Bookkeeping Basics Part I: Four Steps to a Strong Foundation

Business owners working on financials

This is the first article in a two-part series on bookkeeping. Read part II to take your bookkeeping to the next level.

Great bookkeeping habits help you make smarter business decisions, spot opportunities early on and head off problems before they become unmanageable. Good bookkeeping practices also ensure that you’re on top of issues like tax and insurance payments that can get otherwise great businesses into trouble.

If you’re just getting started with your bookkeeping system, or want to make improvements to your business’s current system, it can be difficult to know where to start. Even if you have a bookkeeper on staff,  it’s important that you understand your financials to keep a pulse on your business’s financial health.

Our Business Advisory Services team put together the following steps to help you get started with bookkeeping and assist you along the way. You’ll soon find that keeping good books isn’t nearly as hard as you imagined and is far more valuable than you thought.

Step 1: Determine which categories of revenue and expenses to track

One of the primary functions of bookkeeping is to track your business’s performance over specific time periods and keeping income and expense records by category makes this easier (for example: cost of goods sold, wages, or utilities). Doing so can also help when you need to create financial statements for a potential lender, when you want to take stock of your progress toward financial goals, or when your accountant is preparing your taxes.

If you’re not sure which categories make the most sense for your business to track, a good starting point is to create categories based on standard forms, such as IRS business tax-return forms. Common business forms to review include the Schedule C, 1065 and 1120 forms; all are available for free on the IRS’s website.

Some business owners may need additional categories that are determined by the type of business. For example, in addition to tracking total daily sales, a retail business will also want to track revenue by specific products sold to manage inventory and spot trends.

Often, merchant payment services—such as PayPal® and Square®, as well as banks and credit card companies—offer online recordkeeping tools that can help you categorize and organize revenue and expenses. These may also integrate with online bookkeeping systems, so be sure to learn about the tools available and use them to streamline your process.

Step 2: Create a system to easily organize bookkeeping information

Now that you know what you need to track, the next step is to decide how to track it. Will you use cash-basis accounting or accrual basis accounting? The difference is in the timing: Cash-basis accounting counts revenues and expenses when they move in or out of your bank account. Accrual-basis accounting counts your revenues and expenses at the time they are made, regardless of when they’re actually paid.

Choose what makes the most sense for your business, and talk with your accounting professional to decide if you need to make any changes for tax reporting purposes.

Additionally, while it’s essential to physically keep important paperwork,  it’s also expected that small businesses track their income and expenses through online bookkeeping programs (QuickBooks® is an example of a popular program).

Maintaining these records is crucial to knowing what’s coming in and what’s going out, and it’s also important for preparing your taxes in order to show the IRS your backup information. Here are some recommendations on how to keep your records organized:

  • Paper trail: You’ll accumulate a lot of paperwork, so set up a system that you can use daily (or weekly if it’s more appropriate for your business, but no less than that) to collect, record, scan and file it. Create folders to store receipts, invoices and other important paperwork. Before filing them away, scan them to online files that correspond with your paper files.
  • Digital files: When creating your online bookkeeping system, use a program that’s easy and has the tools you need; look for good technical support and customer service, too. To find the best one for you, sign up for free online trials. Then, set up your business’s bookkeeping files.

Step 3: Schedule time each day or week for bookkeeping

Now that you’ve set up great systems, use them! Schedule time each day or week (depending on the volume of transactions you have) to record revenue and expenses. Reconcile merchant services daily or weekly, and review bank statements at least monthly.

If you haven’t already opened a separate business bank account from your personal account, you should. If you need to “lend” money to your business from your personal accounts, record those transactions by writing checks to your business or making bank transfers and recording them.

Similarly, if you draw funds from the business account to cover personal expenses, record those transactions by writing out checks or making transfers between bank accounts. While it’s fine to use those funds, you want to ensure that you treat your business like a business and not as a hobby, which is an important distinction in the eyes of the IRS.

Separating your accounts also makes tracking income and expenses much easier for you and your accountant, both at tax time and in the event of an audit.

Step 4: Use bookkeeping to make informed decisions and paint a solid financial picture

Know your financial position: Learn about the balance sheet and its components—assets, liabilities and equity. Be knowledgeable about performance and ensure that you accurately track balance sheet activities, such as:  

  • All assets, including office supplies, computers and equipment purchased by the business
  • Money owed to you by your customers
  • Any debts you owe to suppliers, such as payment for inventory
  • All funds borrowed for the business, including business credit cards, loans or lines of credit used and leases for equipment
  • All funds you have invested, borrowed from or drawn from the business

Be sure that you’re able to generate a balance sheet and a profit & loss statement (P&L) on at least a quarterly basis.

If you work with a Certified Public Accountant (CPA), they can help you interpret these documents and provide guidance on financial decisions for your business. Maintain ongoing communications with your CPA to tap into their expertise and better understand how your taxes are prepared — this will be helpful when reviewing your internal P&L and balance sheet throughout the year.

Start strong for success:

Sound bookkeeping practices are the foundation of every successful business. Knowing how to manage your financials helps you spot opportunities or address problems and ensures that your books are always up-to-date for tax preparation, loan reviews and other business needs.

Even if you’ve hired someone else to handle the books, you’ll still have invaluable insight about one of the most fundamental but undervalued aspects of small business success.

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