also called the income statement. This important document reports earnings, expenses and net profits for a specific period. 

There’s a lot to do, but if you take things one step at a time and make sure to be thorough, research your obligations in terms of documentation and reporting and set up an organized set of processes, your small business accounting system will be set up for success.

The business structure you choose to follow can affect several crucial things, including how much you’ll pay in taxes, the forms to file, your personal liability and your ability to raise money. Common business forms include sole proprietorships, partnerships, C corporations, S corporations and limited liability companies (LLCs).

According to the U.S. Small Business Administration (SBA), you’ll need to choose how you want to structure your business before registering with your state, and that consulting with a business counselor, attorney or accountant may be helpful when taking this foundational step.

Your small business should have its own bank account to separate your personal finances, and to help you begin establishing business credit. Once you have your business name and structure set up and have registered with your state, you’re in a good place to open a business checking account. You also may want to open a separate account to help you set aside funds for paying taxes or support cash flow planning efforts.

Before you start earning revenue you’ll need to pick an accounting method. Your business’s accounting method establishes the rules of the road concerning reporting and tracking expenses. As we mentioned earlier, cash and accrual-basis accounting are the two main accounting methods used by businesses:

Whether you decide to keep your own books or hire someone to do it for you, the next step is to establish your bookkeeping system. For small businesses, keeping the books involves keeping track of where the money is going (expenses), and what money is coming in (revenue).

Begin by setting up a list of all the accounts you’ll be recording transactions for. Accounts are typically organized in categories, including asset, liability, equity, revenue and expense accounts. Recording financial transactions accurately will make things easier when it’s time to deduct business expenses at tax time. If you use a bookkeeping software program, keeping track of it all can be much easier as you perform the most important daily, weekly, monthly and quarterly bookkeeping tasks.

You will also need to determine your fiscal year. As you may know, your business could follow a standard calendar year, but a fiscal year is any consecutive 12-month period. Some businesses choose to have their fiscal year start on July 1 and have it end on June 30 of the following calendar year, but ultimately the choice is up to you.

At some point you’ll have to establish how the people who work for you get paid.  

Small business payrolls are typically handled by the business owners. It’s a major expense for most businesses, and is almost always deductible from gross income, which reduces the company’s taxable income.

The payroll process encompasses several tasks, including tracking employee hours worked, calculating pay and distributing it via paper check or direct deposit into the employees’ bank accounts.

But that’s not all. Payroll comes with its own set of accounting and recordkeeping rules, which may include setting aside funds for Social Security, Medicare and unemployment taxes. Because of payroll’s complexity, some businesses may choose to outsource their payroll or use a cloud-based service once they’ve reached a certain size.

Another responsibility that comes along with small business ownership is making sure you familiarize yourself with your tax obligations and the regulations of local, state or federal taxing authorities. This will not only help make tax season more manageable but can also help you avoid costly penalties.  

When it’s tax time, different types of business entities may be required to file different tax forms. The 4-step process you’ll use for filing small business income tax for your business’s taxes will likely be as follows:

There’s more to small business accounting than just keeping accurate records. Knowing your profitability is important too. Gross margin is an important small business accounting benchmark that can help you get your bearings and determine how far away you are from your break-even point. With a strong gross margin, you will be better able to know how much you can reinvest in the business, how quickly you can pay off debts or how well you may be able to attract investors.

Gross margin is calculated by subtracting the cost of goods sold (COGS) from total revenues collected and is usually expressed as a percentage. The higher the gross margin, the more efficiently your company is creating profitability.

Common small business accounting tasks are performed on a regular basis to help you gain a clear understanding of your business’s performance and profitability, as well as to comply with state and federal filing requirements. How often each of them is to be done varies according to the task. Here’s an example of some of the things you’ll need to do and how often you might do them:

With everything that needs to be done to track your small business’s financial performance, you might be thinking if it’s better to use a business accountant or use accounting software. While you could hire a professional to take care of it all, there is an additional expense to think about.

Unless your business is very complex, using accounting software programs can save you a lot of time and be a convenient way to handle regular bookkeeping tasks and track income and expenses. That leaves you with more time to work on the things you enjoy doing and that generate revenue for your small business. This is why an attractive option for small business owners is a hybrid approach, where you use an accounting software program for the regular tasks and an accountant for the big picture work. It might be a good idea to look for a business accounting software platform that is user-friendly, with user resources that offer clear guidance and a customer service line.

An accountant, or more specifically a Certified Public Accountant, can help you with that big picture, providing guidance on how to structure your business and minimize your tax liability. At the end of the year, the CPA can certainly be a big help in preparing and filing your annual tax return and using up-to-date knowledge of the tax code to identify all allowable deductions.

Trying to tackle everything yourself can be a small business mistake, no matter how on top of things you feel. From time to time, we all need help. As your business grows, chances are you will consider hiring a part-time or full-time bookkeeper to take care of many of those regular tasks.