The Basics of Accounting for Small Businesses
Knowing the basics of accounting and bookkeeping is essential in knowing, and growing, your business.
Basics of Accounting: Bookkeeping vs. Accounting
Bookkeeping and accounting are often mistaken as serving the same purpose. In the larger sense, this is correct, as both bookkeeping and accounting aim to assist businesses grow in a financially responsible manner. However, when you take a closer look, you'll see that bookkeeping and accounting are two separate tasks which share a symbiotic relationship. In order to properly grow your company, you'll need to understand the basics of both accounting and bookkeeping and how they interrelate to help your business.
Bookkeeping primarily entails:
- the systematic recording of all of the business' financial transactions
- accurately extracting financial information from business transactions in a form that can be analyzed for issues related to taxes, financial reporting, and the financial position of the business
Accounting generally encompasses:
- interpreting the data provided by the proper recording and extraction of financial information
- providing financial advice about the business' present and future direction
Think of bookkeeping as the first filtering step, where accurate data is recorded, and accounting is the next rung up, where decisions are made based upon the data provided. Both share the same goal of increasing the business' financial security, and you really can't have one without the other (although many businesses combine the two duties into one position) in a business that's running at maximum efficiency. For ease of reference for this basic overview of business accounting, we'll refer to bookkeeping and accounting as the single idea of accounting, as they share the same goal and contain overlap in the duties typically assigned to them.
Basics of Accounting: Maintaining Accurate Records
Much of accounting consists of the non-glamorous "grunt" work of taking your expenses and revenues and systematically and meticulously entering them into your records. You must faithfully keep each receipt and record all financial transactions, including payments received and expenses paid out by the business. You'll need to keep detailed records and keep receipts for at least four years (for tax purposes).
Through this information, you can create summaries of income and expenditures on a regular basis (daily, weekly, monthly) to give yourself a snapshot of the financial state of your business at any particular time and to chart its progress.
Basics of Accounting: The General Ledger
A general ledger is the core of a business' records. It's the single document that presents a record of revenues and expenses, and every financial transaction will make its way onto the ledger. It serves as a permanent record of the business' financial dealings and progress. Every important financial document related to the business, such as balance sheets and profit and loss statements, are derived directly from the general ledger.
Because the general ledger is so important to your business, you'll want to make sure that your receipt-keeping and data entry of the financial transactions is precise. There are also sub-ledgers, which eventually make their way into the general ledger as well. For example, you might have an accounts payable sub-ledger where you log every outgoing check. Once the check is deposited by the recipient, that information is inputted (or "posted") into both the sub-ledger and general ledger.
Keeping receipts and having an accurate record of your transactions is just the first line of defense in your business' financial security. Next, you'll have to take that information and post it to the ledger(s). You don't have to post to the ledger after every transaction, but you should do so at regular intervals which are appropriate for your business. The last thing you want is to fall too far behind and eventually become overwhelmed by the amount of paperwork. Catching up is difficult to do, and more of a headache than it's worth, so be sure to stay on top of posting regularly.
How frequently you post to the ledger will be determined by the amount of business you generate on a regular basis. Large clothing retailers and restaurants have a huge volume of sales and expenses on a daily basis and these transactions need to be recorded meticulously and then posted at the end of the day. On the other hand, if you have a lower volume business, you can probably post on a weekly or even monthly basis.
Your general ledger provides you with information with which you can accurately gauge your business' financial health and also provides a defense against an audit (either tax or other outside audit). You'll also want the record so that you can quickly find any discrepancies to resolve disputes with customers (for instance if you've double billed, you'll be able to see it).
Basics of Accounting: Writing a Financial Report
The point of keeping such accurate records and creating a ledger is to provide you with information with which you can make sound economic decisions for your business. The financial report is basically an analysis of the information provided by your record-keeping and ledger entries. You take the data and distill it into a form that helps you see where the business is making money, where cash flow needs to be improved, and the state of your capital investments.
A financial report can be one single document or several smaller documents, depending on your wishes and the needs of the business. Common reports include income statements, statements of capital, balance sheets, profit and loss statements, and cash-flow statements.
The bookkeeping and accounting tasks outlined above can be done on your own, but with the easy availability of quality accounting software programs such as Quicken, you should seriously consider using those programs to help you in the task. The software can help you keep accurate records and create basic financial reports to ensure your business' security.