One of the first things any new business must decide on is how its records will be kept. Accurate record keeping is a key to many aspects of your business's success -- from assessing your operation's profit margins to ensuring that you're in compliance with IRS tax rules.
Luckily, the IRS does not require businesses to keep records in any one manner. As long as the records produce an accurate accounting of income and expenses, you can choose the system that works best for you and your business. There are two main ways in which business records can be kept: manual record keeping and computerized (or automated) record keeping. Read on to learn how these systems work and the pros and cons of each.
Manual Record Keeping
Operators of smaller business ventures often opt for a manual record-keeping system. For a lot of folks -- particularly part-timers and business owners who have just opened their doors -- the pencil and paper method is adequate. Some businesses grow out of the manual system, but others (like independent contractors and freelancers) may find that the manual system works just fine for the long run, too.
Manual records satisfy the tax code as long as they are accurate and can be understood or explained if questioned. Of course, if you decide to use a manual system, you must learn how to use it. (To learn the basics of business record keeping, see Nolo's article Bookkeeping and Accounting Basics.)
There are a few traditional ways to manually keep small business records.
- Preformatted record books. Inexpensive, preformatted record books are available at most office supply stores.
- Ledger sheets. Ledger sheets (also available at office supply stores) are columnar pads of paper, usually light green in color.
Either way, you must keep a record of each expense -- jotting down a brief description of the business expense, the date incurred, the amount, and to whom it was paid. On the profit side of the equation, you must also keep similar records of any income your business receives.
Pros of Manual Record Keeping
The advantages of manual record keeping systems include:
- low cost (ledger pads and books cost $5 to $20), and
- ease of use (the manual system is pretty painless, especially if you don't have lots of different expense and income items).
Cons of Manual Record Keeping
The disadvantages of manual record-keeping systems include:
- They are often "single entry" systems, meaning you enter each transaction only once. As such, there is no automatic check and balance system like that used in computer programs (like Quicken -- or in more formal double entry bookkeeping systems.
- You must manually tally up expenses or income by category or by month -- which can be time consuming.
Computerized Record Keeping
Keeping your business's records on a computer follows the same principles as a manual system, except the computer automates the process so it's faster and more accurate. A simple-to-use software program like Quicken (Intuit) or MS Money (Microsoft) eliminates the need for a handwritten set of books. You input each transaction (whether expense or income) into the software program and assign a category to each -- whether a descriptive word like "advertising" or a number code such as "201."
Pros of Using a Software Program
By using a software program for record keeping, you can:
- eliminate math errors
- instantly see your income and expenses by category
- get profit and loss statements and other financial summaries quickly, and
- interface with compatible tax software programs -- so you don't need to re-input data come tax time.
Cons of Using a Software Program
Disadvantages of software programs for business record keeping include:
- They are slightly more expensive than manual record keeping supplies. A simple program like Quicken runs about $50, while programs (like Quickbooks) that are geared toward larger businesses can cost $150 or more.
- You must have a computer and be comfortable using it on a regular basis.
Keeping Source Documents
Regardless of how you keep your business's records, you must still hold onto what accountants call "source" documents. These are the receipts, bank statements, purchase invoices, and other records that back up the numbers that get entered into your record-keeping system. (To learn more about bookkeeping and accounting strategies for your business, see Nolo's article Bookkeeping and Accounting Basics.)
Should You Hire a Bookkeeper?
Most new businesses don't have the money to hire bookkeeping help, at least not right away. This makes it that much more important for business owners to choose a record-keeping system that they're comfortable with.
But what if you can afford to hire a bookkeeper? Does this mean that you don't need to worry about the ins and outs of different record-keeping systems? In a word, no. Tax law places responsibility for most bookkeeping and accounting errors squarely on the business owner. So, even if you've hired a bookkeeper to handle your business's books on a day-to-day basis, it is still essential that you have a good grasp of general bookkeeping concepts and an awareness of what's going on with your business's record-keeping practices.
For detailed information on how to keep the books for your business -- including what types of records to keep, how to create ledger sheets, and everything else you need to know about business accounting and taxes -- get Tax Savvy for Small Business, by Frederick W. Daily (Nolo).