Bookkeeping for Entrepreneurs
Bookkeeping can actually make or break your business. When they talk about half of all businesses going under, they often fail to mention why. It’s sad to say that many profitable business ventures actually go under simply due to poor bookkeeping practices.
Bookkeeping for entrepreneurs isn’t really that difficult. It’s all about recording what is coming in and what is going out. You need to do this for a variety of reasons such as so you can do your taxes, make good business decisions, and more. It’s much more than just knowing how much money you have.
- Helps Make Tax Time Easier – When you have everything organized, doing your taxes will take no time at all. In fact, if you have a typical small business, your taxes can literally be done within minutes using tax software. It also pays off if you have a tax accountant, because when you keep excellent track of everything properly your accountant can do their job better too.
- Supports Better Decision Making – When you have all the numbers right in front of you, it’s a lot easier to make the right choices about your business. You’ll be able to look at the numbers and know whether or not you’ve priced your products correctly, or need to discontinue some or bring in something new.
- Assists with Banking Needs – Sometimes, even small businesses need to get loans. The best way to be able to get a loan is with solid financial documents, which when done correctly can hold up as proof of income so that you can get loans when needed.
- Better Tracking of Accounts Payable – You want to ensure that you have good credit for your business, as well as maintain the right cash flow to support your business. If you have no idea who you owe and when the bill is due, you’ll have a hard time managing your cash flow.
- Better Tracking of Accounts Receivable – Just like you need to track what money is going out, you also need to track what money is coming in and what money is supposed to come in. If you don’t have a good handle on what is owed to you, you will have serious cash flow issues that can cause your business to go under.
- Helpful for Monitoring the Health of Your Business – When you do your bookkeeping right, you can truly monitor the health of your business. You can know if your advertising is working to promote your product. You can know down to the penny how much you made on each product or service you offer, so that you know when to adjust your prices up or down.
Bookkeeping for entrepreneurs isn’t hard, but it can be tedious. However, it is very important. Sadly, a lot of entrepreneurs get overwhelmed and don’t keep track of anything and have no idea where they stand.
Not keeping track of your income and expenses can cause a perfectly good business to fail. If you keep track of these things, you’ll give yourself a fighting chance to make it work. Plus, it’s not that hard to keep track. Today there is automation software that makes everything much easier for any entrepreneurs.
Types of Accounts Most Small Businesses Keep Track Of
You may have different accounts than these, but most entrepreneurs have these basic accounts to keep track of. How this is set up will depend on what accounting software you use. Later, we’ll talk about different choices that may work for your needs.
- Cash – This is the main account which every transaction actually either goes into or comes out of. It’s your main business bank account where all transactions occur.
- AR – Accounts receivable are the accounts where you have sent an invoice to someone and they owe you the money. Keeping up to date about this type of account is imperative if you want to ensure good cash flow.
- Inventory – This is how much product you have on hand to sell. If you sell digital products, this will not be an issue for you. It only works with physical products.
- AP – Knowing what is going out of your business in terms of expenses is very important. This will affect the cost of doing business. If your business costs 1000 dollars just to keep the doors open but you only have 500 dollars coming in, you’ve got a serious shortage. If you don’t track this, you won’t realize what’s happening.
- Loans Payable – This is a little different because you can deduct interest on the loans as well as the payment on things that you use for your business. How you deduct loans depends on how you set up your accounting system. For example, if you’re on a cash basis you can actually deduct the full price of items bought on credit – even if you haven’t pay for them yet, then deduct the interest too.
- Sales – This is the account that shows all revenue coming in from what you sell, regardless of whether it’s physical, digital, or a service. If the money was made on a sale, then it should go here. If you sell books in the traditional way, you should also have a “royalties” account in order to keep track of that separately.
- Purchases – If you have raw materials or finished goods used to create your products, such as wood, nails, paint and so forth for your woodworking business, then you should keep track of them here. This is how you calculate “cost of goods sold”. If you don’t have physical products, you don’t need this.
- Expenses – This is anything you buy that is for your business directly. For example, if you purchase accounting software for your business, this is deductible from your income and therefore something you should keep track of.
- Payroll Expenses – If you have employees, you’ll have to keep track of all of your payroll expenses separately from other things that you purchase. Not only for your own use; the government requires that you keep accounts for your payroll taxes and other employee expenses. If you don’t have employees, you might have an account for contractors instead.
- Owners’ Equity – When you add money to your business, it is considered an investment and goes into owners’ equity. You might instead have a “Capital” account and an “Owners’ Draw” account. This keeps track of money you put in and take out of your business.
