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Small Business Bookkeeping (Beginner’s 101)

Simple steps for managing your small business finances.

Small Business BookkeepingBookkeeping is the practice of storing your financial records in a clean state. Knowing how much your company spends, earns, and pays taxes, you can estimate your personal income and put down growth plans.

Good cash flow is also a strong proxy for business success.

Entrepreneurs who spend wisely and save ahead for the rainy day stay in business longer. On the other hand, a negative cash flow, tells that your business is running out of liquid assets (cash). Meaning you’ll need to either sell some assets or seek extra funding.

Soundly, 65% of US small business owners say they have a positive outlook for their cash flow for the next quarter. We’ll show you how to be among this happy-go-lucky crowd.

Financials don’t excite many folks. Yet, over 40% of small business owners do their bookkeeping without any help. So you’ll cope too.

Following is a step-by-step breakdown of how to manage small business finances.

Table of contents

  1. Open a business bank account
  2. Systemize your financial documents
  3. Determine your bookkeeping method
  4. Learn about your tax obligations
  5. Create a monthly budget
  6. Monitor your operating costs
  7. Balance your books on a schedule
  8. Best accounting software for small businesses
  9. Conclusions
  10. FAQ (Commonly asked questions)

Read on to learn how to do bookkeeping and accounting for a small business.

1. Open a business bank account

Even if you operate as a sole trader (non-registered business), open a separate business bank account.

By doing so, you’ll prevent your personal expenses and other income from commingling with financial information for your business. Doing transaction categorization and tax preparation will be ten times easier when you separate the monies.

Retail banks provide affordable checking accounts for businesses with monthly fees ranging from $0 to $15. Shop around and look for discounts. Many business banks offer:

  • Sign-up cash bonuses or discounts
  • Attractive interest rates for savings/checking balance
  • Low or no card transaction fees
  • Low-cost batch ACH payments

On the other hand, you should also watch out for some “hidden” costs and penalties such as:

  • ACH daily batch fees — charged when you exceed the number of free transfers per day.
  • Transaction fees for different types of cards — by the issuer and by country.
  • Address Verification Service (AVS) fees.
  • Monthly minimum balance — the amount required to always stay in your account.
  • Monthly minimum fees — penalties charged if your business doesn’t make a certain amount of transactions.

As for business bank account features, look for banks that can be easily integrated with popular accounting software and bookkeeping apps and used in conjunction with popular POS systems and online payment processors.

The above will save you a ton of time on manual data entry, bank statement generation, and account reconciliation.

NerdWallet compares the costs and fees among popular business checking accounts.
NerdWallet compares the costs and fees among popular business checking accounts.

2. Systemize your financial documents

You can look at your business from different financial dimensions — profit, revenue, sales volumes, expenses, cash flow, operating costs.

All of these act as proxies for the company’s overall health and prosperity.

Individually, however, they offer a more target view into an area you excel in or struggle the most.

For instance, your profit numbers can tell you’re slaying it this month. But the actual revenue can be much lower if you’re also spending a lot of cash on growth.

A bookkeeping system helps you learn to balance expenses and profit generation to not fall into the “feast and famine” cycle.

Thus, you’d need to learn to tolerate the following types of financial documents:

  • Balance sheet — details your company’s assets, liabilities, and available capital during the analyzed period.
  • Statement of assets and liabilities — part of the balance sheet, specifying what cash and physical assets your company owns and what financial obligation it has before others.
  • Profit and loss statement (P&L) — also called an income statement, this document showcases your revenue, operating costs, and other expenses. Complimentary to
  • Profit margin — shows how much you earn from each product/service as a percent or fixed number.
  • Monthly/annual revenue projections — Knowing your projected revenue gives you a better idea of how to manage your business budget.

However, this is far from being an exhaustive list. But it’s a good starting point for small business owners who want to dab into accounting.

