Bookkeeping Basics for Small Businesses

Pathik Shah
July 31, 2021
Bookkeeping Basics for Small Businesses

Introduction to Bookkeeping

Small business owners have many lessons to learn in the initial phase of the development of their
operations. Nevertheless, that does not mar the excitement of signing the first deal or having the
first customer and the enthusiasm of the first profits. They start small; their finances are small, the operations are on a smaller scale; however, multiple tests and trials have to be dealt with on a daily basis, similar to any large business enterprise. One of the key challenges that businesses generally ignore is bookkeeping, which is essential for efficient financial management.

Small business owners make big business plans for the key processes of sales, marketing, strategy, and customer relationships. However, when it comes to bookkeeping, their focus reduces, and
hence the business suffers.

Accurate bookkeeping is a vital activity for the smooth running of healthy business operations.
However, the foremost thing that small business owners must do is to understand bookkeeping, identify the key rules of bookkeeping, and comprehend the small errors or pitfalls in the recording of transactions that can become a threat to business growth in the future.

Therefore, small business owners must make efforts to learn the basics of bookkeeping to understand where the business stands through the cash on hand, debts owed, and the other
financial ins and outs. Furthermore, this ensures to prevent any fraud situations from any customers, employees, or vendors.

We provide the small business owners with the following basics of bookkeeping so that they can
understand the finances better for ensuring the long-term success and sustainability of their
ventures.

Defining bookkeeping

Bookkeeping is the process of recording and organizing a business’s financial transactions, which is a part of the accounting process. The key transactions of bookkeeping include sales, purchases, receipts, and payments. The supporting documentation for each financial transaction, such as a purchase order, receipt, or invoice, is also recorded as evidence of the transaction. It helps the businesses to understand the main causes of expenses and the key sources of revenues. Bookkeeping is different from accounting since accounting includes recording, summarizing, analyzing, and consulting of finances of business while bookkeeping is just collecting of data, and hence, is only a subset of accounting.

Basic types of accounts

Bookkeeping requires business owners to record each transaction in the relevant, appropriate category for better understanding and management of the financial transactions. Small business owners must maintain these 10 basic types of accounts for an efficient bookkeeping process:

Cash

Any business transaction passes through the Cash Account since the owner either pays cash or receives cash for a transaction. Bookkeepers can maintain two journals for Cash Account – one for Cash Receipts and one for Cash Disbursements.

Owners’ Equity

An account recording the amount a single owner or multiple owners put into the business is called an Owners’ Equity Account. Liabilities subtracted from assets result in Owners’ Equity, also called net assets.

Sales

Whatever transaction related to sales of products or services is conducted is recorded in this account. It is the incoming revenue, which must be tracked carefully to know the total income generated from the sales.

Accounts Receivable

When a business owner sells products or services to a customer on credit, that transaction is recorded in Accounts Receivable since the money from customers is due. This account sees changes whenever the payment of a past transaction happens.

Purchases

The transactions involving the purchase of raw materials or finished goods from suppliers to be used for business purposes are recorded in this account.

Accounts Payable

When the business owner purchases something from its vendors and does not make the payment at that time, then that transaction is recorded in Accounts Payable since they owe money to suppliers. This account must be maintained well to avoid double payments and ensure timely payments.

Loans Payable

If a business owner borrows money for buying equipment, furniture, or any business-used thing and the payment is due, then that transaction is recorded under Loans Payable along with the due date of payment.

Retained Earnings

The net income of business after deducting all the dividends declared by the entity is recorded under Retained Earnings Account. Investors and lenders track this account to understand the business’s performance from the start.

Inventory

The Inventory Account tracks all the transactions wherein the product or service is ready for selling, but the sales have not happened. It requires close monitoring since it is a current asset.

Payroll Expenses

Money used to pay the employees is recorded in Payroll Expenses Account. Maintaining this account well is essential since it is used for complying with tax requirements.

Bookkeeping and key decisions

Once small business owners understand the importance of bookkeeping and the significant basic accounts to be maintained, there are few key decisions to be taken to ensure a proficient process of
bookkeeping in the entity.

