Nine Small Business Accounting Practices
When you own a small business, you have all sorts of responsibilities. One of the most important aspects of running a business is managing the finances, but this goes well beyond tracking credits and debits. Most small businesses don’t have the means to hire a full-time accountant, but trying to manage these important tasks can be challenging. As you work to grow your business, make sure to stay current on these accounting practices for small businesses. By managing these tasks on a regular basis, you’ll be better equipped to keep your business finances in order.
Financial statements serve as the official reporting on a business’s well-being. The three main types of financial statements include statements of cash flow, income statements and balance sheets. Some companies will also produce statements of owner equity. To keep up with the best accounting practices for your small business, you should produce the financial statements at least every year, although you may prefer to keep a closer eye on changes with quarterly or monthly statements.
The statement of cash flow includes details about the business’s physical cash with details about how the amount has changed over time. An income statement includes information about expenses and revenue, along with a list of the net loss or profit for the specific period. When calculating the income statement, you should include the gross margin, which is the total sales minus the cost of the sales, along with the net profit, which is the money held by the business after all expenses have been deducted.
A balance sheet includes any liabilities, any physical assets and the equity on the date of the report. The sheet will include two sides: fixed assets and current assets. Fixed assets include any property or equipment owned by a business, while current assets include cash flow and any items that could be converted to cash. This sheet would also show information about business ownership. The various aspects of the sheet must balance out, hence the name. Statements of owner equity outline the owner or owners of the company and what percentage each owns.
Your business will need to submit the required financial statements with the annual tax returns. If you have managers or board members, those individuals will want to see financial statements on a regular basis to keep track of the success of the company and to determine areas for improvement.
Your company’s general ledger is the main building block of your company’s accounting processes. A general ledger lists all of the various accounts and the balances of each one. The general ledger does not include information about bank accounts, but it lists details of the financial classes, such as equity, expenses, assets, revenue and liabilities. Beneath each subcategory, your general ledger will include line items as money flows in and out of the business.
Any time your business handles a transaction, such as collecting money from a customer or paying a bill to a vendor, it should be recorded in the general ledger.
All transactions involving money should be accurately tracked in the general ledger. These transactions might include sales, services provided, proceeds generated from investments or loans and purchases of inventory, assets or equipment. Even the smallest transaction should be included and accounted for within the ledger.
From there, you can balance the accounts accordingly. Some small business owners update the general ledger daily, while others prefer to keep it in real time and make changes as transactions occur. It’s up to you to decide how you want to handle the frequency, but it should never be ignored for more than a day or two. Without accurate insight into the financial details of the business, it’s challenging to pay bills or process payroll.
Most companies opt for digital tracking methods, although you’ll still find a handful of small business owners who use the old-school book to manually enter credits and debits. Digital general ledgers tend to be more accurate since they eliminate the potential human error when adding and subtracting. A variety of software companies offer basic accounting software, often including a general ledger, designed for small businesses. Some of these software options are free, while others charge a nominal monthly fee.
Double-Entry vs. Single-Entry Method
There are two main methods for tracking expenses in the general ledger: single-entry and double-entry. The single-entry method is simpler, but it may not be enough for a small business. Using the double-entry method involves tracking credits and debits in one section of the financial ledger, and tracking those same transactions again in the financial statements section. When you use QuickBooks or other accounting software, double-entry is typically the standard.
Although single-entry is easier, double-entry allows for more balanced and accurate record keeping.
One of the most challenging aspects of business accounting is tracking all required taxes. If you sell products, sales tax is likely required in your state. Business taxes and payroll taxes are just a few additional examples of what is required to stay compliant with federal and state laws. Corporate sales taxes can eat up a lot of a small business’s profits, but investing in tax-free trusts or retirement funds is one way to get around that problem. Conservative investment options allow you to report profits honestly while maximizing the earnings and paying less in taxes.
In order to get a better sense of tax loopholes and legal ways to maximize your profit, you may want to hire an experienced business accountant.
Whether your business has a single employee or multiple workers across several departments, you’ll need to set budgets. Without setting a budget for a specific project or department, people could spend a lot more than the company can handle, leading to financial strain. A lack of a budget will also make it more challenging to rein in a project that got out of control, which means your business might spend a lot of money on something that doesn’t offer a good return on the investment.
Setting a budget for a start-up is challenging, especially if the business doesn’t yet have much cash flow or many projections. However, as the company continues to expand and do well, it will become more apparent how much cash is needed to operate and what you can afford to spend in other areas.
