If you’re like most small business owners, you wear many hats – and that includes accounting. While it may seem intimidating, accounting doesn’t have to be complicated. This guide will cover the basics of small business accounting to help you feel more comfortable tackling these tasks.
101 Accounting Guide for Small Business Owners
Choose the Right Business Structure
The first and most important step is to choose a business structure. If your business is already up and running, you likely have chosen a structure already. However, if you’re in the process of establishing your business, it’s important to choose your structure carefully.
There are four main types of business structures:
- Limited Liability Company (LLC): An LLC shields business owners’ personal assets from legal issues. For example, if your business is sued, your personal assets (such as your family home) would be protected from judgments. LLCs also offer flexibility in how your management team is structured, and there are no requirements for meetings and other formalities that other entity types require.
- Sole Proprietorship: A sole proprietorship is a single-owner business that requires very little setup. However, unlike an LLC, your personal assets are not protected under this entity type.
- Corporation: A corporation is considered a separate entity from its owners and is one of the most complex business structures. However, corporations still offer benefits, such as lower corporate taxes and legal protection.
- Partnership: Companies with multiple owners can share ownership through a partnership structure. Each partner will be responsible for contributing to the business, and their responsibilities must be outlined within a partnership agreement.
Each business structure has its pros and cons, so consider your options carefully. Not only will the business structure affect your accounting, but it will also affect how you manage your operations.
Open a Business Banking Account
Once you have chosen an entity and established your business, the next step is to open a business bank account. Most business structures will require you to have a business bank account, but even if you’re operating as a sole proprietor, it’s a good idea to have one.
Having a business bank account makes it easier to:
- Separate your personal expenses from your business expenses.
- File business taxes
- Pay vendors
To open a business bank account, you will need an employer identification number or EIN. An EIN is a nine-digit, unique number that’s assigned to your business by the IRS. Think of it as your business’s Social Security number. You can apply for your EIN right from the IRS’s website.
Choose an Accounting Method
Now that you have a bank account, it’s time to consider which accounting method you’ll use for your business. Many small business owners are intimidated by this step, but once you understand your options, it becomes much easier to make your decision.
There are two accounting methods to choose from cash and accrual.
- Cash: A simple accounting method that’s often used by businesses with limited accounting activity. With cash accounting, revenue and expenses are only recorded when money exchanges hands.
- Accrual: CPAs often recommend the accrual accounting method because revenue is recognized when it’s earned, and expenses are recognized when they are incurred. Although more complicated, the accrual method often gives a more complete and accurate picture of your business’s financial health.
Choose your accounting method carefully. Changing it will require authorization from the IRS.
Create a Chart of Accounts
At this stage, you’re almost ready to start recording financial transactions. But before you can do that, you’ll need to create your business’s chart of accounts.
Your company’s chart of accounts is a list of all the accounts you’ll use to record your transactions.
There are five main types of accounts that will be used in your chart of accounts:
- Revenue/Income: The money your business earns from the sales of goods or services.
- Assets: All items of value owned by your business are considered assets. These can include the money owed to you by customers (accounts receivable), money in your business bank account, furniture, equipment, and inventory.
- Liabilities: Any money that is owed to another party is considered a liability. Liabilities can include loans and money owed to vendors.
- Equity: A business’s equity is the amount left after subtracting liabilities from assets.
- Expenses: Money spent on items and services needed to run the business. Expenses can include employee salaries, rent, utility bills, etc.
Creating your chart of accounts will give you an overview of your business’s financial situation and may help you make business decisions, such as finding areas to cut back on expenses.
Set Up Payroll
If you’re hiring employees or running payroll for yourself, you will need to set up your payroll system. A payroll software solution designed for small businesses can help you get your system up and running quickly.
Before you can set things up, you will need the following:
- Your EIN
- State and local ID numbers
You will also need to determine whether you’ll be hiring employees or working with contractors.
Reconciling Bank Accounts
One crucial aspect of small business accounting is learning how to reconcile your bank accounts.
Online banking makes it easy to manage your bank accounts, so it’s tempting to skip this step. However, reconciling is an important task and should be done every month. Doing so will help you identify bank errors and items that need to be added to your general ledger.
Manage Your Income and Expenses
Next, you’ll want to establish a method for managing your income and expenses. Income is the money coming into your business, while expenses are the money going out of your business.
Here are some tips to help with income and expense management:
- Send out invoices quickly. Make sure that you understand how to create invoices, and make sure that you send them out once services are rendered, or goods are delivered.
- Make it easy for customers to pay invoices. The easier it is to pay, the quicker you’ll receive your payment.
- Always pay your vendors on time to maintain a good relationship.
- Enter financial transactions regularly.
- Record all of your expenses.
These are some of the most basic aspects of small business accounting. For many small business owners, accounting can be a time-consuming and sometimes overwhelming task. You don’t have to do it on your own! An accountant can help you with all of these tasks, so you don’t have to risk making costly mistakes.
To learn more about how we can help with your small business accounting needs, click here to schedule a consultation.