Accounting 101: A Guide for Small-Business Owners
Intro to small-business accounting
So you're launching a business—congrats! Your great idea, whatever it is (an Asian-fusion restaurant? A made-to-order clothing shop?), is the perfect start. But to stay on the path to success, you need more than a rock-solid pitch. You need the fiscal know-how to keep your business on track. If that sounds overwhelming, don't worry: here's our crash course in the most important financial tasks to check off your list to get your business off the ground.
Table of contents
1. Consult a bookkeeper, accountant, or CPA
You can learn a lot about basic small-business bookkeeping just from browsing the internet (say, a guide to accounting for small businesses . . . wonder where you'd find one of those). But nothing beats up-front, personalized advice from a certified professional—in this case, a bookkeeper, accountant, or CPA.
People who aren't bookkeepers or accountants often use bookkeeping and accounting interchangeably, but they actually mean two different things. Bookkeeping refers to keeping financial records. Accounting means not just keeping financial records but also analyzing and interpreting financial data so you can make wise fiscal decisions.
Bookkeepers, accountants, and CPAs all bring something different to the table:
- Bookkeepers keep and organize financial records. They can also handle financial tasks like payroll and invoicing.
- Accountants keep and organize financial records while providing deeper insight into your business's financial state. They can also tackle tasks like filing taxes.
- CPAs, or certified public accountants, are accountants who have passed the Uniform Certified Public Accountant Exam, which holds accountants to higher, more exacting standards.
Consulting with a bookkeeper will help you get organized and figure out exactly where you stand financially. An accountant or CPA will cost a bit more than a bookkeeper, but they can help with structuring your business, creating a business plan, and forecasting for the future.
Some CPAs and bookkeepers require a retainer if you want monthly assistance, but many simply charge by the hour. You can pay for the advice you need and go from there.
Consulting part-time with a bookkeeper or accountant can work nicely for newer, smaller businesses. But once your business is big enough that you can't (or simply don't want to) wrangle finances by yourself, it's probably time to get a bookkeeper or CPA on your payroll. If you don't want an in-house bookkeeping team, you can also outsource your finances to a virtual bookkeeping or accounting service for a monthly fee.
2. Create a separate business bank account
Ready for the first piece of advice your bookkeeper or CPA will give you? Immediately separate your personal finances from your business finances. That means setting up a separate business bank account to handle all your small-business transactions, including a business savings account to cover your business on a rainy day.
Why is separating your financial accounts so crucial? For one, it's easier to track your business's financial progress if it isn't jumbled with your personal cash and credit. For another, it protects you legally: if your business gets sued, your personal assets can't be taken as collateral.
How to open a business bank account
First, decide what type of bank account you need—business checking? Business savings? A money market account? Interest-bearing checking? A certificate of deposit (CD)? Your initial conversation with an accountant should help you understand what types of accounts you need and how many. At the very least, we recommend both a business checking account and a business savings account.
Second, find a bank that works for you. We have a few recommendations, but make sure you consider these key features while you shop around:
- Number of physical locations
- Number of ATMs
- Online/mobile banking
- Customer support
- Fees, including monthly fees, ATM fees, cash deposit fees, and paper statement fees
- Number of free monthly transactions
- Minimum opening deposit amount
What you need to open a small-business bank account
When you open an account (either online or in person), you'll need a few key documents. Hopefully, since you're this far along in the business-creation process, you already have these docs. But if not, here's your reminder to apply for them now:
- Your Employer Identification Number (EIN), which you'll apply for online via the IRS
- Your Social Security Number (SSN)
- Your federal and state business licenses or permits, which vary depending on your location and business type
If you've filed to create a limited liability company, or LLC, you'll need your articles of organization (or certificate of organization). Be prepared to present other documents that prove your business is real—your bank should give you a rundown of the legal documents they require so you don't show up empty-handed.
Generally, it's a good idea to use a business credit card, but don't rely on it to make overdue payments or fund big purchases. Most business credit cards offer customer rewards, which can save you money on travel expenses, and paying off your business credit card's balance each month is a good way to build good credit for your business.
3. Choose your accounting method (cash or accrual)
Business owners have to settle on one of two basic accounting methods before filing their first tax returns: cash-basis and accrual-basis accounting.
