Bookkeeping Basics Part II: Strategies to Support Your Growing Small Business

This is the second article in a two-part series on bookkeeping. Be sure to read part I on Building a Strong Foundation for your bookkeeping.

Once your business is up-and-running and you’ve mastered basic bookkeeping concepts, you’re ready to take your understanding to the next level. Our Business Advisory Services team has compiled a few bookkeeping practices that will support your growing business. With these tips, you’ll be ready to:

1. Leverage technology to integrate and automate bookkeeping processes and systems to save time and money
2. Gain a better understanding of the balance sheet and how it impacts cash flow
3. Make better business decisions based on accurate and timely financial statements

Work with your accountant to implement these practices and start moving your business toward even greater financial success.

Step 1: Review and revise your accounting method

Two accounting methods are commonly used for businesses—cash basis and accrual basis. Cash basis reporting means you count sales and expenses whenever cash moves in and out of your bank account. Accrual basis reporting means you count sales when they are made (regardless of when you get paid) and expenses when they are incurred (regardless of when you actually pay them).

Cash-basis tax returns are recommended for companies that are just starting out, those below a certain revenue threshold and those that deal primarily in cash, credit cards or merchant-service payments. However, as you grow it may be necessary or even required by the IRS to change to the accrual method.

Remember, bookkeeping practices that are most useful for your business’s day-to-day operations may not be what’s most appropriate for the IRS.

Your business may need to change from cash-basis to accrual-basis if:

• Your company carries accounts receivables such as substantial inventory, and/or credit terms for products or services.
• You provide services under contractual agreements and get paid in installments are best suited to accrual-basis accounting.
• Your business conducts transactions that span between two tax-reporting years.

If it seems that your business may need to adjust its accounting method, work with your accounting professional on changing over.

Step 2: Gain a deeper understanding of expenses that make up your cost of goods/services sold

One of the key ratios that should inform many of your business decisions is your gross profit margin, which can be calculated by: total sales ÷ revenue – cost of goods or services sold (COGS).

Work with your accounting professional to determine which expenses fall under your COGS. These should include materials and direct-labor costs, but other expenses may also be included depending on the standards for your industry.

This is important to understand because an outside party (such as a lender or investor) will often do a comparison of your gross profit margin against an industry standard to assess the strength of your business. Also, note that your COGS is usually calculated based on an analysis of your opening and closing inventory levels, so accurate inventory tracking is essential.

Step 3: Use technology to optimize recordkeeping

Today’s bookkeeping software programs (like QuickBooks®) have tremendous capabilities to help small business owners optimize recordkeeping and make day-to-day, quarterly and annual financial functions much easier. This can save you significant time and lower your administrative costs.

If you’re not already using bookkeeping software or are thinking about a change or upgrade, consider the following factors:

1. Your level of comfort with bookkeeping and accounting concepts
2. The quality and availability of customer service/technical assistance
3. Your accounting professional’s capacity to work with software that you’re considering
4. Your need for certain functionality such as invoicing and payroll
5. The system’s ability to integrate with your merchant services company (e.g. PayPal, Square)
6. Options to purchase additional functionality as your company grows

Importantly, review your current bookkeeping entries with your accounting professional to ensure that they’re set up correctly to avoid issues down the road. Use technology as a time-saver by doing the following:

1. Upload banking and merchant cash transactions into your bookkeeping software and reconcile weekly.
2. Transition customer invoicing and billing functions. (If your system doesn’t allow for this, make sure that your invoicing system can be integrated into your bookkeeping system.)
3. Incorporate payroll functionality.
4. Automate sales, payroll and other estimated tax payments.

Step 4: Update your balance sheet on a regular basis to have an accurate picture of your company’s financial position

It’s recommended that you update your balance sheet at least quarterly. If you have inventory, receivables and payables, you should be updating your balance sheet at least monthly. Talk to your accounting professional to learn more, and review our article on using your balance sheet to track business growth.

To get an accurate picture of your company’s assets (or what you own), make sure you incorporate the following steps into your bookkeeping practices:

1. Keep good records of your accounts receivable (money owed to you by customers), review these accounts at least monthly and follow-up immediately on delinquent payments. This can improve your cash flow position, too. Set a policy regarding what to do with any receivable that’s delinquent beyond 90 days. Consult with your accounting professional on how to report these losses.
2. If you maintain inventory, conduct a quick review at least quarterly so that you’re aware of outdated inventory and slow-moving items and to provide accurate COGS information.
3. If you prepay expenses for future periods, record the amounts as assets on your balance sheet.
4. If you purchase long-term assets, work with your accounting professional to understand the allowable depreciations for these assets so you can get an accurate net fixed-asset value at least annually.

To get an accurate picture of your company’s liabilities (or what you owe), make sure you incorporate these steps into your bookkeeping practices:

1. Keep good records of your accounts payable outstanding to vendors and review these at least monthly to make sure you’re not past the due date. Delinquent accounts can hurt your business credit score. Whenever possible, negotiate discounts for early payments from vendors.
2. For any loans that you incur for the business, understand how to split out your monthly payments between “interest” versus “principal.” Interest paid is recorded on your income statement, while principal repayments are recorded on the balance sheet to reflect the reduction in the outstanding loan balance. 
3. If you pay off credit card balances entirely each month and don’t incur interest, you don’t need to record these payments on your income statements.
4. Report expenses for bank fees for credit cards and merchant services on the income statement in administrative expenses.

Lastly, the owners’ equity or net worth section of the balance sheet can be a focus for third parties, including lenders and investors.  In particular, they’ll look at retained earnings, which equates to the amount of profit that remains in the business, after any owner’s distributions, which can be used to fuel growth and maintain liquidity. To get an accurate picture of owner’s equity/net worth, follow these steps:

1. Record all monies that you have invested over time in your business as “owner’s equity investment.”
2. Record all monies that you have taken out of the business over time, other than salary, as “owner’s distribution.” Note: For sole proprietors and limited liability companies, all operating income that the business reports for a given year is recorded as a distribution and deducted from owner’s equity. Ask your CPA for advice on which is the best option for taking compensation given your circumstance—either as owner salary or owner distribution.

Next-level bookkeeping benefits your bottom line

When you’re ready to implement bookkeeping practices like those outlined here, you’ll find that the benefits are many. For example, you can track your cash-flow cycle so there are no surprises (in terms of liquidity); you can quickly generate accurate financials when meeting with lenders and investors; and you’ll stay on top of payroll and related issues that cause many business owners unnecessary stress.

Most importantly, accurate and timely financial statements can help you make winning strategic decisions based on real-time data. These benefits make a bottom-line difference in your business’s profitability while making your work more productive and enjoyable, too.