- Retained Earnings – This is where any profits that you make are re-invested into the business and not ever given to the owners of the business. This total continues to run forever as long as the business is opened. This helps you track how the business is doing over time.
The best thing to do so that you can get an understanding of this is to take a look at what goes on the Schedule C when you file taxes for your business, and make sure you have an account that tracks those items. Then, consider the money information you need to know in order to make good business choices and keep track of that.
Bookkeeping Options for Entrepreneurs
There are many different options you can use for handling your bookkeeping as an entrepreneur. After looking at the options, you’ll need to decide which one you want to use. Remember, whatever you choose today you can always change later. The important thing to do is to ensure you pick a way from day one to keep track of your income and expenses.
Do It Yourself
Many small business owners and entrepreneurs choose to do their own bookkeeping. In fact, most people do start out that way when their business is small. Most people have no choice because it can be expensive to hire an accounting team when you don’t have any income coming in yet.
It’s important to remember that if you don’t have any training to be a proper bookkeeper, you’ll need to learn and educate yourself. A great resource for education on how to handle your small business bookkeeping is to read books on the subject written by people who understand and can write for people who don’t.
Also, you can choose some form of financial accounting software to help you. We’ll talk more about the options later.
Hiring a Bookkeeper or Firm
You can hire a bookkeeper both in person and online today. Look for someone who has experience and at least a certified bookkeeping certification. It also helps if they’re experienced with your type of business. The reason is that no one can be an expert on everything. But, they can be an expert in one thing.
The great thing about having a bookkeeper or a firm is that if you follow their instructions, you can keep your business organized without any problem – no matter how large your business becomes. But, you will have to manage your bookkeeper and check up on the firm to ensure that there are no issues with theft or mistakes. Even if the professional makes a mistake with your books, it is you who are liable if something should go wrong with taxes and other legal obligations.
Training Your Office Staff
When it comes to bookkeeping, you can actually train your normal office staff to do the data entry for you and handle bank reconciliation duties. You can even train a virtual assistant to deal with your bookkeeping needs if you have set up a system to scan receipts, and you use an online system to help give both of you access to the books.
The drawback to this is that they don’t really know what they’re doing outside of what you’ve trained them to do. If you have learned something incorrectly, you’ll pass on that incorrect knowledge to the assistant. One way to combat this is to hire a CPA firm to train your assistant to do your books correctly, based on how they set them up.
Some business owners prefer to hire a CPA firm. This is a firm full of certified public accountants. They’ll help you set up your accounts, and choose the software you should use and other aspects for you. Then, you can use one of their staff bookkeepers to double check your data entry (or your assistant’s) for accuracy on a periodic basis (usually monthly), to close out accounts and books.
This can be an expensive option, but since the CPA will likely be handling your taxes and other filings with the government, it can be very hands off and helpful. You will simply follow their instructions on how to keep track of everything and essentially hand it off to them. For some types of businesses, this can be overkill though, since it really is simple to do it yourself if you have a very simple business model.
Regardless of which option you choose, you’re still going to have to invest in some form of financial accounting software. All firms and bookkeepers will want to use the software they’re accustomed to using, so if you are going to hire someone, be sure to check with them before choosing software. If you’re doing it yourself then you can choose based on what you like best, your budget, and your needs.
Financial Accounting Software
There are many choices today when it comes to financial accounting software. You can use native software or cloud-based software. It just depends on what you’re comfortable with using. Let’s go over some of the best options.
- Quickbooks – This is probably one of the ones you’ve heard of before and is used by a lot of accounting firms, bookkeepers, and entrepreneurs. You can use both the cloud version and the native version depending on your needs. It’s great to use the online version because you can connect to your bank account so that you can track your income and expenses with some automation.
- Wave Accounting – This free software is fully featured and yes, it’s free. The only way you’d pay money for this software currently is if you use their credit card processing or their payroll services. This software is easy to use and set up. You can connect with your bank accounts and it does everything you’d expect from accounting software.
- FreshBooks – FreshBooks markets their software as accounting software, but we disagree. It is great software to use for time tracking, project tracking and invoicing, but it is not a complete accounting software or bookkeeping system. It works well with other software, though, and is a great system.
- Xero – This is complete software that can handle anything you have to give it in terms of small business accounting. You can try it free and the price is low enough that any business can afford to use it. Also, they have special services set up for accountants and bookkeepers so it’s also a good choice for them.
