Money is the lifeblood that flows in and out of a business. You are in business (hopefully) to make money. However, a poorly run company will either not make money or squander the money it does make. The biggest factor in making money is keeping accurate accounting records. You need to know what money is coming in, what money you owe out, and how much cash you are spending to operate day-to-day.
Secondly, you need to have accurate records to know how much taxes you will owe. When you report to the IRS, you will need to list your income and expenses. Therefore, it is important to keep a recording of your business transactions. There are two methods: cash basis and accrual basis.
A cash basis is the recording of income when you receive it and expenses when you pay them out. The reason that distinction is critical is that you will only be accounting for the money you have actually received. An accrual based accounting method is the recording of income when it is earned, regardless of when the cash is physically received. Likewise, expenses are deducted when they are incurred, not when they are paid out. It is a good idea that you utilize both forms, as you will need to always have an accurate picture of your financial position (accrual) and your reserves on hand at any time (cash).
But let’s not get ahead of ourselves. Before you can start evaluating different accounting methods, you need to first be set up to handle financial transactions. Below are some steps to starting your accounting books:
1. Set up a business checking account. Never mix your personal accounts with business, no matter how big or small your business is. Same goes for business expenses. You will need to set up a separate checking account under the business’ name with you as signatory. Make sure all income goes into that account, and all expenses out of that account are for business and business only.
2. Take inventory. You need to have an accurate listing of all your business assets and liabilities. You will need the current day value of your assets (such as your inventory, machinery and equipment). For this, you might need to consult a qualified accountant who can help you determine the proper amount of depreciation to ascertain current value. You also need have a correct amount of your liabilities (what you owe such as loans or invoices to other vendors). You need to know the financial status of your business today before you can look to the future.
3. Buy accounting software. If you cannot afford to hire an accountant long-term, then at least hire one temporarily to help you set up your books. Both Quicken and Peachtree are great accounting software programs that are easy to use for owners with limited accounting knowledge, however you will need to properly set up your account and list your current inventory (as stated above). Once your business account is set up you can begin entering daily or weekly transactions. The great thing about these programs is that they can run many reports for you, and will assist in helping you track expenses as well as generate invoices and payroll.
4. Learn some accounting basics. At the very least, you will need to be familiar with some basic accounting terms and principles. You need to know whether or not a business purchase is for an asset or is an expense. An asset is any equipment or machinery you purchase which you will use to operate. This will be depreciated over time. An expense is something that will count against your income, such as office supplies. Secondly, you will need to know which expenses are tax deductible, and which ones aren’t. An accountant can guide you through this distinction. Bottom line, if you don’t know what type of transaction you are entering, your books will be harder to analyze and your information may be inaccurate when the time comes to do your taxes.
5. Record transactions every week. Finally, you need to make sure you are staying on top of your income and expenses. The longer you go without entering any transactions, the harder it will be. While not everyone has the time to do accounting transactions each and every day, you need to make a point to do transactions weekly so you don’t get behind. If you are current in your accounts, then you will be able to assess the financial health of your business at any moment.
It is never too late to set up some solid accounting practices, so start keeping up with your financials sooner rather than later.