3. Determine your bookkeeping method

The two main bookkeeping methods are:

Single-entry bookkeeping

Record one entry per transaction. For example, sale +$100 or invoice payment -$100. Single-entry bookkeeping is used for cash-basis accounting. Under this accounting system, you add an entry when the cash enters or leaves your bank account. In this case, you have two accounts — account receivables and account payables.

Double-entry bookkeeping

Record two entries per transaction — debit, and credit. For example, you’ve purchased a new laptop. You then credit -$1,500 from your cash account, but add +$1,500 to your assets account because you incurred an expense, but a new business asset. Double-entry bookkeeping is used for accrual accounting — a system with five types of accounts where you place every transaction. These include assets, liabilities, expenses, equities, and revenue.

Most small business owners start with single-entry bookkeeping and cash-basis accounting because it’s simpler.

But accrual accounting offers a more comprehensive picture of your finances. It also becomes mandatory when your business earns over $5 million annually.

4. Learn about your tax obligations

Business taxation is difficult to grasp initially. But once you wrap your head around the basics, the rest will fall into place. So here’s a quick primer.

The taxation rates will differ depending on:

  • Your business entity type such as LLC, S-corp, partnership.
  • Your location: the state(s) where your business is registered and operates.
  • Business type: some companies need to pay sales taxes (VAT).

Federal business taxes

You need to report your business income to the IRS and file an annual tax return. Then pay

all the applicable taxes.

After you register a company, you’ll need to apply for an EIN (employer identification number) and then use it to access the tax services.

Most businesses opt for an estimated tax payments scheme — monthly withheld tax payments to the IRS — to avoid footing a huge end-of-year bill.

Tax rates vary for LLC, corporation, and partnership entities.

However, another layer of complexity is that, as a business entity, you can opt for several taxation schemes.

For instance, an LLC owner can choose to get taxes as:

  • Sole proprietor (self-employed person) if you’re a single owner.
  • S-corporation
  • C-corporation
  • Partnership

The IRS website explains the tax obligations for each type of entity. Also, consult with a tax advisor or accountant on the optimal tax structure.

State business taxes

On a state level, you’re also bound by specific tax requirements such as:

  • Corporate income tax
  • Individual income tax
  • State-level sales tax
  • Annual (franchise taxes)

All of these will need to be filed with a local financial authority.

For example, if you’re operating out of Nevada, South Dakota, and Wyoming, you don’t need to pay any corporate or individual income taxes from your business income.

The Tax Foundation runs an index of states with the best/worst business tax climate.
The Tax Foundation runs an index of states with the best/worst business tax climate. Source: Tax Foundation.

Some states, however, impose a minimum annual tax (franchise tax) — a payment you’ll have to pay despite the generated income. The sum is based on the net worth of or capital held by the entity.

States with an annual tax for LLC include Alabama, Arkansas, California, Connecticut, Delaware, DC, Rhode Island, Tennessee, Texas, Washington.

Forty-five states (including the District of Columbia) also charge a state-wide sales tax. The rates vary from 2.9% — the lowest in Colorado — to 7.25% — the highest in California.

However, 38 states also collect local state taxes. It means that a business operating in Chicago, IL, and Springfield, IL, will pay different sales tax rates.

In some cases, local tax obligations are the same or higher than state-wide sales tax rates.

Comparison of sales tax rates across states.
Comparison of sales tax rates across states. Source: Tax Foundation.

Fortunately, there’s no federal sales tax. So you just need to worry about this when doing cross-border commerce.

Main takeaway: verify your business tax obligations locally first. Then figure out the federal requirements.

5. Create a monthly budget

A business budget bounds your spending. It provides a quick look into:

  • Recurring spending. Estimated tax payments, rent, utilities, subscription software, etc.
  • One-off expenses. New equipment purchase, consulting services, marketing campaign, etc.
  • Incoming money. Customer payments, capital gains, investment income, repaid loans, etc.

Knowing how much money you earn and spend weekly/monthly is essential to break even and then pace ahead towards profitability.

