The Beginner’s Guide to Bookkeeping
The key to running a healthy and successful business is properly managing the books. Without good bookkeeping, you’re essentially driving blind, as if you were driving a car that didn’t have a proper gas gauge. The car is going fine for now, but how long will it be until you find yourself in trouble and need help?
Today we’ll be taking a look at the ins and outs of bookkeeping, why you need to be doing it, and how you can get started sorting out your books.
Just What is Bookkeeping?
Bookkeeping is a process wherein you keep track of the financial transactions of your company. It gives you an overview of where your money is coming in and out, as well as what you can claim as tax deductibles when tax season rolls around.
It’s a process that needs to be done regularly across the year. Bookkeeping can seem tedious, especially given the temptation of just throwing all of your receipts but your accountant during tax season. Bookkeeping should still be done between tax filings as it provides you with a snapshot of how your business is currently doing financially.
What Makes Bookkeeping Different From Accounting?
Accounting and bookkeeping are both useful for keeping your business financially healthy. It’s important to realize that both have their own purpose, however. Bookkeeping allows you to keep track of finances. Accounting is the process of interpreting these records for strategic purposes.
Bookkeeping involves tasks such as filing receipts and entering expenses into spreadsheets. Accounting includes things such as planning for taxes, financial forecasting for the year ahead, and creating financial reports at the end of the year. You can learn more about the differences between accounting and bookkeeping here.
Why You Need to Stay on Top of Bookkeeping
• You never miss out on potential deductions
There’s a good chance you don’t understand the entire small-business tax code. There’s no need to, after all. But giving your CPA as much information and supporting documents as possible during tax season means you’ll be able to claim more tax deductions.
• It helps you to get business
Are you considering a business expansion? No matter what you need financing for, keeping your books up-to-date gives lenders and investors a clear picture of the current financial state of your business. This allows them to create accurate financial projections for your company and assess your ability to pay off the loan in the future.
• Quickly catch banking errors
If you don’t reckon financial transactions until the end of the year, and you’ll have no idea if the bank has made some kind of mistake until you’re going through paperwork and filing taxes. It’s much easier to reconcile overcharges if they are caught right away, compared to leaving them for several months. A stitch in time saves nine as they say.
• You get a clear overview of where your money goes
Taking a look at your bank balance will show you what your bottom-line looks like, but there is a story to be told by the ups and downs of your account. Have sells grown? Are you spending too much on shipping? Taking a look at financial statements is the best way to learn the story of your business and understand where money is going.
The Seven Steps of Bookkeeping
Here’s a look at the actual process of bookkeeping:
• Step 1: Keeping Business and Personal Expenses Separate
The first step to tracking business finances effectively is to keep them separated from personal finances. The reason for this is liability. If you’re managing a limited liability entity or a corporation and you don’t have enough distance between business and personal finances, then you may be held personally responsible not to mention liable but business debts.
Not to mention how annoying it is to have to remember if you went to the restaurant with the client or by yourself when reconciling bank statements. You have to know was a business expense and was a personal expense.
• Step 2: Choosing a Bookkeeping System
When it comes to bookkeeping, there are two main methods of going about it: single-entry and double-entry. You can’t go wrong the matter your choice, but you do need to choose the system that is best for your business and be consistent about using it.
Single-entry is a simple process that works best with straightforward bookkeeping. Entries will be recorded months, as either money in or out. This is the most likely approach for those who are doing their own bookkeeping.
Double-entry can be more complex, but it is also more robust. Transactions will be entered into a journal, and then items are entered into ledges twice; as a debit and also as a credit.
Let’s say you manage and ice cream shop. Every time you sold a ice cream, it would be entered into your “cash” account as a credit, and also entered into the “ice cream” account as a debit. Don’t worry, we’ll look at accounts in more detail in a minute. The debits and credits that are in the ledger should add up to zero. If they don’t, then it means you’ve made a mistake somewhere. The IRS offers guidelines on understanding all of the different aspects of running double-entry bookkeeping so be sure to take a look at them.
