You can’t run a healthy, successful business without having your books in order. It’s like driving a car without a fuel gauge, or map, or GPS….sooner or later you’re going to get lost or run out of gas.
In this guide we’ll walk you through the basics of bookkeeping, what it is, why it matters, and how to start doing it yourself.
Why Bookkeeping Matters?
1. You need to do your taxes.
You need to know your net profit in order to do your taxes, and to figure that out, you need to know your total income and expenses. And the only way to know for sure is to have up-to-date books.
2. It tells you where your money is going.
Getting your books together is the only way to gauge the financial health of your small business. Are sales up? Are your shipping costs too high? Will you have enough money next month to cover payroll? Is cash flow increasing or decreasing? The only way to know for sure is to start bookkeeping.
3. It ensures that you don’t miss out on tax deductions.
Keeping an accurate and up-to-date set of books is the best way to keep track of tax deductions (expenses that you can deduct from your taxable income). The more information (and supporting documents) you can give a CPA at tax time, the more deductions you’ll be able to legitimately claim, and the bigger your tax return can potentially be. The IRS also has pretty stringent record keeping requirements for any deductions you claim, so having your books in order can remove a huge layer of stress if you ever get audited.
4. It helps if you need to borrow money.
If you need to borrow money from someone other than family and friends, you’ll have to have your books together. Doing so lets you produce financial statements, which are often a prerequisite for getting a business loan, a line of credit from a bank, or a seed investment.
5. It helps you catch errors quickly.
If you wait until the end of the year to reconcile or get your financial transactions in order, you won’t know if you or your bank made a mistake until you’re buried in paperwork at tax time. Regularly organizing and updating your books can help you catch that erroneous overdraft fee today, rather than six months from now, when it’s too late to bring it up.
Where To Start?
There are seven steps you’ll need to walk through to get your bookkeeping machine up and running.
Separate your business and personal expenses.
The first step to mastering your business finances is pretty simple: get a business bank account and separate your business and personal expenses. Why? Liability is one big reason. If you’re running a corporation or an LLC and there isn’t sufficient distance between your personal and business finances, there’s a chance that you could be held personally liable for any debts incurred by your business.
Mixing together personal and business expenses in the same account can also result in unnecessary stress when you need to file taxes or do your bookkeeping. It could mean a business expense gets lost in your personal account and messes up an important deduction. Or it could mean your CPA spends more time doing your taxes. Either way, you end up losing money.
Choose a bookkeeping system.
There are two main bookkeeping methods: single entry and double entry bookkeeping.
Under single entry, journal entries are recorded once, as either an expense or income. Assets and liabilities (like inventory, equipment, and loans) are tracked separately. If you are just starting out and doing your books on your own then a single entry is probably right for you. It’s simple, fast, and good for really basic bookkeeping.
Double entry is more complex but more suitable for established businesses.
Under double entry bookkeeping, all transactions are entered into a journal and then each item is entered into the general ledger twice, as both a debit and a credit.
Most accounting software today is based on double entry accounting, and if you ever hire a bookkeeper or accountant to help with your books, double entry is what they’ll use.
Choose an accounting method: cash or accrual.
You have another important decision to make when setting up your bookkeeping, whether to make your accounting process cash or accrual based.
Under cash accounting, you record transactions only once money has exchanged hands. If you bill a customer today, those dollars don’t enter your ledger until the money hits your bank account.
Many small businesses opt for the cash basis of accounting because it’s easier to maintain, doesn’t require you to track receivable or payables, and tells you exactly how much cash you have on hand at any point in time.
Using the accrual accounting method, you record income when you bill your customers, in the form of accounts receivable (even if they don’t pay for a few months). Same goes for expenses, which you record when you’re billed in the form of accounts payable.
Generally speaking, accrual accounting is better for larger, more established businesses; it gives a more realistic idea of your business income and expenses during a period of time and provides a long term view of the business that cash accounting can’t provide.
Make sure your transactions are categorized.
Every transaction you make needs to be categorized and entered into your books. This helps your bookkeeping catch more deductions, and will make your life easier if you get audited.
Remember, an unmarked receipt for lunch at a restaurant might not mean much to you six months later. Was it a client lunch? Did you treat your employees after a successful quarter? Properly categorizing and recording your transactions can help you avoid doing extra investigative work later.
If you’re going to do your own bookkeeping, it’s worth talking to a pro when you set up your system to make sure the accounts you create align with your industry standards and CPA expectations.
Choose a system for storing your documents.
At tax time, the burden is on you to show the validity of all your expenses, so keeping supporting documents for your financial data like receipts and records is crucial.
Diamonds may be forever, but the ink on your expense receipts is not. Since the IRS accepts digital records, it’s smart to use a cloud-based system like Dropbox, Evernote, or Google Drive so you never have to deal with smudged receipts. You can also use apps like Shoeboxed, which are specifically made for receipt tracking.
Organize your deductions
The IRS golden rule on deductions is that they must be both ordinary (a common expense in your field) and necessary for your business. For example, pens would be an ordinary expense for a writer, but a $900 pen might not fall into the category of necessary. However, even if an expense is ordinary and necessary, you may still not be able to deduct all of it on your taxes. Just because you do most of your work from your dining room table doesn’t mean that you can deduct your entire monthly rent. Luckily, the IRS has put together a comprehensive guide on business deductions that you can consult if you’re not sure about a deduction.
Make bookkeeping a habit.
If you’re a busy small business owner with a million things to do, it’s easy to let bookkeeping fall by the wayside. One way to avoid that is to make it a habit. Try setting aside and scheduling a “bookkeeping day” once a month to stay on top of your financials. Use that day to enter any missing transactions, reconcile bank statements, review your financial statements from the last month, and make any major changes to your accounting or bookkeeping. If you truly make it a monthly habit, you might not even need an entire day, but perhaps just a few hours every month.
If you’re months or years behind, you might want to get a bookkeeper to do some catch-up bookkeeping for you.
DIY vs. Professional Bookkeeping
Most small businesses will either do their books themselves or outsource the work to a professional. Here’s how to choose which method is best for you.
The DIY Approach
If your business is a side project with a limited budget, you can probably get by going the DIY route. You might still consider consulting with a bookkeeper or CPA at the beginning, just to make sure you’re doing everything right. But most businesses in the “hobbyist” stage can get by using either a simple spreadsheet or one of the many software solutions on the market.
Outsourcing to a Professional
If bookkeeping keeps getting pushed aside as your business starts growing and you simply can’t find the time to get your books in order every month you should consider hiring a professional to help.
Outsourced bookkeeping is what we do! At R&D Legal Bookkeeping we take bookkeeping off your hands so you can have time to run your business. Your R&D bookkeeper imports, reviews, and categorizes your transactions every month, providing you with up-to-date financial reports that allow you to make better business decisions.
Accurate and up-to-date financial records are vital to the success of your business. There are several ways to manage your books, from doing them yourselves to hiring someone in house. However, outsourcing this function is the most cost effective way of ensuring they are kept updated by a staff of skilled financial professionals.