It’s tempting for small business owners to view accounting as a hassle—some necessary evil. And while it’s certainly not the most exciting part of running a business, keeping up with your small business accounting will pay massive dividends and make you a better business owner. Not only will you be able to assess financial pain points in your business better and determine where you should allocate your next dollar, but you’ll also stay out of trouble with the IRS—good small-business accounting makes tax return preparation a breeze. What is Small Business Accounting? Small business accounting is the process by which a small business records its financial transactions and presents them in a standard format known as financial statements. The purpose of small business accounting is threefold: To inform internal stakeholders, such as the business owner and key employees, about the historical and current state of the small business’ financial condition so they can make key decisions pertaining to cost control, personnel, marketing, and more. To inform external stakeholders (Ex: creditors or investors) about the historical and current state of the small business’ financial condition, so they can make decisions about whether, when, and how to infuse cash into the small business. To accurately prepare the small business’s tax return. A small business cannot do any of these things without proper small business accounting. Set Up Payroll If your small business has employees or intends to hire employees in the near future, it’s essential that you set up a solid payroll system. Failing to do so can result in both internal crises (Ex: failing to pay your employees on time) and external crises (Ex: falling out of compliance with the federal and state government payroll requirements), which can lead to significant fines and penalties. Open a Business Bank Account While it’s technically possible to run your business out of your personal bank account, it’s a terrible idea. For one thing, bookkeeping—and therefore accounting—will take much more time than it has to, since you’ll have to determine which transactions running through your account were business and which were personal. For another thing, commingling your business and personal expenses could have adverse legal consequences for you personally, if your business were to be sued. With so many low- or no-cost business bank accounts available today, there’s really no excuse to not open a business bank account before your business earns its first dollar. Do it this week if you haven’t yet! Find Accounting Software After you’ve set up your business bank account, you’ll want to get a subscription to an online accounting software. At a basic level, accounting software will electronically connect to your business bank account and download all transactions to its register so you can categorize them into their proper accounts. Once your transactions have all been categorized, your accounting software will use that data to generate financial statements for you, such as a profit and loss statement, and a balance sheet. Most accounting software products also have an interface where you can easily create and send invoices to clients and customers. Tip: While most major banks connect seamlessly with most major accounting software products, you may want to double-check that this is the case if you’re banking with a smaller institution like a local credit union. An alternative is to work the other way around and only consider financial institutions to bank with that are supported by the accounting software of your choice. Manage Your Bookkeeping As convenient as accounting software is, you will have to put in some work to keep up your books—or pay a professional bookkeeper to do it for you. For most small businesses, bookkeeping is a relatively straightforward task. Most of the work consists of categorizing the transactions your accounting software downloads from your bank and making sure that no transactions are missed or double-counted. And most accounting software is “smart”—it starts learning how to automatically categorize certain transactions, gradually lessening the time burden for you. Not sure where to start when it comes to bookkeeping? Check out our bookkeeping guide for small business owners! Prepare Your Taxes If you have a business, you’ll need to prepare and file a tax return reporting its income and expenses. If you’re a sole proprietor for tax purposes—meaning that you haven’t set up a business entity or have set up an LLC that hasn’t elected to be taxed as a corporation—you’ll likely be reporting your business income and expenses on the Schedule C that’s attached to your Form 1040. On the other hand, if you set up a corporation, partnership, or an LLC that elected to be taxed as a corporation, your business will file a separate tax return depending on how it’s taxed: Form 1120 for C corporations Form 1120S for S corporations Form 1065 for partnerships You may also have state and local filing requirements as well. Note that whether you prepare your own business tax returns or hire this work out to a professional, the ease of your tax preparation process is directly proportional to how well you’ve kept up your books! Determine a Payment Processor If, like most businesses, you collect electronic payments from customers, you’ll need to sign up with a payment processor. This company will run your customers’ electronic payment—typically credit or debit card—and deposit the payments to your business bank account, less a processing fee. Your accounting software may have built-in payment processing, but you may be able to save money on processing fees by going with a different processor. Manage Cash Flow Did you know that your business can have lots of clients and be extremely busy with work, but still be broke? It’s true—especially if you extend credit terms to your clients and customers, allowing them to pay you after you’ve performed services, while you have bills, salaries, and other overhead expenses to pay now. This is all part of cash flow management, which is concerned not only with total income and expenses but with the timing of cash receipts and outlays.You absolutely need a system to manage cash flow, or your business will not survive. Intro to Accounting For Small Business Chapter 1: Intro This first chapter of the accounting guide covers the basic steps to get started managing your business finances. Dive further into accounting practices and formulas in the chapters below. Chapter 2: What Is the Accounting Equation Formula? The basic accounting equation formula is: Assets Liabilities + Owner’s Equity This formula is the foundation of double-entry bookkeeping, in which every transaction in your business affects at least two financial accounts. Chapter 3: