Bookkeeping and Accounting Basics
Learn the basics of accounting and bookkeeping for your small business.
Many new business owners are daunted by the mere idea of bookkeeping and accounting. But in reality, both are pretty simple. Keep in mind that bookkeeping and accounting share two basic goals:
- to keep track of your income and expenses, which improves your chances of making a profit, and
- to collect the financial information necessary for filing your various tax returns.
There is no requirement that your records be kept in any particular way. As long as your records accurately reflect your business's income and expenses, the IRS will find them acceptable. (There is a requirement, however, that some businesses use a certain method of crediting their accounts: the cash method or accrual method. For more information, see Nolo's article Cash vs. Accrual Accounting.)
Depending on the size of your business and amount of sales, you can create your own ledgers and reports, or rely on accounting software.
Three Steps to Keeping Your Books
The actual process of keeping your books is easy to understand when broken down into three steps.
- Keep receipts or other acceptable records of every payment to and every expenditure by your business.
- Summarize your income and expenditure records on some periodic basis (daily, weekly, or monthly).
- Use your summaries to create financial reports that will tell you specific information about your business, such as how much monthly profit you're making or how much your business is worth at a specific point in time.
Whether you do your accounting by hand on ledger sheets or use accounting software, these principles are exactly the same.
Step One: Keeping Your Receipts
Each of your business's sales and purchases must be backed by some type of record containing the amount, the date, and other relevant information about that sale. You'll use these to create summaries of your transactions.
From a legal point of view, your method of keeping receipts can range from slips kept in a cigar box to a sophisticated cash register hooked into a computer system. Practically, you'll want to choose a system that fits your business needs. For example, a small service business that handles only relatively few jobs may get by with a bare-bones approach. But the more sales and expenditures your business makes, the better your receipt filing system needs to be.
Step Two: Setting Up and Posting to Ledgers
A completed ledger is really nothing more than a summary of revenues, expenditures, and whatever else you're keeping track of (entered from your receipts according to category and date). Later, you use these summaries to answer specific financial questions about your business, such as whether you're making a profit and, if so, how much.
Post receipts on a regular basis. On some regular basis -- like every day, once a week, or at least once a month -- you should transfer the amounts from your receipts for sales and purchases into your ledger. This is called posting. How often you do this depends on how many sales and expenditures your business makes, and how detailed you want your books to be.
Your posting schedule depends on your sales numbers. Generally speaking, the more sales you do, the more often you should post to your ledger. A retail store, for instance, that does hundreds of sales amounting to thousands of dollars every day should post daily. With that volume of sales, it's important to see what's happening every day and not to fall behind with the paperwork. To do this, the busy retailer should use a cash register that totals and posts the day's sales to a computerized bookkeeping system at the push of a button.
A slower business, however, or one with just a few large transactions per month, such as a small website design shop, dog-sitting service, or swimming pool repair company, would probably be fine if it posted weekly or even monthly.
If possible, use accounting software. You can purchase an accounting software program that will generate its own ledgers as you enter your information (and then automatically generate the necessary financial reports from the same information). All but the tiniest new business are well advised to use an accounting software package to help keep their books. Micro-businesses can get by with personal finance software such as Quicken.
Step Three: Creating Basic Financial Reports
Financial reports are important because they bring together several key pieces of financial information about your business. Think of it this way: while your income ledger may tell you that your business brought in a lot of money during the year, you won't know if you turned a profit without measuring your income against your total expenses. And even comparing your monthly totals of income and expenses won't tell you whether your credit customers are paying fast enough to keep adequate cash flowing through your business to pay your bills on time.
That's why you need financial reports: to combine data from your ledgers and sculpt it into a shape that shows you the big picture of your business. The key reports you need to create regularly are a cash flow analysis, a profit and loss forecast, and a balance sheet. (Both QuickBooks and Quicken Home and Business, as well as other accounting software, can provide these regular reports.)
If you are ready to start your own business, get all the information you need, including tips on accounting and bookkeeping with Nolo's Quicken Legal Business Pro -- a complete business library on your desktop, featuring five Nolo business books, over 140 forms, and a dozen 'how to' checklists.