Income, and Expenses, and Balance Sheets, Oh My!
Even if you outsource your bookkeeping and tax return preparation, as a small business owner or leader of a nonprofit, you need a working knowledge of bookkeeping basics along with basic accounting terms.
Here's a Quick Start tutorial on Bookkeeping Basics You Should Know as a Small Business owner:
Accounting Software vs Spreadsheets
If your business is new, you may be able to keep track of your income and expenses on a spreadsheet. But with any growth or a large volume of transactions, do yourself a favor and purchase software to make it easier.
I recommend QuickBooks Online (QBO) for several reasons:
It's the most commonly used accounting software. If you need to hire a bookkeeper, you won't have any trouble finding one who's worked in QB.
Subscription packages are tiered so that you can start with the lowest and upgrade when it becomes necessary.
QB interfaces with dozens of e-commerce apps and payment processors, the majority of banks, and various other apps. The platform adds new partners often.
QB uses common language vs accounting terms. They continue to tweak this aspect of the app to make it more user friendly to non-accounting professionals.
The most important thing about the program you'll use is choosing one that you'll be comfortable learning at least the basics of how to navigate it.
Cash Basis Accounting and Accrual Based Accounting
You (or the person who prepares your return) are required to make an election of the type of accounting method your business uses. This choice is indicated at the top of Schedule C, E or 1065 if you file a tax return for an LLC.
Cash Basis books income as it comes in and expenses as they are paid
Accrual Basis books income as the work is performed (using invoices) and books expenses as soon as they are incurred (using bills).
Once you know which method your business uses, stick with it when making entries in accounting software. Things can get messy if you mix the two methods.
Bookkeeping Basics: Profit and Loss Report vs Balance Sheet Report
Every financial transaction gets assigned to an account in accounting software.
One of the biggest mistakes I see with new users is not understanding where an entry should be coded.
Accounting software has a Chart of Accounts. These work a lot like folders on your laptop. The chart has accounts that group transactions together as you enter them and is used to generate reports. It's critical that you enter transactions to the correct account within the Chart of Accounts.
The 4 basic groupings within the Chart of Accounts are:
Income
Expenses
Assets
Liabilities
Each one of these categories can have subcategories to help you with better detail for analysis at the end of the month.
As your business grows, you'll need additional accounts within each grouping. For example:
In the Assets grouping, you will have sub-accounts for each bank account, property your business owns, and investments.
In the Income grouping, you may want to separate various types of income you earn. Examples are products sold, types of consulting or labor, or rent collected from tenants.
In the Expense grouping, you'll have sub-accounts for types of expenses such as subscriptions, rent, utilities, insurance, payroll, cost of materials, etc.
Some people choose to keep their Chart of Accounts as compact as possible. But I've worked with businesses with several departments and their Chart of Accounts often have a few hundred separate accounts.
All of these accounts (groupings) within the accounting software report to what we call The Ledger. The ledger (aka trial balance) is a report that shows all transactions, regardless of whether its income, expenses, assets, or a liability.
Therefore, these separate accounts that makeup the Chart of Accounts are often referenced by GL numbers (general ledger numbers).
You probably won't have a need to review the actual ledger, but accountants depend on it for preparing tax returns and planning.
The ledger is what QB uses behind the curtain to create useful reports for business owners such as the Profit and Loss Statement and budget-to-actual reports.
That's enough for one article! I'll continue to post more tutorials on bookkeeping for small business owners. I hope this has been helpful and I'm happy to answer any questions you have in the comments.
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