Remember: 82% of small businesses fail due to poor cash flow. You don’t want to be among that cohort.

What is included in a business budget?

A reasonable business budget includes all the accounts payable and other expenses due during the tracked period.

Accounts payable stands for any financial obligation (debt, invoice, etc.) you have to your supplier, business partner, or lender.

Business expenses are more miscellaneous spending such as one-off-purchases. Also, a tight budget has a tally of projected profits.

Here’s what to include in a business budget:

  • Fixed recurring costs
  • Variable costs
  • Estimated revenue
  • Projected profitability

How to create a business budget

Here’s how to make a simple but effective business budget:

  1. Use an Excel sheet or a business budgeting app with a calculator.
  2. Organize all the recurring, variable, and one-off business expenses in separate categories such as salaries, tax payments, supplies, marketing, payment processing costs, equipment, etc.
  3. Add all accounts payables such as payments to lenders, independent contractors, suppliers, etc.
  4. Do a tally of these.
  5. Separately, create a column for projected revenues.
  6. Detail all the anticipated accounts receivable for the month. Similarly, break these into categories such as product/service sales, capital gains, investment income, etc.
  7. Separately list the money you have saved on your bank balance.
  8. Do a tally and subtract the planned expenses. That’s your business profit, also known as the maximum number of money you can spend this month without going into debt.

The best way is to keep at 30-50% on your business balance (for unforeseen expenses) and reinvest the rest in growing your business.

6. Monitor your operating costs

Operating costs are the sum of all expenses you incur when running your business — from accountant services to a Zoom subscription.

Here is a formula for calculating your company’s operating costs:

Cost of goods sold (COGS) + operating expenses (OPEX) = Total operating costs

COGS represent all costs related to producing a product or providing a service. You also need COGS to calculate gross business profits or losses.

Examples of COGS

  • Raw material costs
  • Labor costs
  • Inventory costs
  • Storage costs
  • Shipping and logistics costs

OPEX is a collection of costs incurred outside of producing or sourcing products (or providing services). Mainly, these are all expenses related to selling, marketing, and administering your business.

Examples of operating costs

  • Website development
  • Equipment and supply purchases
  • Payroll
  • Marketing

What is included in operating costs?

Operating costs will vary a lot from one industry to another. For example, manufacturing or retail businesses have clear-cut COGS, while service providers have more overhead selling, general, and administrative (SG&A) costs.

Some universal operating expense categories include:

  • Salaries
  • Taxes
  • Software subscriptions
  • Website
  • Marketing
  • Supplies
  • Legal expenses

How to track your business expenses?

Knowing your operating expenses is essential to calculate gross profit (revenue).

First of all, you’d be taxed based on your business revenue. So it’s nice to know what to expect.

Secondly, revenue is the money you can pay to yourself, reinvest back in business, or show potential investors or business buyers. Again, you’d want to know how much you’ve got.

Here’s how to track operating expenses for a small business:

  • Keep a spreadsheet, or better use an expense tracking accounting app.
  • Upload all receipts and capture all expenses (including nominal costs such as payment processing fees, discounts, etc.).
  • Connect all your business bank accounts, debit, and credit cards to automate tracking.
  • Reconcile financial transactions weekly or monthly (depending on your business size).

7. Balance your books on a schedule

To understand the state of your finances, you’ll have to create regular balance sheets.

In essence, it’s a snapshot of your company’s worth, with income, expense, and balance neatly laid out.

A preview of the quarterly balance sheet from Slack.
A preview of the quarterly balance sheet from Slack. Source: WSJ.

But the balance sheet tells you:

  • How much money has your business burned over the past month/quarter/year
  • How much profit you’ve pulled in at the same time
  • Who do you own money to
  • What are your assets worth (if any)
  • How much you have left in the bank to spend

Putting together a balance sheet isn’t fun or fast (unless you’re a CPA or use an accounting app).

