Small Business Bookkeeping: Setting Up Your Accounting System

Small business bookkeeping can be very confusing.  Vickey Boatright makes it easy to understand.

She has over 13 years experience as a fund accountant for a nonprofit organization and a small business owner. She is also the author of two online businesses: www.basicaccountinghelp.com and www.freechurchaccounting.com.

Setting up a good accounting system is the foundation for your new small business.

You can have the best product or service in the world,  if you do not have a good accounting system in place, your business will not grow to its fullest potential. Here is your blueprint for setting up your accounting system:

Accounting Checklist:

1. Consult with a bookkeeper or accountant
2. Pick an accounting method: Cash or Accrual Basis
3. Decide which bookkeeping system to use: Single or Double Entry
4. Open a separate bank account

#1: Consult with a bookkeeper or an accountant:
Consult with an accountant or bookkeeper to help you set up your accounting system up front. It will be really helpful if you use a double entry accounting system (more about bookkeeping systems below).

He or she can save you countless small business bookkeeping mistakes that you might not know about until later on.

To be an effective adviser, your bookkeeper and accountant needs to know these three things about your small business:

• Will you have inventory or do you have a service business?
• Will you be working from home or will you rent space?
• Are you a solopreneur or do you have partners?

Paying an accountant or a bookkeeper to set up an accounting system correctly upfront is a cheap investment compared to what it will cost you to fix your accounting problems later on. Make the investment.

A way to save money is to hire a great bookkeeper to set up your books. Then use the accountant to verify the bookkeeper’s work. You’ll get the job done right the first time and it will cost you less overall.

If you want small business tips on how to hire a great bookkeeper, click here.

#2: Choose An Accounting Method: Cash Basis or Accrual

One of the first steps in setting up your books is deciding which accounting method you are going to use in your business. Whatever method you choose, apply that method consistently throughout your business.

A) Cash Method (or Cash Basis):  Use the cash method if you do not have to keep track of inventory. Under the cash method, you do not record your income until cash (or check) is actually received from your customer or affiliate. Expenses are not recorded until you actually pay for them.

Keep in mind, with the cash method, your timing will always be a little “off.” You may complete a project in January but not get paid for it until February.

With the cash method, you book the revenue (income) in February when you receive the check, not when you invoice the client at the end of the project.

The business does not count income until the check or cash arrive. It’s the same with expenses. The business does not count expenses until they’re actually paid.

Assuming you get paid for all your orders and services, this is not a problem. It becomes a little confusing at year-end.

When you finish work in December and don’t get paid for it until January, that reduces your income in December and increases it in January.

Your accountant will know if the cash or accrual basis is best for your small business.

B) Accrual Method (or Accrual Basis): Under the accrual basis accounting method, income is counted and recorded when the sale occurs (not when it’s paid for). Expenses are recorded when you receive the goods or services (not when you pay for them).

The accrual method usually provides a more accurate picture of what is actually going on in the business. It accounts for the time lags between when income is earned and received or when expenses are incurred and paid.

You get a more realistic view of your cash flow.

Accrual basis accounting is more widely used among “bigger” small businesses…especially those with inventory and those who extend credit to their customers. Accrual method is a bit more involved than the cash method, but often, you get a more accurate view of the business with the accrual method.

Don’t know what “cash flow” is? It’s the lifeblood of your business. We explain it all in our Accounting Basics videos on Cash Flow.

#3: Decide Which Bookkeeping System To Use

After you have chosen your accounting method, you will want to decide which bookkeeping system will be right for you. There are two choices.

A) Single entry bookkeeping:  Similar to your check register. You just add the money coming in and subtract the money going out and keep a running balance.

B) Double entry bookkeeping: Tracks your income and expenses AND your assets and liabilities. Assets and liabilities are captured on the balance sheet.

In this system, at least two entries are made with every financial transaction recorded…a debit and credit. Each transaction must balance each other.

To decide which system would be best for your business…consider the type of business you own. Your bookkeeper can guide you. All small business bookkeeping software can handle either single or double entry bookkeeping.

If you don’t know how to measure “income” and “expenses” go here and watch our Accounting Basics videos. We explain it all in simple language.

A small sole proprietorship or home-based business may not require a double entry system for recording business transactions.

However, if you have quite a few accounts receivables (money owed to your business by your customers) or accounts payables (money owed by your business), you may want to consider using a double entry bookkeeping system.

If your eyes glazed over reading the words “accounts receivables” and “accounts payables”, perhaps you should watch our training videos on accounting basics. Just a suggestion. You’ll find them here.

#4: Open a Separate Bank Account:

Very important: Open a separate bank account for your small business. Do not pay your personal expenses out of this account. If you need money from your business for personal expenses write yourself a check or transfer the money into your personal bank account.

The IRS does not look kindly on businesses that pay personal expenses directly out of the business.

Separate accounts help segregate activity and prove you don’t have any funny business going on!

If you do write a check from your personal account and deposit it into the business account, that becomes a personal loan to the business. It shows up on your balance sheet as owner’s equity. Yes, we cover that too in our accounting basics videos.

Once you have taken the time and energy to set up your accounting system…use it! Keep and file all business receipts. Choose at least one day each month for you for your bookkeeper to enter all your business transactions into your accounting system.

The best way to maintain your accounting system is by reconciling your accounting system with your bank statement every month. This will catch any missed transactions and keep you in balance. Your bookkeeper can also do this for you.

This article will provide tips on how to hire a great small business bookkeeper.

Last of all, review your cash flow statement once a week and profit and loss statement at least once a month. Figure out what is working for you and what is not. Then use this information to build and grow your business…the sky is the limit!

We’ll teach you how to read those statements. Your Income Statement, Cash Flow Statement and Balance Sheet are the minimum you should be reading each month.

We make it easy in accounting basics videos.

We’ll explain key terms like “cash flow” and “gross margin” so you can make more money.

If you don’t know these terms or just need a refresher, please take the time to watch our Accounting Basics training videos. It is the best investment you can make. Also see our other articles for more bookkeeping tips.

Thank you, Vickey!

Download our small business cash flow management whitepaper. It’s free.

In your corner as always,

Dawn Fotopulos

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