- Zoho Books – This well-priced cloud-based software is perfect for most small business owners. They even have advanced inventory management software, which is great if you have physical products. Plus, if you have a membership, this one (with an inexpensive add-on) can handle subscription payments too.
- Go Daddy Bookkeeping – One of the choices that are a little different than the above is Go Daddy Bookkeeping. Unlike all the others, which are double entry systems, this is a single-entry system and super easy to use. If you have a very small service-based business, or a single owner online business of some kind, this may work great for you. It’s easy to set up and understand for non-accountants.
- MS Excel – You can use MS Excel as bookkeeping software with the right set-up. If you know how to set up formulas and books, you can make your own. If you don’t, you can download templates for it. Some people just like doing it the manual way, and that’s fine, as long as you keep it up.
The best way to choose is to have an understanding of what you need to track, and then choose the best software for that purpose. Also, test out each software idea before making a commitment. No matter how easy someone says it is, it’s only easy if it works for you in the way that you like to do things.
Steps to Creating Your Bookkeeping System
Creating an easy-to-follow bookkeeping system is really all about categorization and organization. If you are organized and set aside time in your day to do bookkeeping duties, it shouldn’t take you more than a few minutes a day to keep your bookkeeping perfectly up to date.
Choose Your Accounting Method
This is one of the first things you need to do, and this is prior to considering which type of software you want to buy. You need to figure out if you’re going to do your books on a cash or accrual basis. The method you choose will inform how you recognize when income is received and when expenses are booked or recorded.
- Cash Method – Income and expenses are only recognized at the time they are made. So, you record an expense right when you make it even if it’s on credit, and you record income the day you get it, not the day it clears the bank.
- Accrual Method – Income is recognized the moment the order is made even if the money hasn’t cleared yet. Same with the expenses; you count them the moment the order is made even if you haven’t pay for it yet.
In order to choose the right accounting method, you need to understand which one you can choose. The easiest method is the cash basis method, and you can choose this as long as you have less than $5,000,000 dollars’ worth of sales. If you have more sales than that, or your stock inventory that you sell to the public and your gross receipts are over $1,000,000 per year, then you’ll need to use the accrual method.
Figure Out How People Will Pay You
Now that you know which method you’ll use for bookkeeping, you’ll need to choose how people will pay you. Will people pay you via credit, check or barter? Will you invoice them, or do they pay at the point of sale? Knowing how you’ll handle payments will help you set up the right system.
For example, if you want to take credit cards, you may need your bank to set up an authorize.net system for you. If you want to take PayPal, you’ll need a PayPal business account; if you want to take checks you’ll need to work with your bank. However you choose to accept payment, set it up in advance and be clear about it.
Determine If You’ll Need a Payroll System
Do you plan to hire employees? If so, you’ll need your bookkeeping system to have a payroll option. This is because you have to withhold Medicare, social security and other withholdings from each employee’s paychecks. This can be difficult to keep up with, but it’s easier if you have a good accounting system that enables you to do it easily.
If you do not plan to have employees but only contractors or “1099” workers, you don’t need a payroll system as you simply pay them the agreed-upon amount. In some cases, you may need to send each contractor a 1099 form in the mail at the end of the year; no later than January 31st. Please read about the current laws to ensure that you’re following them.
Determine If You’ll Need an Inventory System
If you don’t have physical inventory, you don’t need an inventory system. Even though you may artificially limit the number of digital downloads you allow for your digital product, an inventory system is not needed in the traditional sense.
You really can’t do without an inventory system if you do have physical inventory. It’s a necessity – not only for your records but for tax purposes too. Avoiding these things may not save you money. Most people who don’t keep track of everything properly tend to overpay on their taxes rather than underpay.
Understand Whether or Not You’ll Need to Collect and Pay Sales Taxes
If you sell physical items, you’re going to have to collect sales taxes in your home state, as well as any state your business has a nexus in. This means that if you have sales people (even contractors) in a particular state or an actual business in that state, you’ll need to collect sales tax and pay the sales taxes in every state. This is something you most certainly should discuss with a CPA to ensure that you do this accurately.
Choose Your Software
Once you are aware of all of the above, you need to choose the type of software you’re going to use, or whether or not you’re going to do it yourself. If you’ll do it yourself, you can pick the software that best fits your needs and budget. If you choose to hire a CPA, you need to allow them to choose the software they’re most comfortable with.