Best accounting software for small businesses

As you’ve learned from the previous section, small business accounting involves a lot of data entry, spreadsheets, formulas, and calculations.

The good news is that you don’t have to be a financial whiz to do your books. You can call in accounting software to the rescue.

What is the difference between bookkeeping and accounting software?

Bookkeeping services help you organize and store your records. It’s a digital ledger for logging your interview.

Accounting software is more comprehensive.

Popular apps help you do the basic bookkeeping tasks such as invoicing, transaction categorization, and account reconciliation. Plus, provide some reporting and forecasting functionality such as revenue projections, tax obligations/estimated payments, and other financial report generations.

If you use a comprehensive accounting app, you don’t need separate bookkeeping software.

Here are the top three small business accounting apps for small businesses.

QuickBooks

QuickBooks (by Intuit) is a cloud-based accounting app with a dead-simple interface but robust under-the-hood functionality.

The product hits all the functional boxes — provides income tracking tools, in-built invoicing, expense management, and financial analytics tools. Moreover, you can pay extra to connect with a live accountant to do your books.

QuickBooks provides stellar expense tracking and financial statement generation functionality.
QuickBooks provides stellar expense tracking and financial statement generation functionality. Source: QuickBooks.

Pros

  • Great for managing sales and income
  • Convenient mobile app for capturing business expenses
  • On-demand access to trained CPAs
  • Tax preparation toolkit

Cons

  • Limited inventory management functionality for retailers
  • Not highly accurate auto-categorization for expenses
  • Limited payroll account settings options

Xero

Xero is another strong contender for small business owners. The app seamlessly integrates with popular business banks and payment services to overview all inbound and outbound payments. Similar to QuickBooks, you can automatically capture recipes and invoices and then have the software doing the book balancing act.

Xero is well-packed with dynamic price quotes, invoicing, and account reconciliation features.
Xero is well-packed with dynamic price quotes, invoicing, and account reconciliation features. Source: Xero.

Pros

  • Integrates with many other business systems (CRM, ERP, analytics tools)
  • Fast and easy onboarding and setup process
  • Provides claim management feature for processing employee expenses
  • Convenient, searchable document and contract storing interface

Cons

  • Fees charged for ACH payments
  • You need to install a separate mobile app for expense tracking
  • It doesn’t provide live chat help

FreshBooks

Unlike the previous two accounting apps, FreshBooks exclusively focuses on small business owners and solopreneurs. The software is very intuitive for beginners yet advanced enough for the financial-savvy folks too. With FreshBooks, you can track all things about your business — from daily mileage to annual cash flow statements — without stressing over complex reports.

With FreshBooks, you can easily stay atop your P&L management, quickly generate balance sheets, and enjoy a stress-free tax season.
With FreshBooks, you can easily stay atop your P&L management, quickly generate balance sheets, and enjoy a stress-free tax season. Source: FreshBooks.

Pros

  • User-friendly and intuitive interfaces, convenient navigation
  • Multi-format invoices, including retainers
  • Invite an accountant or bookkeeper to collaborate
  • Automatic financial statements and report generation

Cons

  • No payroll taxes functionality
  • No quarterly tax estimates
  • The mobile app lacks certain desktop features

Conclusions

Small-business bookkeeping and accounting can be intimidating, especially if you’re not comfortable with numbers.

But being proactive about the state of your finances pays off (literally) as you can precisely tell how much money you can pocket or spend confidently on business growth.

Commonly asked questions (FAQ)

Here are the answers to some of the most frequently asked questions about small business bookkeeping and accounting.

Tomas Laurinavicius

Article by:

Tomas Laurinavicius

Editor in Chief

Tomas Laurinavicius is the Editor in Chief at SimplifyLLC. He's built multiple online businesses and helped scale companies with streamlined content marketing operations. His work has appeared in Forbes, TIME, New York Observer, HuffPost, Adobe, and BigCommerce, among many other publications.

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