At NorthOne, we know our customers didn’t get into business because they are passionate about accounting. However, like it or not you can’t have a successful business without understanding how your business is financially performing. In this article we’ll be breaking down the basics of what you need to know about bookkeeping to ensure long term success for your business.
How Bookkeeping Basics Can Support Your Small Business
No one really enjoys bookkeeping (except accountants) but the more you stay on top of it, the easier it gets. Having transparency with your business finances is the only way to ensure long term growth and success. In order to make your business better and more profitable, you’ll first have to understand what’s working and what isn’t. You can’t make adjustments and improvements to increase profit margins and productivity without having a clear idea of what’s going on with your money. Below is a list of the key things you need to understand to have a good grasp on your business finances and ensure your business is moving in the right direction.
1. Understand the Key Terms of Bookkeeping Basics
There are some terms all business owners should know, especially when it comes to bookkeeping. Here are some you should learn and commit to memory.
In business, an asset is anything that creates revenue or that the business benefits from owning. Here are some examples of types of assets your business might have:
- Accounts receivable
- Real estate
Liability is basically the opposite of an asset. This is something that your business owes. For example, if you took out a business loan and you are paying it back with interest this is considered a liability. Here are the types of liabilities your business might have:
- Accounts payable
- Interest payable
- Unearned service revenue
Even if you’re pretty new to business you probably have an idea of what revenue and income means. This is the money that is earned by the business. Here are the types of revenue/income your business might bring in:
- Interest income
- Rental income
- Sales income
Expenses is the money flowing out of a business. This is the money that needs to be spent in order for the business to run properly. For most businesses the biggest expenditures are usually payroll and paying vendors. Here are the different types of expenses:
- Insurance expense
- Interest expense
- Salaries and wages
In business, equity is the value of ownership . Basically, how much your business is worth to each owner. An example of equity would be stocks. Here are some of the types of business equity:
- Owner’s capital
- Retained earnings
2. Organize Your Banking
When you think about organizing your banking, you might think of late nights sorting through piles of paperwork and waiting in line at the bank only to receive mediocre service. But banking has evolved and those things no longer have to be part of your routine when staying on top of finances. The easiest way to organize your business banking is simply by keeping two separate bank accounts, one for your business and one for personal expenses.
Having separate accounts makes things super easy and also minimizes liabilities and protects your personal assets in the case of an audit or other legal issues. If your business is structured as an LLC, having separate accounts is even more important because the company’s expenses pass through your own personal taxes.
Trust us when we say, separate accounts for business and personal expenses will save you time and money. If you have a bookkeeper it will be much easier for them to keep track of your expenses and avoid costly mistakes when filing your business taxes. Tax time will be much easier when you have separate bank accounts.
3. Develop a System for Storing Records
It is important that you have an organized system for storing your financial records throughout the year. This makes it easy to do your financial reporting on a monthly and biannual basis, and will make things much easier come tax time. Below is a list of things you should include in your system for storing financial information.
Capture the important information
If you’re not sure what financial documents are worth keeping on file and organizing, here is a list.
- Bank statements
- Credit card statements
- Cancelled checks
- All checks written
- Customer invoices
- Customer payments
- Sales receipts
- Deposit slips
- Tax returns
- 1099 forms
- Payroll documentation
Validate its accuracy
When organizing your financial documents, take the time to check they are actually accurate. This will prevent confusion and headaches down the track.
Record the information
How you record your financial information is really up to what works best for you and your business. You might hire a bookkeeper to make financial records for you or you might prefer to enter your financial information into bookkeeping software.
Consolidate the information using monthly reporting
The point of keeping a clear record of your business finances is not just to hand them over at tax time. Understanding how much money your business is making and spending every month is the only way you will be able to grow your business over time and ensure long term success. Keep your monthly reports in one place so you can easily look back at data and see if you are improving as a business. This will help you identify what’s working and what’s not and see any opportunities to improve your business.
4. Master the Three Important Financial Documents
To do your bookkeeping right, you’ll first need to master three key financial documents– balance sheets, profit and loss statements and cash flow statements. By mastering these documents you can get clear visibility on how your business is performing financially. This will help you spot problems early and also find opportunities to grow your business.
Balance sheets show you how much value your business has by breaking down what you owe and measuring that against what you own. Your balance sheets should outline your assets, liabilities and equity. For a more indepth run down on balance sheets, check out our article, What is a Balance Sheet?