It can be complicated to use double-entry at first, and you may have to call in a professional bookkeeper to get you through these initial hurdles.
• Step Three: Choose Between Cash or Accrual Accounting
Another important step is choosing between cash or accrual accounting methods. If you’re going to use cash accounting, and you only need to record transactions when money has exchanged hands. If you were to bill customer today, then the money won’t come into your ledger until you have been paid.
With accrual accounting, you record the income when the customer has been billed, rather than band AP. This means that you record all income earned during a tax year, whether or not you have collected it yet.
This also applies to deductions. Deductions are taken out when you build and not when you pay for them. If your company Horton inventories, then you will likely be expected to use accrual accounting methods.
• Step Four: Categorize Transactions
Each transaction you make should be categorized when it goes into the books. This allows your bookkeeper to find more deductibles, and make things much easier if you are to get audited. An unmarked restaurant bill is not going to mean much after six months. Was it when you had lunch with the client? Was it because you decide to treat employees for a successful business quarter?
The way that you categorize transactions depends on the business and industry. In general, transactions were full and to 5 different account types – assets, equity, liabilities, expenses, and revenue. Individual items will then be broken down into a range of subcategories known as accounts. Using our earlier example of an ice cream shop, these accounts may be things such as “ice cream sales revenue”, “ice cream ingredient expenses”, and such.
The actual process of categorization depends on which bookkeeping solution you are using. If you’re managing everything yourself, then you could make notes on receipts. If you’re using online bookkeeping services such as Bookeeping.com you can talk to your bookkeeper and let them manage it for you.
IF you are taking care of your bookkeeping on your own, then you should consult a pro when putting together the bookkeeping system. This ensures that the accounts you make are in line with the standards of your industry and any CPA expectations.
• Step Five: Organizing and Storing Documents
The burden falls on you to show how valid your expenses are when tax season comes. It’s crucial that you hold onto the supporting documents such as records and receipts. Diamonds are forever, but the ink on receipts isn’t. Given that the IRS now accept digital records, it’s worth using cloud-based solutions such as Evernote, Google Drive, and Dropbox to avoid damaged and smudged receipts. Apps such as Shareboxed are designed to track receipts and should be considered as well. No one wants to have a shoebox of receipts lying around after all.
• Step Six: Organize Potential Deductions
The golden rule of deductibles, at least according to the IRS, is that they have to be ordinary (a common expense for your industry) and necessary to the business. Pens would be considered an ordinary expense for someone who works as a writer, but that $900 pen might not be considered “necessary”. Okay, it’s definitely not necessary!
Even if an expense could be considered ordinary and necessary, it might not be something that can be deducted one-to-one on a tax form. Working from home doesn’t mean that you can deduct the entirety of your rent on your taxes. The IRS provides a comprehensive guide to business deductions that you should take a look through.
• Step Seven: Get in the Habit of Doing It
Never underestimate how easy it can be to fall back on bookkeeping, especially when you get busy. Try setting financial dates for yourself – or a business partner – at least once a month where you will get everything done. If you do fall behind, then Bookkeeping.com gets you caught up quickly.
Should You Manage Your Own Books or Hire a Professional?
There’s plenty of choices when it comes to handling books. All of these choices fall into two main categories; taking a DIY approach or hiring a professional.
• The DIY Approach
If you’re managing your business on a small budget as more of a side hustle, then going at it yourself is the best way to start. Consider arranging a consultation with a CPA or professional bookkeeper to ensure your books are done properly and don’t need to be re-done by a professional at the end of the year. You can handle bookkeeping by yourself using a spreadsheet or by taking advantage of the endless number of bookkeeping programs online.
• Outsourcing Bookkeeping
If you get so caught up in bookkeeping that the rest of the business suffers, or you just have a larger business, then you may want to call in a professional. The bookkeepers at Bookkeeping.com will take care of your books for you and provide you with software that lets you stay on top of finances so you aren’t in the dark.
If you’ve amassed a lot of physical financial records or would just prefer a face-to-face meeting, you can also consider hiring freelance bookkeepers or a bookkeeping service in your local area.