You may have initially thought that starting a small business is as easy as selling your products or services and turning it into profit. But, any financial planner like Capstone would most likely tell you, you’ll have to do accounting.
Every business needs to do it so that they can manage their finances and make sound decisions that will help them in the long run. To make keeping your books more efficient, focus on all other aspects of your small business afterwards, here are some of the best practices you should apply:
1. Keep business and pleasure separate
Even if you have yet to make your first accounting entry ever, you should already start opening a savings account for your small business. Make sure not to use any of the money in your business savings account for personal expenses. Don’t get tempted to pursue the seemingly convenient option of having only one bank account as you’ll have a hard time knowing whether you bought something for yourself or your business. You’ll also have trouble figuring out whether a certain amount of money you deposited in your bank account is for personal or business use if you don’t open another one where you can stash all of your venture’s earnings.
2. Record every business expense you make
Regardless if you took out money from your business savings account and used it for something as small as printing out customized calling cards or as big as a fleet of delivery trucks, you should track every expense that you make for your little venture. As already mentioned earlier, you should keep all of your purchase receipts so you can present proof to your government’s tax collection agency should they perform a full-scale audit on your small business. Scanning digital copies of those receipts should be fine – though you should still secure all written and printed ones in a place where they won’t get wet or catch fire.
3. Draft a balance sheet as well as income and cash flow statements
Once you do accounting for your business, you’ll find yourself spending hours working on the following financial documents:
Your balance sheet reflects how much your small business is worth and should have these three sections:
1. Assets that you have to divide further into two, namely:
- Liquid which includes cash that you can see with your very eyes as well as any other business assets that you can easily exchange for real money, and
- Non-liquid which consists of any assets that you can’t convert to cash right away such as the land where you decided to build your small business, the building on top of it, and any equipment that you have as well as intangible ones like patents and licenses.
2. Liabilities such as the amount of money you owe to a supplier of your product as well as all other debts, both of which you have to break down into two, namely those that are due in a year and those with a more extended repayment schedule, and
3. Equity which should be equal to the difference between your small business’ assets and liabilities
However, your balance sheet should only have two columns with all of your small business’assets in one and the sum of all of its liabilities and equity in the other. Both columns should reflect the same total amount. To illustrate:
Say that your small business’s total assets amount to $300,000.00 while its total liabilities amount to $120,000.00. Observing the equity formula as mentioned above, you should get:
$300,000.00 (total assets) – $120,000.00 (total liabilities) = $180,000.00 (equity)
It follows then that:
$300,000.00 (total assets) = $300,000.00 (total liabilities + equity)
If the two columns in your balance sheet don’t reflect the same total amounts, you’ll have to check if you forgot to include a specific business asset, liability, or equity in there or if you have duplicate entries.
Your income statement provides you with an overview of whether your small business is turning a profit or losing money and should have these sections:
- Revenue which you have to break down into two, namely earnings that your small business makes from selling products or providing services, and those that you earn by other directly related means like any income that a billboard you placed outside your building has generated.
- Expenses incurred for both direct and indirect business activities.
- Gains or any income that you earn outside of selling products or providing services.
- Losses sustained after selling a product at a severely discounted price without making any revenue from it only because you want to get rid of it as quickly as you can, settling a lawsuit, or any other instance where your small business loses money.
- Net income that you have to calculate using the formula: (revenue + gains) – (expenses + losses)
For a better grasp of how to compute your small business’ net income here’s an example:
Say that total sales of your product throughout a particular month amounted to $40,000.00 and you sold one of your delivery trucks for $3,000.00 anytime during that period. Aside from that, you also incurred a total of $12,000.00 in expenses for the same month and $1,000.00 after a competitor filed a copyright infringement lawsuit against you which you eventually won.
Calculating your small business’snet income for the month, you’ll get:
Net income for the month= [$40,000.00 (revenue) + $3,000.00 (gains)] – [$12,000.00 (expenses) + $1,000.00 (losses)]
Net income for the month= $43,000.00 – $13,000.00
Net income for the month= $30,000.00
Your cash flow statement should give a clear picture of how your small business pulls in money and spends it. Anyone who wants to invest in your little venture will refer to your cash flow statement to see if you’re doing well financially. Creditors will also use the same document to check if you have enough money to pay any business-related debts that you owe them.
Without going into too much detail, your cash flow statement will find you adding all money coming towards your small business and subtracting whatever amounts go out of it.
The paperwork that you’ll do as part of keeping your small business’ books will help you attain transparency as you have evidence to present to your government in case your venture has to undergo a random audit.
4. Know the right accounting method for your small business
Accounting is more than jotting down numbers and doing basic arithmetic to them as you’ll have to follow any of the following methods:
- Cash basis wherein you jot down your small business’ revenue only after you collect the payment for any products or services that you sold as well as its expenses after you’ve paid for them, and
- Accrualmethodwherein you have to make an entry on the day when your small business sells a product or service or incurs an expense regardless as to when you collect or make the corresponding payment for it.
If your small business doesn’t manufacture or keep any stock of the products that you sell to your customers, you can use the first accounting method. Otherwise, you should use the second one.
5. Set aside some time to keep your small business’ books
Doing accounting for your small business can be gruelling but only if you don’t update your entries regularly. Time management is critical when it comes to keeping your small business’ books accurate and timely.
If you can designate a few hours of your time to unwind or partake in a hobby of your choice, you can do the same for your bookkeeping. Just make sure to commit to your weekly accounting schedule and not let yourself be distracted by anything that isn’t an emergency as the future of your small business is at stake.
A 2015 survey Found out that only 40 percent of the almost 400 small business owners who participated in it have a high degree of knowledge when it comes to accounting. That’s why as a small business owner yourself, you should overcome your “fear of math” and get used to crunching numbers regularly.
However, keeping your small business’s books shouldn’t turn into a constant source of frustration and sleepless nights. The best practices listed above should make you slowly but surely appreciate doing accounting for your business that you might eventually find yourself enjoying it unlike before.