Profit and loss statement
Profit and loss statements show you how profitable your business is performing. Is your business making money, losing money, or staying stagnant? To figure out profit and loss you follow a simple formula:
Revenue (-) expenses = profit or loss
If you want to know more about profit and loss statements, read our recent article, How to Write Your Small Business’s Profit and Loss Statement.
If you want to calculate your business’ net working capital, you can read NorthOne’s article on this formula with examples.
Cash flow statement
A business simply can’t run without cash flow. A cash flow statement is arguably the most important part of your bookkeeping. This will show you where you are spending your money and what is bringing money in. If you want a more in depth introduction to cash flow, we recommend checking out our article, What is Cash Flow.
5. Decide on an Accounting Method
There are two primary methods of accounting that businesses use: accrual accounting and cash-based accounting. Before you start, you’ll want to decide on a method. Below are some of the pros and cons of each.
Cash-basis accounting is the simpler method of accounting and is usually used by small businesses. With cash-basis accounting, the bookkeeper (whether this be you or someone you’ve hired to do your bookkeeping) records the expenses when the cash has been received. The downside of cash-basis accounting is that the expenses and revenue aren’t matched on a monthly basis. Expenses of both current and past months aren’t recognized until the cash has been received. This could become a problem if you are looking for financing from a bank or investors, as the books of the business look weaker than they are month to month.
Accrual accounting is a slightly more complicated method of accounting usually used by larger more complex businesses. In this case the revenue is recorded, even if the customer has not paid yet. This allows a business to get a clearer picture of how much it is spending and how much it is making. This can help with analyzing cash flow and making business adjustments. However accrual accounting does not take cash not received into account, so this makes it difficult to know what cash is actually available and not just available in theory.
6. Invest in Small Business Accounting and Bookkeeping Software
We know that old habits die hard but when it comes to running your business bookkeeping, a shoe box full of receipts simply won’t cut it. Especially in today’s world when you have a range of incredible accounting and bookkeeping software at your fingertips. Investing in accounting and bookkeeping software will not only save you time by automating a lot of the work, it will improve the accuracy of your bookkeeping.
Using accounting software will help you organize and manage your financial records so they are always on hand when you need them. This is particularly useful when it comes to protecting your asset in the case of an audit or legal concerns.
Come tax time, you’ll be grateful you invested in accounting and bookkeeping software that lets you streamline the whole process and will save you an abundant amount of time and money.
There is a lot of variety out there when it comes to choosing accounting software. This can be a little overwhelming at first. We suggest you start by thinking about your business goals and look for software that can help you meet those goals. Try to find something that is relatively flexible so as your business grows and changes your software can change with it. You’ll also want to take cost into consideration. We recommend you pick software that is no more than 25% of your bookkeeping and accounting budget.
NorthOne lets customers integrate their favorite accounting software with their bank account. Some of the accounting and bookkeeping software NorthOne customers like to use are Quickbooks, Freshbooks, Xero, and Wave.
7. Integrate Your Accounting and Bookkeeping
NorthOne let’s you integrate your bookkeeping and accounting software with your business bank account. This makes it super easy to have full financial transparency. With all your finance tools working together there will be a lot less work for you to do so you can focus on the fun parts of running your business. You won’t have to spend hours manually matching transactions and your books will always be neat and tidy.
8. Prepare for Tax Season All Year Long
The problem most business owners have with tax time is that they leave it all to the last minute. By preparing for tax time year round you make the task of filing taxes much easier.
Even if you are filing with a hired professional you’ll need to provide them with documentation so they can do your taxes properly, so always keep these documents together so you’re not scrambling come tax time. Relevant information includes profit and loss statements, balance sheets and records of all business assets sold and bought throughout the year.
It is important as a business owner to understand what is required to file taxes for your specific business structure (sole proprietor, LLC, S Corp, C Corp). This will help you avoid making mistakes when filing your business taxes.
9. Prioritize Emergency Savings
Any good business owner will tell you that it’s always best to be prepared for the worst when it comes to your business savings. Some common business emergencies that will cost you money include: money owed after filing taxes, misreporting, unforeseen circumstances, uppaid/unfulfilled invoice payments. Our recommendation is that you put away a percentage of your revenue every month. NorthOne’s subaccounts can be automated to do this for you so you can literally save emergency money in your sleep.
There you have it. The basics of business bookkeeping. We’re not saying you’re going to be a brilliant bookkeeper overnight, but keep working on it. Focusing on these areas of bookkeeping is the secret to long term success for your business.