How vital is accounting to a business? Every business owner who knows their onions will tell you that it is essential for the growth of a business no matter the size. But then why is accounting important for the small business owner? Basically, it is essential for business growth. When a small business takes accounting seriously, it becomes vital to keep track of business spending and identify new development opportunities.
Starting a business can be very fulfilling. When the business owner makes a sale or gets a new client, it comes with a level of self-fulfilment. However, all these will not matter if they do not find a way to keep tabs on the entire financial process of the business. Small business accounting serves as a bolster for business growth. This is why it is vital that small business owners take their accounting process seriously.
This article aims to provide small business owners with a comprehensive guide on how to go about their accounting processes. Accounting for small businesses goes beyond opening an excel worksheet and filling in details of the sales or debits recorded. The result of doing that is a cluttered worksheet and a very confused accountant. With our help, small business owners will know exactly how to go about their business accounting.
What Is Small Business Accounting?
The only difference between accounting and small business accounting is the phrase small business. Accurate bookkeeping is required for small business accounting, which comprises keeping orderly records of a business’s financial operations, such as sales, expenses, assets, and liabilities. Purchases, sales, liabilities, and payments are all tracked by small business accounting. While accounting, especially for big enterprises, might cover a wide variety of operations, for small businesses, the process basically entails three key steps:
- Bookkeeping (recording financial transactions)
- Creating financial reports
- Filing tax returns
Accounting is the language of businesses. It provides insights and proper communication of the business’s growth to all necessary shareholders. It allows business owners to keep tabs on how the finance is being managed and if things could be done better.
Understanding the Basic Accounting Terminology & Equations
According to the accounting equation, a business’s total assets are equal to the sum of its liabilities plus its shareholders’ equity. The core of the double-entry accounting method is this primary number on a corporate balance sheet. The accounting equation ensures that the balance sheet is always in good shape. That is, for every debit entry, there is an equal and opposite entry (or coverage) on the credit side.
The accounting equation is sometimes known as the balance sheet equation or the basic accounting equation.
The financial situation of any business, big or little, is determined by two fundamental balance sheet components: assets and liabilities. The third section of the balance sheet is owners’ equity, often known as shareholders’ equity.
The accounting equation depicts how these three crucial components are linked.
Liabilities represent the business’s commitments, whereas assets represent the business’s valued resources. Liabilities and shareholders’ equity illustrate how a business’s assets are financed. It will appear as a liability if funded with debt, but it will appear in shareholders’ equity if it is funded with equity shares issued to investors.
The accounting equation aids in determining if a business’s operations are accurately reflected in its books and accounts. The following are some examples of elements seen on a balance sheet:
- Assets: Cash and cash equivalents and liquid assets such as Treasury bills and certificates of deposit are examples of assets. An asset may create money for a business, or it may benefit the business in some way by holding or using the asset. The balance sheet illustrates a business’s assets and how those assets are financed, whether through debt or stock.
- Liabilities: Liabilities are the debts that a business owes and the costs it must pay to be in business. Whether it’s a long-term loan or a payment that needs to be paid, debt is a problem. Rent, taxes, utilities, salaries, wages, and dividends are all costs.
- Equity: A business’s total assets minus its total liabilities equals its shareholders’ equity. It can be described as the entire amount of money left over after a corporation has liquidated its assets and paid off all of its debts. After then, the money would be divided among the stockholders.
Apart from these three crucial parts of small business accounting, there are other accounting terms a business owner should know not to be lost at sea when handling his accounting. Some of these terms include:
- Revenue or income: Revenue, often known as sales, is the gross income generated by routine operations. Multiply the sales price by the number of units sold to get the revenue. Depending on the type of accounting, the calculation for revenue might vary, but essentially, this definition stands.
- Expenses or expenditures: The term “expenses” refers to the costs of doing business. Some acceptable expenses can be deducted from a business’s taxes. Fixed, variable, accruing, and operation expenses are expense types. Rent, salary, and insurance payments are fixed expenses that do not alter month to month. Variable expenses fluctuate every month and can include optional or unpredictable but necessary spending.
- Accounts payable: The money owed by a business to its suppliers, vendors, or creditors for goods or services purchased on credit is referred to as accounts payable. Accounts payable is a short-term loan that must be paid back soon to prevent default. It appears on a business’s balance sheet as a liability.
- Accounts receivable: Accounts receivable is the inverse of accounts payable and refers to the money owed to a business by its customers for the proper delivery of goods or services.
- Accounting Period: The length of time between the release of a set of financial statements is referred to as an accounting period. Businesses and investors compare different accounting periods to measure financial performance over time.
- Balance Sheet: Balance sheets are financial documents that show the liabilities, assets, and shareholders’ equity of a business at a certain point in time. Balance sheets are a sort of financial statement that is used to assess a business’s financial health and value. To produce balance sheets, accountants employ the accounting equation, often known as the balance sheet equation.