The Difference Between Bookkeeping and Accounting Bookkeeping is the more rote process of recording transactions in your company’s accounting software, while accounting is the process of interpreting, analyzing, and summarizing this data. Chapter 4: Assets, Liabilities, Equity: An Overview For Small Business Assets are what your business owns, liabilities are what your business owes, and equity is what you own with respect to your business. Chapter 5: Debits Vs. Credits Every transaction recorded in your company’s books has a “debit side” and a “credit side,” and debits and credits affect different kinds of accounts differently. For example, a debit to an asset account signifies an increase to that account, while a debit to a liability account signifies a decrease to that account. Chapter 6: What is Double-Entry Accounting? Double-entry accounting is the accounting system used by all modern businesses. Rather than keeping a running list of transactions (single-entry accounting), double-entry accounting maintains that every transaction must affect at least two financial accounts. Chapter 7: Recording Journal Entries A journal entry is a record in your company’s books of a transaction or group of transactions. In every journal entry, one or more accounts are debited, and one or more accounts are credited. For example, if your business completes a job and is immediately paid $10,000 in cash, you would debit your cash account by $10,000 and credit your revenue account by $10,000. Most accounting software automatically determines which accounts to debit and credit for a given journal entry, if the underlying transaction is categorized correctly. However, bookkeepers sometimes must make manual journal entries to reflect transactions or adjustments not directly from the bank feed. Chapter 8: General Ledger Examples Your business’ general ledger is a record of every transaction recorded in your business for the time period the ledger covers; typically, general ledgers are grouped by account. Chapter 9: How to Master Inventory Accounting Inventory accounting is how your business accounts for and values its inventory. Chapter 10: What Is Financial Reporting? A Comprehensive Guide Financial reporting is the summarizing of your business’s financial data into financial statements, such as the profit and loss statement, balance sheet, and cash flow. Common Accounting Formulas Chapter 11: Calculating Cost of Goods Sold: Formula and Meaning Cost of goods sold (COGS) is a financial account representing all the costs that were directly incurred in producing or purchasing products that you have sold to your customers. Chapter 12: What You Should Know About Profitability Ratios Profitability ratios are financial ratios that typically involve dividing the balance of one or more account(s) by one or more other account(s). Their purpose is to give you a quick idea of how profitable your company is in relation to various items on its financial statements. The accounts involved in calculating profitability ratios are typically income and expense accounts, though your company’s total asset balance and total equity balance are used in calculating some profitability ratios. Chapter 13: Calculating and Understanding the Acid Test Ratio The acid test ratio (or quick ratio) is calculated by dividing your business’ cash, marketable securities, and accounts receivable balances by its total liabilities balance. This ratio is used to get a bird’s-eye view of a company’s short-term liquidity. Chapter 14: The Current Ratio Formula The current ratio formula is current assets divided by current liabilities. Chapter 15: What is a Good Current Ratio? With Examples The current ratio is calculated by dividing your business’s current assets by its current liabilities. Ideally, your current ratio should be at least 1.0—a smaller current ratio indicates that your company does not have short-term assets to pay off its short-term liabilities. Chapter 16: Calculating the Activity Ratio An activity is a type of financial ratio that gives you a sense of how efficient your business is at utilizing assets or converting them into cash. Chapter 17: How to Calculate Your Debt-to-Equity Ratio Your business’ debt-to-equity ratio is calculated by dividing your business’ total liabilities by its total equity. It essentially gives you a sense of how much of your business’ cash and other asset balances are debt-funded and how much is from owners’ capital infusions or business profits. Chapter 18: How to Calculate Inventory Turnover Ratio The inventory turnover ratio for a given period is calculated by dividing a business’s cost of goods sold by its average inventory. Here, the average inventory is calculated as the average of its beginning inventory balance and ending inventory balance for a given period. This ratio tells you, on average, how many times in a given period a business turns over its inventory. Chapter 19: Break-Even Point Formula The break-even point formula tells you how many units of a particular product—or all your products at the average sales price and variable cost—you’d need to sell to break even on the sale when taking into account both fixed and variable costs. The formula is fixed costs of production divided by sales price per unit less variable costs of production per unit. Chapter 20: How to Calculate Profit Margin Profit margin is calculated as the percentage yielded when you divide your business’ profit by revenue and multiply by 100. It tells you how much of your business’ revenues are left over as profit after expenses are paid. Chapter 21: What is Total Revenue? Total revenue is the total receipts your business earned from selling goods or services in its normal course of business, net of allowances, discounts, and refunds. It is calculated by multiplying the number of units your business sold by the average sales price of those units and subtracting total allowances, discounts, and refunds on those units. Chapter 22: What is Gross Profit? Gross profit is calculated by subtracting the cost of goods sold from net sales. It is a measure of a business’s profitability after paying only for direct costs of sale, rather than also including overhead and other fixed costs in the calculation. Chapter 23: What is Net Profit and How to Calculate It Net profit is the amount of a business’s revenue that remains after all expenses have been paid. Naturally, this is an important figure since it represents your company’s “bottom line.” Chapter 24: How to Calculate Operating Margin Operating margin is calculated as the percentage yielded when you divide your business’ operating profit by its revenue and multiply by 100. It tells you how much of your business’ revenue is left over after paying not only direct costs of sales but also operating expenses.