The accounting method you choose has a huge impact on your business, so we highly recommend you talk to your accountant, CPA, or bookkeeper about which method works best for you. With that caveat in mind, here's a quick overview of the two types—and which type certain businesses are legally required to use.
If you set up your finances with cash-basis accounting, you'll record financial transactions when the cash moves accounts.
Let's say your home repair company charges a client $5,000 for a repair you did on April 15, but the client doesn't pay you until May 1. In this case, you won't record the transaction until you receive the cash in May. The same thing is true of expenses: if you received an invoice in September but didn't pay it until November, November is when you'll list the expense.
If you set up your finances with accrual-basis accounting, you'll record financial transactions when they occur, not when the money moves accounts. Per our previous example, if you charge a client for repair work you finished on April 15, you'll record the income on that same date. And if you received an invoice in September, you'll record it then, not when the company you owe actually processes the payment.
Accounts receivable are lists of money owed you by clients. Accounts payable are lists of expenses your business owes. With accrual-basis accounting, you'll include your accounts receivable as current assets on your balance sheet and accounts payable as current liabilities. But cash-basis accounting does not use accounts payable and receivable.
Which method is right for you?
Some businesses aren't allowed to use cash-basis accounting, including businesses with inventory and companies that trade publicly on the stock exchange. So depending on the type of business you own, you might already know which method you're using. However, yours might be one of the businesses the IRS exempts from the rule (which is another reason to consult an accountant—you don't have to decipher the IRS's tax rules on your own).
For those businesses that can choose, here's a quick overview of each method's pros and cons.
For most businesses, accrual-basis accounting is a more accurate way to track financial trends, but it does present a key risk: if you charge a client in December who doesn't pay you until February, you'll have to record that income in December, which means you'll pay income taxes on it for the current tax year, not the next tax year when you actually have the money in hand.
And since you aren't looking at the exact cash flow, you'll need a super accurate cash flow statement—a handy document that tracks how much cash you have at a given moment—ready at all times so you aren't spending money you don't have.
But cash-basis accounting has its downsides too. While you won't pay taxes on unearned income, you could end up spending unwisely: unpaid bills won't show up on your income statement or be tracked as current liabilities, so you might invest with money you don't actually have.
Most accounting software providers let you choose which accounting method you want to use when you set up the software. Others (most notably Patriot Software) let you toggle between the two views. You'll still have to choose one method for tax purposes, but having the option to switch views is one way to track both cash flow and current liabilities.
4. Start bookkeeping
Once you've settled on an accounting method, it's time to create the actual books you're going to be keeping. Remember, bookkeeping means recording financial transactions. In turn, you can use these transaction records for accounting, or creating financial documents that will help you and your accountant make sound business decisions (more on those documents later).
Here are the main things you need to decide as you set up your bookkeeping processes:
- Which method will you use for bookkeeping: spreadsheets, accounting software, or in-house professionals?
- How often will you update your books?
- Will you use the double-entry or single-entry method of bookkeeping?
There are three primary methods for keeping your books:
- With spreadsheet software like Excel or Google Sheets
- With accounting software like QuickBooks Online or Wave Accounting
- With a bookkeeper or accountant
The first bookkeeping option is the cheapest: spreadsheet software. It's easy to find general ledger templates for spreadsheet software like Excel or Google Sheets. You'll enter transaction amounts and list dates, and the software's equation functions will crunch the numbers for you.
However, spreadsheets are cut out for only the smallest of businesses. Tracking sales tax, calculating payroll, and cataloging inventory are beyond spreadsheets' purview. With no safeguards, you might not notice an incorrect entry or calculation until your finances have already taken a hit.
Depending on the software provider you choose and the plan you sign up for, accounting software automates most of bookkeeping's most tedious tasks, from calculating sales tax to generating easy-to-read financial reports. Accounting software ranges in price from free to hundreds of dollars a month. And generally, no matter the plan or price, accounting software is infinitely more reliable than by-hand spreadsheet accounting.
Accounting software usually comes in one of two forms: desktop software, which you pay a lump sum for and download onto your computer, or cloud-based software, which costs a monthly fee and stores all your information in the cloud. Cloud-based software is the more popular choice. Their pay-as-you-go plans are often more affordable for small-business owners, and the cloud-based data makes collaboration easier.
Who else uses accounting software besides small-business owners? Accountants and bookkeepers. With cloud-based software, you can set up your business's books and then share them with your recordkeeper (or vice versa).