The Common Financial Reports
For a set of financial statements to be considered complete, they have to have certain reports. There are four essential statements, and they are, the balance sheets which reflect what a business owns and owes at any point in time, the income statements which indicate how much money a business makes and spends over time, the cash flow statements which depict the flow of cash between a business and the rest of the world through time. Then there is the fourth financial statement, referred to as a “statement of shareholders’ equity,” depicts changes in the business’s shareholders’ interests over time. Taking a closer look at these terms might be necessary to understand them better.
The Balance Sheet
The balance sheet shows the entity’s assets, liabilities, and equity. This data should be up to date as of the time of recording. As a result, the data displayed is from a particular point in time. Assets are valuable items that a corporation has. This usually means they can be sold or used to create items or deliver services that the business can sell. A business’s liabilities are the sums of money it owes to others. The equity of shareholders is sometimes known as capital or net value. It’s the money left over after a business sells its assets and pays off all of its debts.
The report is set up so that the total value of all assets equals the total value of all liabilities and equity.
Because it contains information regarding an organisation’s liquidity and capitalisation, balance sheets are usually regarded as the second most essential financial statement.
The Income Statement
The income statement shows how much money was made, how much money was spent, and how much money was made throughout the reporting period. The statement’s literal “bottom line” usually reflects the business’s net earnings or losses. This shows how much money the organisation made or lost over the year. Earnings per share (or “EPS”) are also reported on income statements. This calculation shows how much money shareholders would get if the corporation opted to distribute 100% of the period’s net earnings.
The total amount of money received from product or service sales appears at the top of the income statement. Gross revenues or sales are common terms for this top line. It’s called “gross” since it hasn’t been adjusted for expenses. As a result, the figure is “gross” or unpolished.
The following line represents money that the corporation/business does not expect to receive from specific sales. This could be owing to sales discounts or goods returns, for example. The business’s net revenues are calculated by subtracting returns and allowances from gross revenues. After net revenues, the next line usually indicates the sales costs. The next line subtracts the sales costs from the net revenues to arrive at the gross profit subtotal. The next section is about running costs. These are costs incurred to support a business’s operations over a specific time period. You get an operational profit before interest and income tax expenses, after all, operating expenses are removed from gross profit. Following that, corporations must account for interest income and expenses. Businesses get interest revenue by holding their cash in interest-bearing savings accounts, money market funds, and other similar investments. Interest expense, on the other hand, is the number of money corporations/businesses have paid in interest for money they have borrowed. Finally, after deducting income taxes, you arrive at the bottom line: net profit or a net loss.
Because it shows an entity’s operating results, this is frequently regarded as the most essential of the financial statements.
Cash Flow Statements
The cash inflows and outflows that happened during the reporting period are shown in the statement of cash flows. This can be a useful comparison to the income statement, especially if the profit or loss recorded does not accurately reflect the cash flows experienced by the business. The cash flow statement’s bottom line displays the period’s net increase or reduction in cash. Cash flow statements are typically broken into three sections:
- Operating activities
- Investing activities
- Financing activities.
Statement Of Shareholder’s Equity
The statement of retained earnings shows how the business’s equity has changed over time. The sale or repurchase of shares, dividend payments, and changes caused by reported profits or losses are all included in the report format. This is the least widely used of the financial statements, usually appearing solely in the audited financial statement package.
How To Efficiently Execute Small Business Accounting
To effectively manage a business, there is a need to see beyond the basics. To run accounting for a small business, business owners have to properly document their finances and extract accurate and insightful data from these documents. Below are the processes for efficiently carrying out small business accounting:
Choosing The Right Accounting System
It is critical to select the appropriate accounting system in order to track the business’s performance. It is based on regulations that must be followed by businesses while reporting revenues and expenses. In some aspects, the two basic accounting procedures, cash, and accrual are similar, but they differ greatly in others. When considering the right system to choose, it is important that business owners have to consider the size of the business. They also have to consider how fast they want their business to grow. Other considerations are whether the business is looking out for investors. If the business is looking for stakeholders then it would be wise to choose an accounting method that would be easy for the shareholders to understand.
There are basically two types of accounting systems. There is the cash system of accounting that only records revenue when cash is received or when expenditures are made. This method is easier because it does not allow for the tracking of amounts payable and receivable. It also does not necessitate journal entries and is easy to manage. Because of this reason, it is the best option for businesses that are just starting out. However, it might not foster growth.
The accrual technique of accounting is more difficult to understand than the cash method. Accrual accounting is also the recommended method by accounting experts. The accrual method of accounting, unlike the cash method, requires you to record your revenues and costs when they are earned rather than when they are received or paid. One of the biggest benefits of accrual accounting is that it gives you a more accurate picture of your business’s income and expenses.
Decide A Bookkeeping Method
Bookkeeping is a crucial part of small business accounting. It is the process of entering a business’s financial transactions into organised accounts on a regular basis. It can also refer to the various recording techniques available to businesses. For these reasons, bookkeeping is an important aspect of the accounting process. Updated transaction records aids in the production of accurate financial reports that aid in the evaluation of a business’s performance. In the event of a tax audit, detailed records will come in helpful. For the appropriate maintenance of the finance books, deciding on the sort of bookkeeping method to utilise is critical.
