A critical part of running a successful business is to keep accurate financial records of your business transactions. This is known as bookkeeping. Without good bookkeeping you are driving the business by the seat of your pants. You literally have nothing to rely upon to back your decision making. Sooner or later this lack of data is sure to cause you problems.
If you’re an entrepreneur who recognises the need to do your own books, this guide is for you.
This guide will take you through bookkeeping basics, tell you why bookkeeping matters and outline the critical steps required to launch your bookkeeping process the right way.
Bookkeeping is the meticulous process of recording all of your business’ financial transactions, enabling you to understand what you are spending money on, where your income is generated and importantly what tax deductions will be claimable.
Why bookkeeping is critical?
Here are the key reasons.
1. It ensures that you identify all claimable deductions.
It’s not your responsibility to be a walking encyclopedia on the small business tax code. However, your accountant will be grateful for the range and depth of information that good bookkeeping delivers him. The more information he has, the more legitimate tax deductions he will identify. That means your tax cheque will be larger.
2. Assists in securing finance
Well kept financial statements are a great way for you to state your case when seeking finance. Lenders and potential investors appreciate the clarity that well-kept books deliver. They will use your numbers to forecast and assess your business’ ability to service the loan.
3. It helps to quickly identify banking errors.
The sooner that you identify any bank errors the easier it will be to have the error reversed. Regular reconciliation of bank records helps with keeping your business running smoothly.
4. You get a clear picture of your financial health
Your bank balance is a mere snapshot of your business cash flow whereas; bookkeeping can give you clear insight into trends within the business. Paying close attention to the data contained within bookkeeping can help you to spot good and bad trends quickly. Increased sales of line items and production costs can be quickly identified and action taken accordingly.
Getting Started With Bookkeeping
The Critical First Seven Steps in the Bookkeeping Process
Let’s not pretend that these seven bookkeeping steps are easy- we guarantee that there will be times when your head is full of numbers and nothing wants to reconcile that the last word you’ll use to describe bookkeeping is easy.
Here then are the critical first steps that you need to take to get your bookkeeping journey on the road.
Separate Your Personal Expenses from Your Business Expenses
In order to record your business finances effectively, you simply must separate them from your personal expenses.
If for no other reason, you need to this for legal liability reasons. If your personal and business transactions are entwined, you could find yourself held personally liable for any debts that the business incurs.
It also makes it much easier to reconcile bank accounts when you only have to account for business transactions.
Choose Your Bookkeeping System
Essentially, you have a choice between two bookkeeping systems – single entry or double entry. Both systems have their advocates and there is no right or wrong answer. You simply have to pick one and stick with it.
A single entry system is a simple system that is suitable for straightforward bookkeeping.
Entries are simply recorded once as either income or expense, while assets and liabilities are separately recorded. If you have no inventory and little equipment and are keen on doing your own bookkeeping, then this system may be best for you.
A more robust but complex system is double entry booking. All transactions get recorded twice as both debits and credits.
An example of how this works would be this. Imagine that you own a shop that sells hot dogs. Each time you sell a hot dog the sale is recorded as a credit to your cash account and as a debit to your hot dogs account. (We’ll discuss this concept further later on). There should always be corresponding debits and credits so that the sum total always equals zero. If you’re looking for further explanation of the double entry bookkeeping process, the IRS has a handy set of guidelines published on its website.
While double entry bookkeeping might be hard to come to grips with initially, but the overall accuracy of the method is higher.
Choose Either the Cash or Accrual Accounting Method
Before you start bookkeeping, you must choose one of these accounting methods and stick to it.
If you choose to use the cash accounting method, you will only need to record transaction when cash changes hands. So, if you sent an invoice to a customer today, the dollars you have earned won’t enter the ledger until the invoice is paid.
On the other hand if you choose the accrual accounting method income is recorded at the moment the invoice is issued. This means that when the financial year concludes all income that you have earned will be declared even if you have not received payment at that time.
The same rule applies to deductions – you deduct them when the bill is issued as opposed to when you pay them. If your business has inventory, you will most likely be expected to use the accrual accounting method.
Categorize your transactions
As each transaction is recorded in the books, it needs to be categorized. This process will assist your bookkeeper to identify more deductions and make life easier if you are subjected to an audit.
An uncategorized, unmarked receipt from a restaurant dated six months ago is almost impossible to categorize – it could have been a client lunch, or it might have been a reward for some employees? Categorising at the time of transaction is important.
How you categorize transactions will depend on the industry that you operate in. In a general sense, transactions are categorized as either assets, liabilities, expenses, revenue and equity. From there you will have individual line items that become subcategories or accounts.
If we revert to the hot dog example some ledger accounts would include revenue – hot dog sales, expenses – hot dog buns, expenses – hot dogs and expenses – other ingredients and so on.
How you categorize items will depend on several factors. If you choose to do all the bookkeeping yourself, a simple note on each receipt would suffice. On the other hand, if you choose to use an online bookkeeping service you will need to discuss the process with your bookkeeper.
If you choose to do your own bookkeeping, it would be wise to discuss the process with a professional to ensure that your system aligns with industry standards.
Store and Organize Your Documents
When tax time arrives, the onus is on you the business owner to prove the validity of all your expenses. It’s therefore essential to maintain accurate records and retain all supporting documentation.
Unfortunately, the ink on expense receipts has an unfortunate habit of fading away. It’s therefore a good strategy to store digital receipts and records on a cloud based system like Google Drive or Dropbox. There is even a purpose built app called Shoebox that has been built for the sole purpose of receipt tracking.
Organize all potential deductions
The golden rule on deductions according to the IRS is that expenses should be ordinary and necessary. An obvious demonstration of this would be a writer needing pens for their work, however, the purchase of a $1200 pen would not be necessary.
Even when expenses are classified as legitimate they may not be fully apportioned dollar for dollar. If you work from home, for example, the power costs of your home will not be fully deductible as a business expense. A good guide in this area is the IRS comprehensive guide on business deductions.
Get Into the Habit of Bookkeeping
Falling behind on bookkeeping is all too easy for busy business owners. It is best to set a date set a date at least on a monthly basis to complete any outstanding bookwork.
If you use a calendar app set a recurring reminder to keep yourself accountable. Use the time to enter all the transactions, do bank statement reconciliations and analyse your financial statements for the previous month.
Is DIY or Professional Bookkeeping the Answer?
There are many bookkeeping options available to the small business entrepreneur. Essentially they boil down to a choice between doing it yourself or engaging a professional service to do it for you
Taking the DIY Option
The DIY approach is a good option if your business is a straightforward one that has a limited budget and maybe even a side project. If you do choose to go down this route, it may be worth sending some professional guidance from a professional CPA or bookkeeper. This way should be able to guard against having a set of books that needs to be redone by a pro.
DIY bookkeeping can be done using simple spreadsheets available online or using one of the many bookkeeping programs available online.
Taking the Outsourcing option
Once your business starts to grow or if you simply find bookkeeping keeps getting left on the “to do” list, it might be time to outsource the process. Our highly skilled team of professional bookkeepers is ready and available to do your bookkeeping for you and we’ll provide you with specialised software to help you stay on track with your finances.