Accounting software can work well for small businesses, freelancers, or solopreneurs, but as your business grows, bookkeeping will start to take up more and more of your time. Hiring an in-house bookkeeper, setting up an in-house accounting team, or outsourcing your bookkeeping and accounting to a virtual provider is the most expensive accounting option, but it frees you up to focus on the business side of things (not just the financial side).
Again, this method is the most expensive, but it's also a huge time-saver once your business is big enough that you need more people than just yourself handling issues like payroll, taxes, and financial forecasting.
How often should you sit down with your books? As a responsible business owner, you need to record every single financial transaction you make—so the answer might depend on how many bills you pay and invoices you send out. At the very least, you'll want to sit down for bookkeeping monthly, but we strongly recommend you update your books at least weekly, though preferably daily.
Bookkeeping systems: Single-entry vs. double-entry
Single-entry bookkeeping means entering each financial transaction once. You list the transaction date, amount, and type (for instance, bill, sale, or interest payment), and that's about it.
In contrast, double-entry bookkeeping requires you to list each transaction twice, once as a credit and once as a debit. This method is definitely more complicated and has a bit of a learning curve, but it's a curve your accounting software, bookkeeper, or CPA can help flatten.
For most businesses, we recommend double-entry accounting. Yes, it's more complicated, but it's so much more accurate that it isn't really worth comparing the two methods. Most accounting software offers double-entry accounting, and it's how most accountants work too. Only try single-entry bookkeeping if you're a freelancer who works just a few hours a month—even then, double-entry bookkeeping might be the safer option.
5. Start recording financial transactions
You've opened a business checking account, chosen your accounting method, and decided how you're going to keep your books. Now you're ready to start recording the transactions themselves.
Here are some crucial terms you'll encounter when you first start keeping the books, especially if you use double-entry accounting:
- General ledger (GL): The "book" (physical or virtual) where you store and organize all of your financial transactions. The GL is organized by different types of financial accounts.
- Chart of accounts (COA): The list of every financial account in the general ledger.
Journal entry: A single financial transaction listed in your general ledger. When you add a financial transaction to the ledger, you're making a journal entry.
You'll record each transaction in a separate financial account in your general ledger. There are five primary types of accounts:
- Asset accounts, where you list everything your business owns
- Owner's equity (or shareholder equity) accounts, where you list everything you or your shareholders have invested in your business
- Liability accounts, where you list everything groups other than yourself or your shareholders have invested in your business (for instance, banks)
- Revenue accounts, where you list money your business earns by selling products or services
- Expense accounts, where you list the money your business spends to stay afloat and operational
For instance, accounts receivable (where you record outstanding client invoices) is an asset account—it's money you've earned and expect to be paid. Accounts payable (where you record bills you owe) is a liability account. An inventory account would be an asset account, sales income would be a revenue account, and salaries and paychecks would be an expense account.
Your CPA can advise you on which types of accounts you need. Alternatively, as you set up your accounting software, you should see a list of optional financial accounts for you to add to your chart of accounts and general ledger.
Information to store
To make accurate journal entries and record financial transactions correctly, you need to hang on to some essential documents:
- Tax statements
- Invoices and bills
- Employee tax forms, like W-2 and 1099 forms
Most accounting software automates entering information from the documents above. For instance, receipt scanners let you take photos of receipts that you upload to your software for easy journal-entry generation. And if you send invoices or pay bills with your software, the numbers should sync automatically with your ledger.
Your accountant can let you know how long you need to store physical and digital copies of the above types of statements. Typically, we say hang on to them as long as possible, and digital copies cause less clutter and are harder to lose (as long as you find an accounting provider with secure online storage—most have it).
6. Figure out your payment gateways
Unless all your financial transactions are bills (we hope not), you need a way to get paid to start fleshing out your ledger. You have a few main options, and the right one for you depends on your business size and type:
- Point-of-sale (POS) systems
- Mobile credit card readers
- Online payments
Taking in-person payments? You need a point-of-sale (POS) system. Along with a cash register (if you take cash payments), a POS system can include these components:
- Tablet, mobile device, or computer terminal and keyboard
- Credit and debit card swiper
- Receipt printer
Depending on your business, your POS system could also include a barcode scanner, customer-facing tablet, pin pad, or scale. Along with letting you accept cash, credit, and check payments, a POS system can track inventory, sync with your accounting software, and give you detailed, real-time sales reports. POS providers like Square even offer time tracking so employees can clock in and out on the POS system itself.