Single-entry accounting is a simple method that involves making one entry for each transaction in your books. To keep track of incoming money and outgoing expenses, these transactions are frequently recorded in a cash book. Double-entry accounting is more reliable. Every transaction impacts at least two accounts, and these transactions are recorded as debits and credits. The total credits must always match the total debits under the double-entry system. When this occurs, your books are balanced.
Open A Dedicated Bank Account For Your Business
It is important to keep the business and personal finances distinct. To do this, businesses can open separate bank accounts for the business. A business checking account, as well as a savings account, will assist you in organising your revenue and planning for taxes at the end of the year.
Track Business Expenses
The basis of a solid small business bookkeeping system is learning how to track and record business transactions. The source papers assist you in keeping track of your deductible expenses (tax deductions), preparing financial statements and tax returns, and tracking your business’s progress. One of the crucial things to remember with business expense tracking is that you should only keep track of expenses that are directly related to your business.
Make Journal Entries
Business owners must keep track of every commercial transaction they make. Making journal entries is the process of recording all transactions. The general journal keeps track of all of these transactions. Journal entries now follow the above-mentioned double-entry bookkeeping procedure. This means that two accounts are affected at the same time by each journal post. One account will be credited, while the other will be debited.
Set Up A Payroll System
Business owners have to determine whether they will conduct payroll themselves using payroll software or hire a payroll service firm to do it for them. Many payroll software choices offer features that allow for the automation of paycheck entries, filing quarterly tax forms, and remaining compliant with federal and state regulations. Payroll services are third-party businesses that manage payroll from beginning to end.
Owners of small businesses have the free will to choose between handling payroll tasks by themselves especially if they do not plan on growing out the business quickly. However, if the business is set for massive growth it may be worthwhile to hire a payroll professional to handle their payroll for them.
Learn About Taxes
Business owners should pay attention to taxes. They should learn every detail involved in paying and filing for their tax return at tax time. That being said, they do not need to know as much as business tax accountants but enough so a sophisticated conversation can be held. Understanding tax filings highlight why proper bookkeeping is important as the insights generated will help during the tax seasons. Apart from the taxes that are involved in running the business, the business owner should also pay attention to the taxes the employees have to pay, their superannuation requirements and figure out the proper way to manage all of this. A quality business accountant can quickly outline these obligations and some management options in a meeting.
Growing businesses are always on the lookout for funds. Small business owners need funds to expand. They also need funds to maintain the business or even to purchase inventory.
Initially, small business owners may have to rely on more accessible alternatives to raise finances, such as borrowing from the owner, or their close network of friends, family members, credit cards, and so on. Whatever the source of the borrowed funds, the business owner must establish a formal promissory note that specifies the amount borrowed, any interest that must be paid, and the payment due date.
Build Business Credit
Building business credits is important for people who want to open up funding opportunities. Small business owners should make sure they maintain cordial relationships with every stakeholder in the business. Especially vendors as this will give them the chance to avoid upfront payment when they make purchases of things like inventory. Small business owners can also be eligible to getting a business credit which can be used for business activities.
Figure Out How To Get Paid
When it comes to payment options, small business owners are presented with two choices. Either they get paid online or they get paid offline. Getting paid also requires sending professional invoices in most situations, and when dealing with large businesses these invoices can only be sent after a purchase order is made etc. We refer to payments made with a check or cash when we talk about offline payments. On the other hand, online payments can be made through eWallets, credit cards, payment gateway providers, bank transactions, and other methods. In today’s world, more and more businesses are migrating from accepting payments in person to accepting payments online. However, the business owner has to look at their business and decide what works best for them.
Consider Using Basic Accounting Software
There are a lot of ways small business accounting can go wrong. There is a need to pay attention to details, and it is easy to get caught up in some mixup while working to maintain accurate financial records of a small business.
Accounting software for businesses lowers the risk of human error associated with paper accounting and allows them to access crucial information with just a few keystrokes. Many of these people who make business accounting software have put a lot of time into researching their users and work hard to make sure users find it simple to use.
However, with so many options, selecting the best accounting software for their business can be tough. Consider the following suggestions:
- Business owners should keep in mind their business requirements and accounting abilities.
- They should keep their financial constraints in mind.
- They should pay attention to the features that come with the add-ons.
- Finally, they should make their choice with the assistance of an accountant.
Consider Professional Help
Another option open to business owners would be to seek out the help of professionals in the field of accounting. They might set up what is needed for the initial running of the accounts making it easier for the business owner to continue afterwards. A professional accounting firm like The Accounting Centre provides small businesses with the best form of accounting services to keep the business fully functional.
Running a small business can become really daunting, it is, therefore, necessary that all forms of safety measures are taken to ensure that everything works smoothly, and this includes the process of small business accounting. This process will ensure the smooth development of small businesses.