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Part of the Series Understanding Small Business Taxes: A Comprehensive GuideRecordkeeping, Business Structures, and Business Taxes
Writeoffs, Tax Breaks, and Tax Reduction Strategies
Tax Compliance and Reporting
Tax Credits and Deductions
Accounting is an instrumental part of running a small business. Implementing systems and best practices for keeping track of expenditures and revenues is key to managing cash flow. Without these systems in place, it’s all too easy to lose track of funds or create the financial records necessary to file taxes and apply for small business financing, if necessary.
Proper accounting for small businesses encompasses a number of important tasks.
Accounting as a small business owner begins with laying a proper foundation. That includes four key activities:
Here’s a closer look at each step.
Opening a business bank account allows you to separate business and personal spending, which can be helpful when it’s time to file taxes if you plan to deduct eligible expenses. To open a bank account for a small business, you’ll generally need to have the following:
You’ll also need a minimum opening deposit if the bank requires one. Minimum deposit requirements can depend on the type of business account and whether you’re opening the account at a traditional bank, credit union, or online bank.
Remember to compare the fees, features, and benefits associated with different business bank accounts to find the one that best aligns with your needs.
Your accounting method determines how you report income and deduct expenses for the year. The Internal Revenue Service (IRS) allows you to choose between two options: cash and accrual. Here’s how they compare.
If you select one accounting method and then decide that you’d like to change it after filing your taxes, you’d need to complete IRS Form 3115 to formally do so.
A chart of accounts is a list of all accounts available for recording transactions in your accounting software program if you use one or a general ledger if you don’t. To create this chart, you’d first organize your accounts into specific categories, then further break your organization down into relevant subaccounts.
Each category is assigned a range of numbers that are used to track individual accounts. For instance, if you have a category for business asset accounts, your organization might look like this:
You’d follow this system for all of the account categories that you have. Common categories include asset, liability, equity, revenue, and expense accounts.
A fiscal year is 12 consecutive months for which accounting activity is recorded. Small business owners can decide when their fiscal year begins and ends; the only rule is that it must be 12 consecutive months.
For instance, you might choose to start your fiscal year on July 1 and have it end on June 30 of the following calendar year. Or you may choose a more traditional approach and have your fiscal year follow the standard calendar year, depending on what works best for your business. If you operate a seasonal business, for instance, then you may choose to begin your fiscal year at the beginning or end of your peak sales season.
Basic bookkeeping for small business owners revolves around a core set of tasks, all of which are designed to help you keep track of where funds are going. The most important bookkeeping practices include:
In terms of which expenses to track for a small business, the short answer is all of them. Anything that you spend money on—whether it’s your monthly lease payment, utilities, office supplies, or postage fees—should be recorded in your accounting system. And those transactions should be recorded accurately to ensure that you have the correct amounts when you’re ready to deduct business expenses on your taxes.
The IRS encourages small business owners to maintain proper documentation for expenses, such as receipts showing the amount spent, the date, the payment method, and what was purchased.
Taken separately, those tasks can be time-consuming. When utilizing a comprehensive bookkeeping software program, they become easier. The best bookkeeping software syncs with your business bank account and payroll systems so that you’re easily able to import and export transaction history. We’ll cover some of the best business bookkeeping software options a little later.
Financial statements can yield valuable insights into how well your small business is managing income and expenses. You’ll also need to present up-to-date financial statements to lenders if you plan to apply for small business financing at some point.
There are three financial statements that all small businesses should consider creating.
If you’re already using an accounting software program for small businesses, you may be able to generate these statements automatically using the expense and income information you’ve already entered.
Running a small business means you have to file a tax return and pay what you owe, if anything, to the IRS. Businesses will need to pay federal and state taxes, as well as any local taxes that may apply. There are five types of small business taxes at the federal level:
Your business structure determines which types of tax you must pay. Remember that if you have employees, you’ll also need to account for payroll tax. If you’re unsure about your tax obligations, you may want to talk to a professional accountant or tax expert for advice.
Small businesses that are required to pay estimated quarterly taxes but fail to do so may be assessed a penalty by the IRS.
The IRS allows business owners to deduct a number of expenses. Deductions reduce your taxable income for the year. Some of the expenses you may deduct include:
Again, you’ll need to keep track of all of these expenses and maintain the proper records for each one. Keeping accurate records serves two purposes:
If you’re using tax filing software, you may have the option to organize and store receipts electronically.
Software programs, apps, and tools can save your business time and potentially money if you’re able to ensure more accurate accounting. Using a software program can also eliminate the need to retain a full-time accountant, which can add to your business expenses.
Additionally, accounting software can help you to:
There are numerous software options for small businesses, with QuickBooks and FreshBooks being two of the most popular. When deciding which software program to use for accounting, it helps to first consider what your business needs. You can then compare different programs to evaluate the range of features and benefits that are included, and the overall cost of using it.
While you could handle accounting for your small business on your own, you may consider outsourcing it to an accounting pro.
In terms of the advantages of doing so, letting someone else handle your accounting means you have one less thing to worry about. Instead of crunching numbers, you’ll be free to focus on other tasks that are necessary to run or scale your business. An accountant can also ensure greater accuracy and may be more knowledgeable about the tax code and reporting requirements.
The disadvantage is that outsourcing means your business’s financial information is being viewed by someone else, which you may or may not be comfortable with. Aside from that, you also have to consider what you might pay to hire an accountant on a full-time or part-time basis.
In terms of how to choose an accountant, you may ask other business owners you know for a referral. If you’re able to get a few names, you can schedule meetings with those that look promising. During your meeting with them, consider asking the following questions to get a better idea of how well they align with your business:
You might choose to work with a virtual bookkeeper if you’re comfortable connecting via Zoom call or email. The fees may be lower, but be sure to ask about their background and experience before entering into an agreement to contract their services.
Following best practices can minimize room for errors in your small business accounting and help you to keep better records. What those practices look like may vary from business to business, but at a minimum, it’s a good idea to include the following:
Setting up a document management system can help with organizing your records so that they’re easier to review. There are different ways to organize files, depending on what you need to store.
You might choose to use document management software to keep track of key financial information and statements. You’ll want to periodically back up your files and ensure that you’re adhering to security protocols so your information isn’t compromised. For example, if you need to save a copy of a document separately from other files, you may put it in its own password-protected folder inside your document management software.
Using accounting software can allow you to save time when managing the books for your business. You can sync financial accounts to easily import transaction history, track expenses, double-check transactions for accuracy, and generate important financial statements.
Some of the best ways to ensure accuracy in financial records include keeping business and personal accounts separate, using an accounting software program to track cash flow, regularly updating financial statements, and conducting an annual audit to review your business’s financial history.
Small businesses need to keep accurate records relating to any expenses they incur, particularly for expenses they plan to deduct. It’s also important to keep records of any agreements with vendors and suppliers, bank statements, documents showing payment of estimated quarterly taxes, and annual tax returns.
The importance of accounting for small businesses can’t be underestimated. Whether you’re starting a brand-new business or you have some experience under your belt, creating a solid accounting plan can help you monitor and maintain your financial health.