Starting a business can be exciting, but there are likely to be parts of it that may seem intimidating – such as bookkeeping. This involves keeping a clear record of all your business’s earnings and expenses. Bookkeeping has a reputation for being tedious, and there’s a certain amount of financial lingo you have to learn to do it right. However, it’s not as long-winded or complicated as some people assume (especially when using modern technology such as accounting software). This post aims to demystify bookkeeping by delving into the basics.
The importance of bookkeeping
Keeping a record of all your company’s financial transactions has a few important benefits. These include:
Tax preparation
By law, every business must keep a record of all transactions for tax purposes. Bookkeeping helps you to accurately calculate how much tax you have to pay each year. This includes tracking expenses that you are able to deduct from your tax bill. Without keeping clear records, the IRS has no way of knowing whether your taxes were accurately calculated or not, and you could face severe penalties if a tax audit is carried out.
Budgeting
Bookkeeping is essential for tracking and controlling how much you are spending, so that you don’t spend too much each month. This can prevent you getting into unnecessary debt, as well as helping you to set aside savings.
Forecasting
Keeping on top of bookkeeping is also important for financial forecasting. By keeping a record of how much you are spending and earning each month, you can spot patterns and changes – such as identifying periods of the year where you get less sales. This can allow you to prepare for the future better by making cutbacks or coming up with new marketing strategies.
Choosing accounting software
Gone are the days of doing bookkeeping manually. Accounting software can be linked up with your cards, bank accounts, websites or sales software to automatically record all your earnings and expenses. This software can also automatically calculate your tax, advise budgets and create financial forecasts using graphs. It’s an essential piece of software that every business owner needs to use.
Which accounting program should you choose? There are many different software providers to choose from. Ideally you should choose a program that is appropriate for the size and complexity of your business. Most small new businesses can get away with using cheap basic software plans (there are even free options out there). Try to choose a plan that is scalable if you plan to grow your business in the future – many accounting programs have different price plans that you can choose from, and if your business outgrows the cheapest plan, you can upgrade to a more advanced plan.
Categorizing transactions
To help you organize your transaction, it’s worth dividing them into categories. Most transactions fall into one of three basic categories:
- Income: Money going into your accounts.
- Expenses: Money going out of your accounts.
- Transfers: Money being moved between accounts.
Of course, it’s worth dividing each of these categories much further to give you a good idea of where most of your earnings are coming from and where you are spending the most amount of money. If you own a restaurant, this could include potentially categorizing earnings into different categories like ‘drinks’, ‘appetizers’, ‘entrees’, ‘desserts’ and ‘sides’. Meanwhile, expenses could be divided into different categories like ‘food/drink supplies’, ‘equipment’, ‘labor’, ‘rent/mortgage’ and ‘marketing’.
Many accounting programs will let you create your own categories, however some have their own category system (which may include technical labels like ‘COGS’ and ‘assets’). If you want the freedom to choose your own category labels, make sure you choose the right accounting software.
Organizing receipts
Keeping physical receipts of each purchase can help when recording expenses – especially when paying in cash. You could keep these in a physical folder, or keep digital copies by photographing or scanning each receipt.
Once you’ve got the receipt, you should record the expense in your accounting software as soon as possible (some accounting programs are available as apps – allowing you to do this from your smartphone wherever you are). This is usually more convenient than having to sift through a pile of receipts every month (or worse every year) and allows you to track each expense there and then. This post details more receipt management best practices.
Managing cash flow
Cash flow management is a key part of bookkeeping that involves making sure you have enough money coming in to cover your expenses and make a decent return. It involves a mix of budgeting and forecasting.
If you do not get paid upfront for your product/services and rely on invoices, tracking your cash flow could be more difficult. You need to keep a record of exactly what money clients still owe you so that you can budget accordingly and chase up late payments. This is known as Accounts Receivable (AR).
If suppliers have sent you bills and invoices that you are yet to pay, you also need to keep track of what you still owe to make sure that you don’t fall into serious arrears. This is known as Accounts Payable (AP).
Accounting software can help you calculate all of this by automatically drawing information from every invoice you send out and every invoice/bill you receive.
Conclusion
These are just some of the basics to bookkeeping. By getting into the habit of regularly dedicating time to bookkeeping, you can keep your financial records accurate and up-to-date. As mentioned throughout, accounting software can help automate much of the process, but you will sometimes have to manually enter information. Start by choosing the right accounting software and establish a consistent category labelling system as soon as you can. Collect receipts of purchases to further help maintain good records and make sure to digitally track invoices and bills that you owe/are owed to help you track your cash flow. Doing all of this will help you to maintain clear financial records and run a successful business.
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