7 minute read. By Diane Buxton. Photo by Fabian Blank on Unsplash
So - you have a great idea for a business and are ready to jump in. Congratulations on taking this exhilarating and terrifying step! But wait -- you feel clueless about accounting. What are you supposed to do?
Accounting is defined as "the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results." Practically, this simply means keeping track of a business’s financial transactions -- the money in and money out. Over time, the transaction raw data can be analyzed for patterns and turned into useful information about a business's financial condition. For instance, a profit and loss statement compares the money earned by the business with the money spent over a month, a quarter, or a year. This reveals whether the business is making a profit or losing money during that time.
Okay, How Do I Set up a System?
Before computers and spreadsheets, people used to record transactions in ledgers— journals with lines and columns. This is why a company's accounting is also called its "books" and why the process of recording is called "bookkeeping." Nowadays, most accounting is done with computer software that tracks the ins and outs and provides reports with little effort.
The system you need depends on who you're reporting to and what kind of information they need. As a small business owner, unless you received funds from an investor or lender, the government is the only entity you need to report to. The IRS wants to know your income and expenses, plus a few other things like fixed asset and inventory your business may or may not own. If you collect sales tax, you'll need to track the amount to be forwarded to the state authority.
You also report to yourself. You need to know whether or not you're making a profit, your best selling products and services, which customers owe you money, and your highest expenses, etc.
When you first start your business, keep it as simple as possible. Your most pressing concerns are to perfect your products and services and to get the word out. While accounting is necessary, it shouldn’t take up a lot of your time.
Your accounting system consists of:
Do I Need a Business Checking Account?
You may not need a business checking account if you:
If you're a sole proprietor, you can start your business without a separate business account if you accept payments in your own name and have few income and expenses. As a sole proprietor, your business is not a separate entity from you as a person, so the separation between your personal and business accounts are for convenience rather than legal reasons.
If you have a freelance service business with relatively few business expenses (such as a writer, coach, programmer, or graphic designer), and you don’t use a trade name, you may never need separate business accounts. You just need to track your business income and expenses for tax purposes.
You need a business account if you:
For sole proprietors, the best reason for getting a business checking account when you’re starting out is to receive payments under a trade name. Otherwise, you want to get business accounts if you expect to have a lot of transactions or use double-entry accounting software, such as QuickBooks or Xero.
Double-entry accounting software tracks the balances of business checking (and credit card) accounts through which income and expenses flow. These account balances are considered assets (what the business owns) and liabilities (what the business owes to creditors). For this reason, this type of software is not meant with personal accounts. While you can categorize expenses as "personal" and not have it affect the profit and loss statement, too many of these transactions can make your bookkeeping more complex.
Structuring your business as an LLC or corporation requires you to have separate checking and credit card accounts because they are separate legal entities (whereas a sole proprietorship is not separate from you as a person). LLCs and corporations protect your personal assets from your business creditors. As such, you can't mix or "co-mingle" your personal and business assets. This means keep your personal and business accounts separate. Don’t pay personal expenses with your LLC's account, and don't deposit business income into your personal account. Transfer money between your business and personal accounts instead and pay out of the appropriate account.
Tracking Income and Expenses
If you are just starting out and have few transactions, you can get away with using a simple spreadsheet to track your business income and expenses. Record all money earned by the business and all money spent on the business. Don't make it complicated! I've provided a template you can use for this purpose.
You'll want to categorize each income and expense for tax deduction purposes. Common tax deduction categories are included, which you can modify and add your own. I've also created a profit and loss report on a separate tab that automatically populates based on your entries.
Should I Use Accounting Software?
Using accounting software can speed up your bookkeeping tasks and provide additional functionality like faster invoicing, receiving electronic payments, downloading bank transactions, tracking open invoices and unpaid bills, reviewing profit and loss and sales reports, etc. And that’s just the beginning.
QuickBooks Self-Employed is the lowest-cost option at $10 month. It is mainly intended for those who work as independent contractors, such as Uber drivers, who do not need to invoice customers or invoice infrequently. It doesn’t track accounts receivable (open invoices) and is designed for tracking income, expenses, and mileage for a simple Schedule C.
Freshbooks costs a bit more, starting at $15 a month for five clients and goes up to $25 a month for 50 clients. It includes invoicing, accounts receivable, electronic payments, project management, as well as expense tracking. Freshbooks has a very user-friendly design and is great for very small businesses to automate the work they do on spreadsheets and don't need more robust software. However, it's missing some key accounting components that limit its usefulness for businesses with more than 100 or so transactions a month.
Full-featured accounting software like QuickBooks and Xero have a greater learning curve because they’re built around the double-entry accounting system. This can ensure accuracy because revenue and expense transactions are reconciled (cross-referenced) against bank and credit card statements. They are also more flexible and can work for more types of businesses, as well as scale up with your business in ways that QuickBooks Self-Employed and Freshbooks cannot. There are many third-party apps that add additional functionality specific to your business needs, such as project management, payroll, and cash flow management.
However, this cross-referencing and flexibility increases the likelihood of errors if you don't understand the accounting concepts behind some of the functions. If you choose to get a double-entry accounting software and don’t have any accounting background, expect to need help setting up the software and getting trained to use it. You may also need help with quarter-end or year-end cleanup.
Your Filing System
Nobody likes keeping and filing receipts and invoices. Even in businesses where people get paid to keep the office in order, filing is usually the last priority and piles up during crunch time. But if you ever need back up for your tax accountant, get audited, or have disputes, you'll be glad those records are there.
The Lazy Filing Method
So simple, it's a no brainer. Take a file folder and label it with the year, and stick all of your business receipts in there. If you have business checking and credit card accounts, be sure to save all statements either on your computer or in another folder. You want to keep your own copies of account statements instead of look them up online when you need them because sometimes we close accounts and open new ones, and you typically lose access to your documents once an account is closed. This method is super easy to keep up with and is sufficient if you’re self-employed and don’t have a lot of transactions.
Paperless Filing Methods
These days, we get a lot of our receipts by email, and you probably don't want to have to print everything out and file them. Here are a couple of ways to file your receipts quickly and easily on your computer or in the cloud.
1. Scan and store to your hard drive, cloud drive, or accounting software.
Scanner apps like Scannable, Scanner Pro, or Adobe Scan make it easy to create clean scans to PDF with your smartphone or tablet. You can then email it to yourself, upload to a cloud drive, or upload to Evernote, depending on the app. Keep in mind you still have to digitally organize your receipts once they are emailed or uploaded. You can also attach the receipt to the expense entry in your accounting software, a commonly available feature, so you can always look it up what exactly you purchased.
2. Use a receipt processing service like Hubdoc or Shoeboxed.
They have slightly different features, but both of these services allow you to scan or email in receipt and invoices to be filed in the cloud. The receipts are then read by the computer and filed away automatically. They also connect to cloud-based accounting software and allow expense entries to be created easily with receipts attached. These services speed up bookkeeping, make your receipts easy to find, and give you the peace of mind that your books are audit-ready.
This is a brief introduction to setting up your bookkeeping system and the different types of software available. Once you start digging into apps for small businesses, the options can be overwhelming! I hope this has been helpful for those who are new to bookkeeping and business administration. Much more can be written about the different options for accounting software, but that needs to be a whole other article. Stay tuned!
Please let me know if you enjoyed this article, and if you have any questions in the comments below.