If you’re picking your own, use the free trials to try out different software. At least set up the chart of accounts, and enter some data so that you can figure out if it’s user-friendly for you. Even though most of the software out there does the same thing, one will feel easier to use than another. The best thing to do is choose the one that is easiest for you so that you’ll keep up with it.
Open a Business Bank Account
It’s very important to open a business bank account so that you can do business. It does cost a little more than a personal account. However, if you want other people to take you seriously, and you don’t want problems with the IRS, it’s best to keep business funds and personal funds completely separate.
To open a business bank account you’ll need a business license and an EIN (employee identification number), even if you don’t plan to hire anyone. Check with your city and county license department for what to do.
Get a Business Credit Card / Debit Card
Once you have a bank account, you’ll want to get a business credit card or at least a debit card. It is very helpful when you’re out and find something that would work for your business. If you keep business and personal purchases separate, it’s going to be a lot easier to keep your bookkeeping and finances accurate.
Put Every Transaction into Specific Categories
The thing that the chart of accounts does for a business is to put everything into a particular category. This is probably the best way to organize your files in accordance with state and federal requirements, so that you can prove your deductions if you ever need to. If you know what category a transaction goes into, you’ll have an easier time with bookkeeping duties.
Keep Everything Organized
It’s important to set up a way to keep everything organized where it’s easy to find. The best way to do it is to set up a procedure for how you handle all your receipts, paperwork, and information that you need to save each year. You can use something as simple as an accordion file, or you can scan everything and save it in the cloud. There are special scanner apps just for this purpose that you can download for your mobile devices.
Do Your Monthly Reconciliation
Never skip each month’s reconciliation. You want to reconcile the bank account, double check AR and AP, and handle all your state and federal requirements. Waiting can cause you to miss out on something, and late fees and issues ignored today can cost a lot more tomorrow. If something is not right, you’ll be able to get it resolved faster if it’s recent.
Keep Data Entry Up to Date
Set aside a specific time at least once a week to update your data entry and bookkeeping. If you have a lot of transactions that aren’t automated, then you may need to set aside time each day to work on it. If you set aside the time you need now, you’ll save time later, because it’s a lot easier to book things correctly if you’re doing it in a timely manner.
When you are recording any type of transaction, always be as detailed as possible. Write down on the receipt information that you may need if a question ever arises. Keep everything together so that you can find it too. The more detailed you are now, the less you’ll need to try to remember tomorrow. Also, you won’t remember as much as you think you will about every transaction.
Keep Personal and Business Finances Separate
This was mentioned above a little bit, but it needs to be repeated to make it clear why. When you co-mingle your business accounts with your personal accounts you can get confused about what is income, what isn’t income, and how much you can actually pay yourself. Just because you bring in a certain amount each month doesn’t mean you can spend it all; probably half or more of it is an expense.
Always Back Up Your Data
Don’t do all that work without backing up your data. Most systems have some form of back-up system. If you use a cloud system you probably don’t even have to worry about backing up, since they use redundant systems. You should definitely ask your cloud service whether or not you should back up or not.
Use Automation When You Can
Most bookkeeping software has some form of automation. Usually, you can connect your software to your bank account. If you can do that, it’ll automatically book a lot of transactions for you without your having to do any data entry. It is important to double check on a scheduled basis if the automation is working properly and booking transactions properly. The right automation can save you hours each week.
Use Scanning to Support Income and Expenses
One way to automate and keep things organized is to use a special scanner to turn all your paper into legal digital documents. This will make them searchable too. Some bookkeeping software has these functions and allows you to attach the receipt to the transaction when needed.
It’s very important that you set up some sort of procedure for these tasks so that they become a regular part of doing business. If you do it regularly, you’ll also learn the software. Also, there is something wonderful about being able to print out an accurate profit and loss statement at a moment’s notice.
Possible Deductions You Should Track
Always check with a tax professional before you take any list like this to heart. The reason is that there is no way that anyone can know what is deductible for your particular type of business. Some of these may be deductions you can take, but some may not be. However, this list is designed to help you get an idea of what might be possible.
- Business gifts
- Business meals
- Business use of your vehicle
- Charitable contributions
- Home office
- Legal and professional
- Office supplies
- Travel expenses
The key to whether an expenditure is deductible or not, is whether it’s a normal and regular business expense for your industry. That means other businesses like yours do it and expense it, because the item is needed in order to do business. It’s also important to stay up to date on changes in the tax laws, because things change constantly.
Common Financial Formulas Bookkeepers Need
Even if you plan to hire someone to do your bookkeeping for you, it’s important to have a general understanding of the different formulas and terms used in bookkeeping and financial accounting.