Performing a self-audit is a good way to check in on your company’s financials. Some companies refer to this practice as closing the books, but it should involve fully reviewing the general ledger, line by line, and making adjustments for potential oversights or errors. If you have accounts with temporary or outstanding balances, such as unpaid invoices, you should also close these accounts as part of the self-audit. The final step is deciding which account balances should carry over to the next month or quarter.
The process of self-auditing should be done at least once every quarter, although some small business owners opt to audit themselves at the close of every month. Keeping up with this practice offers insight into any changes in business revenue and expenses. Plus, by performing audits more often, you can eliminate some of the stress that comes with a real audit. You’ll have a clear picture of the financial health of your company, which can provide confidence as you head into an IRS audit.
When to Hire a Professional
If you are facing an audit, you may want to hire a professional accountant to manage the documents and other tasks associated with this process. You don’t have to hire a full-time accountant to handle the tasks, but you could bring an external professional in as a consultant on a short-term basis.
In certain industries and sectors, businesses are required to hire external auditors regularly to review the general ledger, financial statements and books. Even if your business doesn’t fall under these government regulations, it’s still smart to bring in an independent entity who can perform a thorough review, go through the transactions line by line and fix any errors. Another aspect of an external audit is checking for any evidence or signs of fraud, which can instill trust in customers, investors and others with a vested interest in the business.
If you do choose to hire an external bookkeeper or accountant, make sure to stay in constant communication with them. Failure to communicate a purchase or fulfilled order could throw a wrench in their job duties and cause an account to dip below the positive. Report everything to your accountant, including expenses, cash flow changes and other aspects of running your business, to avoid an expensive mistake.
As you search for the right accountant or bookkeeper for your business, look for people with proven experience in your industry. Brand-new companies often benefit when working with accountants who have start-up experience. Different regulations across various industries can be confusing, so bring in someone who has a clear understanding of what’s required.
Mistakes to Avoid
One of the most common mistakes made by small business owners is misunderstanding the significance of accounting. The key to success is effective accounting, which involves recording every single thing that happens within the business. Transactions should be recorded, properly categorized, and accounted for every time you review your financial statements. If you’re only pulling up these documents when tax time comes around, you’re probably feeling a lot of stress around late March to mid-April. Instead of making it more difficult for yourself, take the time throughout the year to establish better accounting practices.
Another common mistake is reporting profits too early. For example, if you close a $20,000 deal that will take $10,000 to fill, you shouldn’t immediately track a $10,000 profit. In fact, the profit shouldn’t be calculated until the goods have been delivered or the services have been provided. If your company experiences a delay in filling the order or the customer cancels some or all of the order, you could end up with a $10,000 mistake in your books. This type of profit reporting and tracking will distort the financials of your company, which could get you into legal trouble.
Risks of Ignoring Best Practices
If you’re trying to get creative with your business accounting methods, now is the time to make a change. Although privately-owned, small businesses have some advantages over publicly traded corporations. The owners of these smaller businesses are still responsible for following the laws and regulations that govern all businesses. As a small business owner, you don’t have to show financial transparency at the same level as a public company, but any investors or board members of your company will still want to be involved and know what is going on within the company’s financials.
Creative accounting methods, such as failing to track expenses, understating the profits and earnings or tossing receipts and other documentation, can destroy the financial health of your company. If you face an IRS audit, you could also be found guilty of fraud and tax evasion, which come with steep penalties and potential prison time. Understating the profits of a business could impact the credit rating of your company. All legally reported profits stay on the business records, which are available to any potential investors and lenders.
When your company’s credit rating goes down, it becomes much more difficult to qualify for loans and investors are less likely to trust what you report. You could even damage your ability to qualify for governmental benefits, like Social Security, on a personal level. Your small business is directly linked to you personally, which means that any fraud or tax evasion will be applied to your personal credit and tax history.
Poor accounting habits or a lack of accountability can be the downfall of your business. Examples of bad behavior and mistakes, both intentional and accidental, are ever-present in the news. Instead of burying your head in the sand, make sure to implement any and all of these best practices as part of your business accounting processes. Consider checking out an online lending platform if you’re in need of extra funds to implement important accounting practices. Be sure to make accounting a priority from day one of starting your business. If you’re new to the accounting world, use all available resources that can benefit your company and help you get a better sense of the most important tasks.