Single-entry vs. double-entry bookkeeping

Besides the types of multiple accounts required to be maintained for a well-organized bookkeeping process, business owners must decide on whether to keep single-entry or double-entry accounts. If the business is extremely small and the number of transactions is less, single-entry bookkeeping works, wherein one entry is made for each transaction.

For example, if there is no requirement to deal with any equipment or inventory and if there are not many cash transactions, business enterprises can move ahead with single-entry bookkeeping. In the case of double-entry bookkeeping, two entries – one debit and one credit transaction are added to two different accounts.

This is required in highly complex organizations with a larger volume of transactions. Double-entry bookkeeping is more challenging than single-entry bookkeeping; however, accuracy and balanced books can be ensured with double entries of each transaction.

In-house or outsourcing

Making journal entries for every transaction and managing the supporting documentation is a tedious and complex task. Without special training in accounting, it is difficult for entity owners to manage it themselves.

However, the decision depends on the owner based on the factors of costing, accuracy, and trust. If the number of transactions remains very few, managing it in-house by hiring an accountant is best, while if the business involves multiple, complex transactions daily, outsourcing to a CA firm is better.

When the businesses are just following a passion or hobby with rare transactions, then the Do it Yourself (DIY) route is manageable. If the business owners and their team are too occupied in
operations to ensure growth that they are not able to focus on bookkeeping, then hiring a professional would be the best decision.

Excel or software

Many computer software is available that can help business enterprises with bookkeeping entries and maintaining accounting journals, different from maintaining physical papers and account books that were prevalent in olden times. Business owners, who choose to manage accounts themselves, have the option of either using:

Frequency of recording the transaction

Business owners must make it a habit to maintain daily records. Daily recording enables us to keep track of all the transactions, thereby helping the owners to keep an eye on the financial condition of the business. If not possible to manage it daily, the supporting documentation must be saved so that each transaction is recorded at the end of the week.

Furthermore, business owners must ensure to balance and close the books regularly – monthly or quarterly, depending on the volume of transactions. The balance of credits and debits calculated after every month or quarter must satisfy the equation of Assets equal to the summation of Liabilities and Equity. If not, the errors must be found, checked, corrected, and the final balance must be achieved for the closure of books.

Cash method or accrual method

It is crucial for business owners to decide whether they will use the cash accounting method or the accrual accounting method. In the cash method, the revenues and expenses are recognized at the time of actual receipt or payment of cash for the transaction. This method is easier to maintain, and the business owner is aware of the actual cash in business at any given time.

On the other hand, in the case of the accrual method, the revenues and expenses are recognized when the transaction occurs, even if the cash payment or receipt has not occurred. Herein, the business owner is required to track all the receivables and payables; however, it gives a more realistic and long-term picture of the business.

Benefits of good bookkeeping

If bookkeeping is done regularly and with accuracy, it can result in a multitude of positive consequences as follows:

Easier fixing of problems

Mistakes happen in businesses; under billing a client, overpayment for raw materials, double charge by the bank, improper credit of the deposit, or any other. With good bookkeeping practice, it is easier to notice any such error made in the transactions, and hence, it becomes easier to fix them.

Dealing with taxation on time

Handling taxes for a business is one of the most fundamental tasks. The business is operating means it will have central and state taxes, professional taxes, indirect taxes, and any other annual charges or fees. Payment of these taxes before the deadlines is essential to avoid late payment fees, penalties, or interest amounts. Besides, income tax filing is also a critical task, which should be completed on time with no errors.

Better planning and management of business

Reporting and recording each transaction helps the businesses to obtain a view of the current business situation, which, in turn, can ensure planning and budgeting for the future. If the accurate financial transaction is not collected and reported, it becomes difficult to understand how the business is doing, where it is headed in the future and the related financial planning for the same.

Increased probability of receiving financing

Accurate and timely bookkeeping enables business owners to provide the lenders with business
reports on financial statements and income tax returns. This enables the businesses to demonstrate
the actual financial scenario of the enterprise to investors for obtaining a business loan. If such
critical statements are not available, it becomes difficult to obtain the approval of the lenders or
investors.

Therefore, for successful operations of your business ad better financial management, it is advisable
for small business owners to engage in a regular, accurate bookkeeping process.