Assets = Liabilities + Owner’s Equity
- Assets – What you own for your business, which includes all furnishings, inventory, property and so forth.
- Liabilities – Anything that you need to pay to stay in business: loans, taxes, fees, and so forth.
- Owner’s Equity – This is what you’ve invested in the business minus the draws you’ve taken on the business, plus the net income of the business since the day your business began.
Net Income = Revenues – Expenses
- Revenues – The cash flow you get from sales.
- Expenses – The costs associated with the sale.
- Net Income – The money left from revenue after all your expenses are deducted.
Break-Even Point = Fixed Costs / Sales Price – Variable Costs Per Unit
Fixed Costs – Many fixed costs are costs that recur such as rent, software subscriptions, salaries, insurance and so forth. If you need to have it in order to produce the product and make the sale, then it’s a fixed cost.
Sales Price – The price you actually sell the item at.
Variable Costs per Unit – This is how much it cost to make each item that you sell. If you are selling digital products, the VCPU is zero. If you make a physical product, the cost typically goes down the more items you produce.
Break-Even Point – This is how much you need to make to stay in business to simply cover your business costs or cost of doing business.
Profit Margin = Net Income / Sales
Net Income – The amount of money you’ve earned after all your expenses have been deducted from revenue.
Sales – How many sales you’ve generated in the period.
Profit Margin – You want to look at this number to ensure that your net income is reasonable for your industry. If you have a low profit margin, your company may need some tweaks to fix it. If you have a high profit margin, then you’re doing great. You can check this with industry standards to see where you stand.
Cost of Goods Sold = Cost of Materials / Inventory – Cost of Outputs
This formula is only needed if you actually produce something yourself. For example, if you make knit items for sale on Etsy, then you’ll need this to ensure that your business is healthy and your costs aren’t too high for what you’re charging people.
Cost of Materials / Inventory – How much does it cost your business to buy the materials, tools and more, necessary to produce your product? You can figure this out by working out how much you spent on materials, then dividing it by the cost of the inventory’s worth.
Cost of Outputs – How much did it cost you in total to produce the items you plan to sell?
Cost of Goods Sold – This is what you’re paying to make your product. It’s a good figure to know so that you know how you fit in with the rest of your industry. Plus, if you don’t know this figure, how can you know if you’re really profitable as you could be?
Typical Financial Statements You’ll Need to Produce for Your Business
There are a few different types of financial statements that you may need to produce for yourself and others. These statements can point to the health of your business at any given time.
This is a snapshot of your business on a particular day in time. The first formula which is the Accounting Equation: Liabilities + Owner’s Equity = Assets is essentially the balance sheet. Most financial software will produce this for you automatically with a touch of a button. As long as you’ve done your data entry right, the balance sheet will be accurate as of that date. Both sides of the balance sheet should be equal if you’ve entered everything properly into your system.
Profit and Loss Statement
Some people also call this an income statement. This basically lets you know what your net income is at the time of creating the statement. To determine your net profit, you’ll need to use the Net Profit formula: Gross Profit – Total Operating Expenses = Net Profit.
Most accounting software will also produce this document for you with a touch of a button. It’s important to figure this out occasionally and at least quarterly, so that you can pay your self-employment taxes properly.
Cash Flow Statement
One of the most often overlooked financial statements among small business owners is the cash flow statement or statement of cash flows. This statement helps you understand how much money is coming in and going out of your business on a periodic basis. It’s based on any type of cash coming into the business (not just income from sales), and any type of money going out of the business (not just expenses).
The formula looks like this:
Beginning Cash Balance + Cash Inflows – Cash Outflows = Ending Cash Balance
Understanding your cash flows will help you run your business better. Knowing it, you can make a cash flow budget to help you better manage your business so that you always have enough cash on hand. For example, if you have a slow time of year, you need to manage the cash flow when it’s high so that you can cover times when it’s low.
If you want to get started on the right feet with bookkeeping for entrepreneurs, remember that this is one of the most important aspects of business success. Knowing your numbers is important because you will be acting with knowledge instead of just guessing. Guessing can be a big mistake.
Knowing the real numbers will help you know if your business is becoming more profitable as you go. It will also mean that you will know when you need to do something to save your business. Business bookkeeping isn’t really that hard. People like to make it more complicated than it is. It’s simply keeping track of everything coming into your business and going out of your business on a regular basis, and keeping the documentation for it all in an organized manner.