Small business accounting requires you to keep complete records of all income and expenses in addition to the accurate extraction of financial information from all business transactions. While this may seem like a daunting endeavor, it is vital to keep your business on track and manage your money effectively.
Setting Up Your Accounting System
When you open your business, the first thing you need to do is open a separate bank account. Having a designated business account is the best way to keep your personal and business finances separate.
Next, you must decide if you are going to use the cash-basis method or the accrual basis method for recording expenses and income. With the cash-basis method, you simply record transactions when they are done. For instance, you only record revenue once a customer has paid. With the accrual basis method, you record sales incomes and business expenses when they are incurred, regardless of when they are paid.
Then, decide how you will record transactions. You have the option of recording each transaction by hand, using accounting software, or hiring an accountant. You are going to need a chart of accounts, which is a list of all of your business transactions. This is necessary for compiling statements, locating transactions, and reviewing progress. Therefore, these charts must be updated frequently to ensure all business transactions are included.
Finally, you must decide on your payment terms. You can choose to offer your customers credit and invoice them later, or you can collect payment at the time of each sale. If you choose to offer credit, you will need an effective system for invoicing your customers.
Basics of Bookkeeping
Accounting for a small business begins with analyzing financial transactions. Any that pertain to your business will be entered into your accounting system. All of your business transactions will be entered into a journal in chronological order. Each journal entry will include two accounts, which are credit and debit. To help with this process, keep a special journal for recurring transactions like cash receipts, sales, and purchases and record all other transactions in a general journal.
You will also need to keep a general ledger. This collection of accounts allows you to keep up with changes made based on previous transactions, as well as the current balance in each account. A trial balance will allow you to verify that your total debits equal your total credits. Extract these accounts from your leger and arrange them in a report. The balance columns should be equal. If the columns are not equal, errors must be found and corrected.
Once the accounting period ends, you must adjust entries and update accounts summarized in your financial statements. This includes any income that was earned but not recorded in your books. These entries are made for allowances, deferrals, depreciation, expenses, and prepayments. After adjusting entries, you need to prepare an adjusted trial balance to make sure debits and credits match. Then, you are ready to prepare your financial statements.
Your business financial statement will include:
- Changes in equity
- Cash flow
Prepare for the next accounting period by closing temporary accounts. Then prepare a post-closing trial balance to verify credits and debits are equal.