Mobile card readers
If you take in-person payments on the go, a hardware-based POS system might be too bulky. A mobile card reader paired with a POS app or cloud-based electronic point-of-sale system lets you accept credit and debit cards using a device attached to your smartphone or tablet.
Accounting software providers like QuickBooks, Xero, and FreshBooks make it easy for you to draw up invoices, send them out to clients, and receive online client payments via the invoice. Pricier plans with providers like these offer features like batched invoicing, recurring invoicing, automatic invoicing, and late payment or unread invoice reminders for clients.
If you own an online store and don't see customers in person, you just need an online payment provider like Stripe, which lets you accept card payments online.
7. Hire employees and choose a payroll provider
Working on your own and for yourself? Skip this step! Otherwise, you need to set up payroll.
Classify your employees
If you employ an independent contractor (or 1099 contractor), you aren't responsible for withholding the contractor's federal and state income tax or paying unemployment taxes.
In contrast, if you hire W-2 employees, you'll withhold and pay their federal and state income taxes. You'll also withhold Social Security and Medicare taxes, pay employer Social Security and Medicare taxes, and pay federal unemployment taxes. Employers also have certain obligations toward W-2 employees, like health insurance benefits and workers compensation.
Classifying a W-2 employee as a 1099 contractor can result in huge penalties and fines for your business. Make sure to classify employees correctly up front to avoid massive financial and legal problems in the future.
You must have your W-2 employees fill out certain IRS forms to return to you ASAP:
- Employees should fill out and submit W-4 forms, which gives you the info you need to withhold the right amount of taxes.
- Employees must also fill out Form I-9, which certifies that they are US citizens and eligible to work in the country.
Employers must also report each new hire with their state's new hire reporting agency.
Choose a payroll method
As with accounting and bookkeeping, you have a few main payroll methods: by-hand payroll, payroll software, or professional accountants. If you really want to do payroll by hand, a payroll calculator can help you determine how much tax to withhold and how much to pay yourself. Honestly, we recommend payroll calculators only as a last resort—entering one digit wrong can land you in huge trouble with your employee and the IRS.
Full-service payroll software like Gusto or OnPay automates payroll. You enter your employees' information and the software calculates, withdraws, and files payroll taxes for you. Most full-service payroll providers offer a tax-filing guarantee, which means that if the payroll provider makes a mistake with your payroll taxes, they'll pay any IRS fines and deal with the fallout instead of you. And most payroll software syncs with accounting software to make journal entries and financial statements easier.
With cloud-based software, you'll pay a monthly base price and an additional amount per employee paid per month. If you work only with contractors, Gusto and Square both offer contractor-only plans. These plans waive the base fee. You pay a fee for each person you pay, but that's it.
Cloud-based software can start as low as $20 a month plus $2 dollars per payee or cost as much as hundreds of dollars a month for larger, established companies.
Like accounting software, payroll software works best for small to midsize companies. If you're managing more than a hundred employees, you'll probably want an in-house team to deal with payroll.
That could be a financial team—bookkeepers can calculate payroll taxes and accountants can file taxes, including payroll taxes—or an HR (human resources) team that handles wages, benefits, and paid time off. Businesses can also outsource their HR and payroll needs to payroll service providers or split the responsibility with a PEO, or professional employer organization.
Set a payroll schedule
Most employers choose one of four payroll schedules: weekly, biweekly, semimonthly, or monthly. Each payroll schedule gives you a certain number of payroll periods during the year:
- Weekly: 52 payroll periods a year
- Biweekly: 26 or 27 payroll periods a year
- Semimonthly: 24 payroll periods a year
- Monthly: 12 payroll periods a year
Some states regulate how often you must pay employees. Other states regulate payroll schedules only for certain industries, like childcare. You'll want to check your state's rules and regulations about payroll schedules and talk to your accountant about how to choose the right payroll schedule for your unique work environment.
8. Get familiar with your tax responsibilities
And now for everyone's favorite subject: taxes. You already know this, but just to make sure it's crystal clear, taxes are ridiculously complicated. Small-business taxes vary between industries, states, and business types, so to get the best advice on what taxes your business needs to pay, consult with your accountant.
