SME accounting is done by completely recording all income and expenses. This is a necessary task to help small business owners extract financial information from business activities and effectively track and manage their money, especially in the early stages.
Small business owners' bookkeeping concentrates on the company's past and present performance and helps in billing and payroll creation.
Here's a snapshot of all that we have in store for you:
- What Is Business Accounting for small business owners?
- Setting up a Business Accounting System for small business owners
- How to set up an accounting system for small business owners – A step-by-step guide
What Is Business Accounting for small business owners?
Small business owners' accounting requires accurate bookkeeping and keeps an organized record of a company's financial transactions, such as sales, expenses, assets, and liabilities. If you're new to accounting for small business owners, you should be aware of three types of accounting reports - Balance sheets, income statements, and Cash flows.
Each report records different values and provides unique insights into the small business owners’ financial position. The balance sheet measures what the company owns and what the company owes. This type of statement provides a snapshot of the financial status of small business owners at any given time.
Accountants can see at a glance the numbers for a company's assets and liabilities. Companies typically prepare financial statements at the end of each quarter, but individuals can prepare financial statements at any time. Assets, liabilities, and capital make up the balance sheet.
Assets have economic value and can reduce costs and increase sales. Examples of assets include inventory, cash, real estate, and accounts receivable. The balance sheet lists the assets in order of liquidity, which means how easy it is to sell, consume, or convert an asset to cash.
Debt Responsibility or liabilities mean what the business owes to others. Examples of liabilities include employee income tax, mortgages, wages, and accounts payable.
Shareholders' equity represents the company's net assets. That is the amount that shareholders will receive if they liquidate all their assets and repay all their liabilities. Net worth means assets minus liabilities. For example, a company with $ 20,000 in assets and $ 5000 in liabilities has a capital of $ 15,000.
Setting up a Business Accounting System for small business owners
Here is what you need to understand about the accounting process of small business owners:
1. Analyze financial transactions
The accounting process begins with the analysis of financial transactions and the entry of transactions belonging to a company into the accounting system. For example, a loan borrowed for personal reasons is not included in the business record. The first step in the accounting process involves creating a source document or business document that serves as the basis for recording the transaction.
2. Journal transactions and entries
These are recorded in chronological journals and are also known as Books of Original Entry. You must maintain these journal transactions using a double-entry bookkeeping system. Journals consist of two accounts, a debit, and a credit. To simplify this process, accountants use special journals to record regular transactions such as purchases, sales, and cash receipts. Transactions that cannot be recorded in the special journal are recorded in the general journal.
A ledger, which is also called the Books of Final Entry, is a collection of accounts that displays changes to each account based on past transactions, along with the current balance of each account.
4. Unadjusted Trial Balance
A trial balance is created to test that the total expenses match the total credit. Accounts are extracted from your ledger and put together in a report. The balances in the debit and credit columns must be the same. If not, the trial balance contains an error and must be corrected using correction posting. It's important to note that some errors can quickly occur, like errors due to double reservation or omission of entry.
5. Adjusting Entries
At the end of the accounting cycle, the accountant must create an adjustment entry to update the accounts summarized in the financial statements. For example, income generated but not recorded in the books. Adjustments are made for revenue and expense accruals, depreciation, value adjustments, accruals, and upfront payments.
6. Adjusted Trial Balance
After the correction posting, you need to create an adjusted trial balance. This is done to test that the charges match the credits after the reconciliation entry is created. This is the final step before preparing the annual financial statements.
7. Annual financial statements
The annual financial statements, including income statements, statements of changes in shareholders' equity, balance sheet, cash flow statement, and notes, are the final product of accounting.
8. Closing Entries
Periodically measured temporary accounts, including income, expenses, and withdrawal accounts, are closed to prepare the system for the next settlement. Balance sheet accounts, also known as perpetual accounts, remain open for the next billing cycle. The final step in the billing cycle is to create a trial balance after closing and test if the debit and credit amounts are equal after closing the posting. This test balance includes only real accounts, as this billing cycle closes temporary accounts.
How to set up an accounting system for small business owners– A step-by-step guide:
This is not the recommended method, but all you need is a pencil and paper, and a lot of patience to get started with your small business owners' bookkeeping. However, accounting software is the best way to get started. If you still can't tell the difference between debits and credits and can't distinguish between assets and liabilities, accounting software can make your life much easier. But even when you're ready to find the accounting software that suits small business owners, there are some other things you need to do first.
Step 1: Select the structure of the company
First and foremost is the choice of corporate structure you have as accounting is majorly influenced by your business structure. There are four basic corporate structures.
- Sole Proprietors: Sole proprietors have a single owner and require little setup. The disadvantage is that the legal distinction doesn’t exist between you and your company. Therefore, you are responsible for whatever the company owes
- Partnerships: When doing business with more than one person, ownership of the company can be shared equally through partnerships. Each partner contributes to the success and failure of the business, and the details of the responsibilities are outlined in the partnership agreement
- Limited Liability Company or LLC: LLC is similar to a sole proprietor, except that it is not responsible for its business debt. Another advantage of an LLC is that you can have a sole proprietorship or multiple partners. This also provides flexibility in filing business taxes
- Corporation: It is a legal entity that also has a complex structure. It is considered a separate entity from the owner for tax reasons. The business structure can be complex and expensive, but there are benefits like additional legal protection and corporate tax reductions
Step 2 - Open a bank account
When small business owners start a business, you open another bank account that keeps your business finances separate from your finances.
