Your Guide to Small Business Accounting

Accounting involves recording, classifying, reporting, and summarizing financial transactions. The goal of small business accounting is to provide financial information about the business to its stakeholders and regulators and for tax purposes. You can also use this information internally to decide how to allocate resources and manage risks. A good small business accounting system can also enable you to keep your business running efficiently and profitably.

Accounting software, including cloud-based programs, is changing the way businesses complete accounting tasks. In some cases, small business owners may be able to do their own accounting, especially with the use of software. At the same time, accountants are increasingly expected to be proficient in using software to support small businesses with their accounting and financial needs.

What is small business accounting, and why is it important?

Small business accounting is the process of tracking, recording, and analyzing your company's financial transactions. Accounting is important for small businesses because it helps provide insight into a company's finances and forecasting with accurate data. You can use this information to make decisions about pricing, inventory, expenses, investments, and growth for your business. You’ll need an accounting process to comply with your statutory business accounting requirements.

Learn the basics of small business accounting

If you own or manage a business or are looking for jobs in an accounting department, you must understand accounting basics, including important terminology. 

Important accounting terms 

The accounting language is vital because it provides a common glossary for communicating your company's finances. Here are some of the primary accounting terms:

Accounts payable are debts that a company owes to its suppliers.

Accounts receivable is the money that other entities owe to your business.

Assets are things owned that hold value.

The chart of accounts is all the funds used by a business.

Equity is the portion of the company owned by the shareholders.

Expenses are the costs involved in operating the business. 

The general ledger is a record of all financial transactions made by a business.

A journal entry is a financial transaction entry in the general ledger.

Liabilities are company debts or owned items that will depreciate in value. 

Revenue is income received by the company.

A trial balance lists all account balances at a specific time.

Read more: How to Get a Job as an Accountant | 10 Tips

Types of financial reporting

Financial reports are essential tools that help you to make informed decisions in your company. You’ll produce three primary financial reports: the balance sheet, income statement, and cash flow statement. They all track financial metrics over a given period.

• The balance sheet is an overview of your company's shareholder equity, assets, and liabilities.

• The income statement shows your company's revenues, expenses, and net income.

• The cash flow statement tracks your company's inflows and outflows of cash.

Accounting vs. bookkeeping

One of the main differences between accounting and bookkeeping is that accounting involves more than just recording financial transactions. It also includes you analyzing, interpreting, and communicating financial information. Bookkeeping is primarily concerned with recording transactions.

Another way accounting and bookkeeping differ is that accounting is a broader field that covers a more comprehensive range of topics. As an accountant, you may be responsible for tax planning, financial statement preparation, and auditing. On the other hand, bookkeepers are typically only responsible for recording transactions and keeping track of financial data.

Accountants also typically have more formal education than bookkeepers. Most accountants have at least a bachelor's degree in accounting or a related field, while bookkeepers may gain employment with a high school diploma or associate degree.

Read more: What Is Bookkeeping? Getting Started in Accounting

How to set up a small business accounting system

Setting up an accounting system is critical to your business's success if you run a small business or new accounting department. The accounting system you choose depends on your business's size, status, complexity, and personal preferences. Here are a few key steps to starting your small business accounting system:

1. Establish a legal structure.

Businesses can take on different legal structures, which can affect how they are taxed, as well as their legal protections and obligations:

• Sole proprietorship: an unincorporated business that a single person owns. Sole proprietors are liable for anything the business owes.

• Partnership: a business in which two or more people share ownership and responsibilities.

• Limited liability company (LLC): an incorporated business owned by one or more people who are not liable for the business's debt.

• Corporation: a business structure that is considered separate from its owners; it can own assets and incur debt.

An accountant may be able to advise you on which legal structure is best for your business, depending on its size, complexity, number of founders, and other factors.

2. Open a business bank account.

A business bank account will help you track income and expenses and keep your personal and business finances separate.

3. Choose an accounting method.

Two main ways of recording and reporting financial transactions in accounting are available to you, as defined below:

• Cash basis accounting: records transactions only when cash changes hands. This means your revenue is recognized when it's received, and expenses are only recognized when paid. However, it can give a distorted picture of a company's financial health with it’s limited insight on income and expenses.

• Accrual basis accounting: your revenue counts when the transaction occurs, regardless of when the money arrives. Expenses get reported when they happen, even if the money goes out earlier or later. This method gives a more accurate picture of your company's financial situation, but it can be more challenging to track and manage.