In general, you can look forward ( . . . or not) to paying these taxes each year:
- Income taxes, which is a tax on your business's income and has a (shall we say) complicated relationship to your personal income taxes—talk to your accountant for help.
- Sales taxes, or a tax separate from income tax that is specific to your state. You must have a sales tax permit (or seller's permit) before you charge and gather sales tax. Check with your state on how to apply for a seller's permit.
- Payroll taxes, which include Federal Insurance Contributions Act (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes. FICA taxes are employer contributions to Social Security and Medicare, while FUTA taxes are employer contributions to unemployment taxes.
Self-employed? You'll be charged a self-employment tax, which is different from small-business taxes and personal taxes. We know it's exhausting—but we're rooting for you! Accounting software, accountants, and bookkeepers will be your invaluable allies in the quest to pay taxes correctly and on time. Don't be afraid to take advantage of their many resources.
How to file small-business taxes
The specifics vary, but almost every business follows these steps to get their taxes in on time:
- Assemble the right documents. These could include your employer identification number (EIN), bank statements, prior years of tax returns, and employee W-2 forms. If you use accounting software, it should help you store all this info in the right place to access easily during tax time.
- Parse your tax deductions. Small-business tax deductions could include travel expenses, meals, and business insurance.
- File the right tax forms. The forms you file differ based on what type of business you own. For instance, sole proprietors attach a Schedule C form to Form 1040, which is the individual tax return form. Partnerships file Form 1065, which reports a business's profits and loss, and a Schedule K-1 Form, which breaks down deductions and income by partner.
- File on time. Filing your taxes late can ding you with nasty penalties. Make sure to double- and triple-check tax deadlines and get your paperwork in (or file for an extension) on time.
Small-business accounting glossary
Here's a quick overview of the accounting terms you're most likely to encounter on a daily basis.
Accountant: A professional who records financial transactions, creates financial documents, analyzes financial data, and works to set financial goals.
Asset: Any resource owned by a company. An asset can be tangible, like a piece of equipment, or intangible, like a copyright.
Balance sheet: A financial document that shows your assets, liabilities, and shareholders' or owner's equity. If your business is healthy and growing, a balance sheet should show that your assets are equal to your liabilities and equity.
Bookkeeper: A professional who records financial transactions and keeps detailed financial records.
Cash flow statement: A financial document that shows all of a business's sources of cash, namely cash flow from operating, investing, and financing activities. The document also shows where that cash goes and determines if you have negative or positive cash flow. If you have negative cash flow, your business is losing money; positive cash flow means you're earning money.
Chart of accounts: A list of every financial account in your general ledger. Financial accounts include asset, liability, equity, revenue, and expense accounts.
General ledger: A collection of financial records and accounts that details a business's financial history. Information in the general ledger can be used to generate financial reports that help stakeholders make informed decisions about the business's growth and future.
Liability: Everything owed by a company (a.k.a. debts).
Profit and loss statement: A financial document that lists a business's profit and loss (including revenue, operating expenses, and non-operating expenses), also known as an income statement.
Small-business accounting checklist
Phew, you made it to the end—nicely done! Thanks for sticking with us, and best of luck to your small business. We know you're going to do great.
8 steps to launching your small business
✓ 1. Consult an accountant, bookkeeper, or CPA
Get expert advice on important topics like how to organize your books, what taxes you can expect to pay, and how to read important financial documents.
✓ 2. Create a separate business bank account
Protect yourself legally and financially by setting up business checking and savings accounts and splitting your personal and business finances.
✓ 3. Choose your accounting method
Get your CPA's advice on the right accounting method for your business: cash-basis or accrual-basis accounting.
✓ 4. Start bookkeeping
Decide if you want to use accounting software or work with an accountant to keep your books. Choose between single-entry bookkeeping, which is simpler, and double-entry bookkeeping, which is financially safer.
✓ 5. Start recording financial transactions
Set up your general ledger and chart of accounts.
✓ 6. Figure out your payment gateways
Decide if you want to accept payments using point-of-sale systems, mobile credit card readers, invoices, or online payments—or a combination of all four. Find a payment gateway provider.
✓ 7. Hire employees and choose a payroll provider
Classify your employees correctly. File the correct new-hire paperwork. Decide on a payroll software provider.
✓ 8. Get familiar with your tax responsibilities
Understand income, payroll, and sales tax.