Step 3 - Accounting method selection
When setting up an accounting system for small business owners, you need to choose how to record financial transactions. There are two ways to record revenue and expenses - Cash basis and accrual accounting
- Cash-based accounting records revenues and expenses for cash transactions. For example, track product sales only if the customer pays for the product
- Accrual-based accounting tracks revenue at the time of sale and costs at the time of sale. It doesn't matter if you received the product or service in cash or paid for it. You need to use a dual accounting system and record two entries per transaction
Step 4 - Record a transaction
Small business owners can choose to hire an accountant to record transactions manually or use accounting software to record business transactions. You can use spreadsheets or manual ledgers to track your accounting transactions. There are a plethora of small business owners accounting tools and you can try the application yourself before you buy.
Step 5 - Create a chart of accounts
The chart of accounts lists all small business owners' transactions and is used to generate bank statements, check progress, and search for transactions. These charts need to be updated frequently to include various business transactions.
Step 6 - Determine payment terms
Depending on the type of small business owners' accounting, you can offer a loan to your customers. Instead of collecting the payment at the point of sale, you can bill it later. If you choose to lend to a customer, you need a unified system for creating and sending invoices.
Step 7: Understand the basics of accounting
There are a few accounting basics you need to know. When using accrual accounting or double-entry bookkeeping, you need to understand the accounting equation and the debit and credit charges that are the most critical part of the accounting system. You need to be familiar with the five types of accounts used in your chart of accounts.
- Assets: Anything of value that small business owners own is considered an asset. Assets include bank account money, accounts receivable, computers, inventories, and furniture
- Debt: Debt is everything your company owes. Liability includes the balance of accounts payable (the amount payable to the supplier) and the loan or promissory note that the company is responsible for
- Revenue: Revenue is the money a company earns from the goods sold or the services provided
- Expenses: Expenses are counted as the cost of doing business. Typical small business owners' costs include employee salaries, over-the-counter rent, and utility bills
- Equity: After deducting small business owners' liabilities from business assets, you get equity. This is a financial interest held by the company
Accounting software applications always come with a standard out-of-the-box chart of accounts.
The accounting equation is as follows:
Asset = Liability + Capital
To follow the accounting equation, all postings in the general ledger require a debit and a corresponding credit. Debiting increases the asset or expense account and is always recorded on the left side of the booking. Credits increase debt, income, or capital accounts and are always recorded to the right of the entry.
You should also be familiar with the billing cycle. The accounting cycle has nine steps that should be followed:
- Organize transactions
- Record diary entries
- Post journals to the general ledger
- Perform unadjusted test balance
- Create a reconciliation entry
- Prepare a suitable test balance
- Perform financial reporting
- Close the book of the month
- Start the next cycle
Accounting software automates the accounting cycle and significantly reduces the number of steps.
Step 8: Set payroll
There are many payroll software solutions specifically designed for small business owners. These applications can help you throughout the payroll process. However, there are some things you need to do before you start paying.
Get EIN (Employment Identification Number) from IRS.
Obtain state and local ID numbers from the appropriate authorities. Once you have this information, find a good payroll service provider and prepare to hire your first employee.
Step 9: Learn how to manage your income and expenses
Most of your financial transactions are related to income and expenses. Knowing how to deal with these two points will help your business run smoothly.
- Learn how to create an invoice - The most important thing for small business owners is to learn how to write invoices. Next, invoices can often include a link to an online payment option so that customers can easily pay
- Pay your supplier on time. Good credit is important for small business owners, so pay invoices on time
- Make a note of all your costs. All operating costs must be properly recorded to be able to pay accurate taxes at the end of the year
- Enter all financial transactions regularly. Whether you use bookkeeping software or a manual bookkeeping system, make sure your transactions are properly recorded
Step 10 - Collate your bank accounts
Monthly collations of bank accounts are important and should be done regularly. When you complete a bank collation, it helps you identify the items that you need to enter in your general ledger and shows your bank's errors.
Step 11 - Create a financial report
Once all the transactions have been entered, you are ready to prepare your financial statements. Start with an unadjusted trial balance that will help you find the failed account. Here you also have the option to enter adjustment entries. Once this is done, prepare a financial report for the month and review these statements to see what's happening in your business.
The three most important financial reports that need to be produced at the end of the month are:
Accounting for small business owners doesn't have to be difficult. Even beginners can take on the job of accounting and bookkeeping for the company. Whether you buy accounting software, hire an accountant, or choose to do it manually, you can use several accounting tools available. Keep in mind that the simpler the accounting process, the better value you can render in your business. Take a deep breath, learn the basics and start today.
- Accounting is not just a unit of measurement - Bookkeeping for small business owners is more than just a measure of how much money you made last year or what your tax obligations are. When used correctly, accounting can also help identify trends in sales and spending
- Do it every month - Small business owners need to create an income statement to calculate the profitability of their company every month. Ideally, you should also check your balance sheet. By reviewing your monthly financial statements, you can quickly adjust your spending and sales efforts to keep your business within budget
- Keep a careful record - Keep a very carefully organized record. One of the reasons for maintaining a good record is for tax purposes
- Understand the basic principles - The basic concept is very simple. Even if small business owners decide to hire an outside accountant or use accounting software, you must understand the basic principles of accounting