4. Track your expenses.

You must track your business expenses to deduct them from your taxes. Expense tracking methods include using accounting software, Excel spreadsheets, or receipt scanning. Here are some examples of expenses you may be able to deduct:

• Software

• Payroll

• Equipment and office supplies

• Professional fees

• Transportation

• Advertising and marketing

4. Establish a bookkeeping system.

A bookkeeping system will help you keep track of your income and expenses and prepare financial statements. You can hire a bookkeeper, use automated accounting software, or do it yourself.

5. Choose a method for accepting payments.

Several options exist, including cash or check, credit card payments on an e-commerce website, and payment apps such as:

• PayPal

• CashApp

• Venmo

• Zelle

Consider how your customers prefer to pay, as well as the process of setting up payment options.

5. Set up a payroll system.

If you have a team, you’ll need to set up a payroll system to pay wages. Payroll services you can investigate include:

• OnPay

• Gusto

• Paychex

• Wave Payroll

• Paycor

6. Set up a system to pay tax obligations.

When you have a small business, you’re responsible for paying taxes on your income and profits. Tax obligations may include federal, state, and local taxes. You can adopt accounting software to help you calculate your taxes.

7. Calculate gross margins.

Gross margin is the difference between the selling price of your product or service and the cost of goods sold. To calculate gross margin, divide the selling price by the cost of goods sold. For example, if you sell a product for $100 and it costs $50 to produce it, your gross margin would be 50 percent. Knowing your margin is fundamental to planning growth.

8. Apply for small business funding.

A small business loan may support you when starting up or investing in growth resources. To qualify for a business loan, you'll need to provide a lender with accurate records of your business's financials. Financial statements, such as a balance sheet, income statement, and cash flow statement may be necessary.

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Tip:

As your business grows, periodically reassess your accounting system, so that it suits your needs, tracks your financials efficiently, and saves you time.

For more ideas on small business accounting, watch this Introduction to Accounting video from the Intuit Academy Bookkeeping Professional Certificate.

Small business accounting software explained

Investing in accounting software can make it easier to automate financial tasks, improve accuracy, compile data, produce reports, and comply with laws and regulations. When deciding on a software, consider which features you need and how much you’re willing to spend. Compare the different options and find the best fit for your business.

Here are some user-friendly and affordable online accounting software programs for small businesses:

• QuickBooks Online starts at $30 per month and helps with auto-tracking income and expenses, processing credit cards and ACH, integrating payroll, etc.

• ZohoBooks starts free and helps with invoicing, tracking expenses and mileage, importing bank and credit card statements, generating reports, etc.

• FreshBooks starts at $8.50 per month and helps with invoicing, accounting, payments, expenses, time tracking, reporting, etc.

• Xero starts at $13 per month and helps with invoicing, paying bills, bank reconciliation, cashflow, payroll, etc.

When is it time to hire an accountant?

If you run a small business, you may wonder when it's time to hire an accountant or accounting professional instead of doing your own small business accounting. Look for these signs to help you decide:

1. Your business is growing.

As your business grows, you may find that finances are becoming more complex, while at the same time, you need to devote more time to the core activities in your business. An accountant can support you in keeping track of varied expenses, multiple income streams, payroll, tax returns, financial planning, and more. With this support, you can understand your business's financial health at a glance and focus your energy other tasks.

2. You are considering investments.

Investing in different areas of your business can be an important next step. Some examples of business investments include hiring a brand designer or marketing manager, hiring an in-house team or contractors, purchasing a customer relationship management system or other software, and developing new products. An accountant can help you assess which investments will best support your business goals, like increased brand awareness, better quality leads, and ultimately more revenue, while still making good financial sense.

3. You want to apply for a business loan.

It's important to have a sound business case when you are applying for a business loan to increase the likelihood that a bank or other lender will approve your loan and offer a good rate. An accountant can help you ensure that you are in a financial position to apply for a business loan.

Ready to learn more about accounting?

Taking online courses can be a great way to learn the basics of accounting for your business. Consider the Introduction to Finance and Accounting course offered by Wharton Online or the Intuit Academy Bookkeeping Professional Certificate and build skills like financial statement analysis, basic bookkeeping, and more, at your own pace. 

To become a certified accountant and help small businesses and organizations with their accounting needs, you’ll need to qualify. That means getting a relevant degree and experience and taking the Certified Public Accountant (CPA) exam to advance your career. Consider the Online Masters of Accounting (iMSA) offered by the University of Illinois Urbana-Champaign. A master’s degree in accounting will help you satisfy the semester credit hours required to become a licensed CPA.