There is no official “right” way to organize your small business book keeping. As long as your records accurately reflect your business income and expenses, official bodies such as tax authorities will generally find them acceptable.
As your business grows, you can expect the quantity of records, and the kinds of records you must keep to increase. One example of this is the difference between the cash method of book keeping (usually used by smaller businesses), and the accruals method.
The cash method records cash received (income) as amounts in the books as they happen, and records payments when they are physically made.
This is pretty much like most of us run our own bank accounts. We collect what we earn from our paycheck each month, then pay the bills, and if we’re lucky, there is a bit left at the end (our profit). And if we go overdrawn, we made a loss.
The accruals method is a major concept in book keeping, and aims to match the amount of income or expenditure to the time that it related to.
For example. It is possible to pay for something after you have used it. In an accruals based small business book keeping system, we would record the expense as we used it, and elsewhere the fact that we owe someone some money – in the “amounts payable” account.
At a later date when we have paid the supplier, we would reduce what we owe in the amounts payable, and our bank balance would reduce, because we spent the money by giving it to the supplier.
The actual process of small business book keeping can be made easier when broken down into three action steps.
1.Keeping the paperwork
Comprehensive summaries of your business income and expenses are at the heart of the book keeping process. Each business sale or purchase must be backed-up by records containing the amount, the date, and details of what the money was used for (e.g. I bought a power tool from Josies Toolshop for $150 on 31st March) or received in respect of (Mrs Smith paid me $100 to fix her Shower on 1st April) . This is true whether your accounting is done by computer or in a book in hand written ledgers.
From a legal point of view, your method of keeping receipts can range from slips kept in a cigar box to a sophisticated cash register hooked into a computer system. It is best to choose a small business book keeping system that you understand and can use, but also meets your business needs.
2. Summarize your income and expenditure records on a periodic basis
A Profit and Loss account is nothing more than a summary of Income and expenses, taking into consideration the period when they occurred, as opposed to when they were really paid for.
Your analysis of the records, will help you understand your business, and give you ideas about how to control it.
On a regular basis, like every day, week, or at minimum once a month, you should transfer the amounts from your receipts for sales and purchases into your books. In the trade this is called “posting”.
Your volume of transactions will normally determine the frequency you must do this. The higher the number, the more often you should post everything, to avoid losing control.
A retail store, for example, that has hundreds of sales amounting to thousands or tens of thousands of dollars every day will be using an automated point of sale system that records everything on a computer as it happens. With that volume of sales, it’s important to see what’s selling well, and what isn’t. The Devil is in the detail as they say.
If you want to leave the small business book keeping process to your accountant then don’t be surprised when he insists on your keeping some controls over receipts. With the many bookkeeping software programs now available, it is very easy to “post” to the ledger. You’ll save a lot of money in fees and leave the more critical year end and tax functions to the accountant.
3. Use your summaries to create financial reports
Financial reports are the small business book keeping prize for having taken the effort to keep your books in order.
The profit and loss report and balance sheet are the terms everyone has heard, but you may also of heard of cash flow summary and ratio analysis. It is a general rule that the more customers, and inventory your business has, the better your business will be served by more comprehensive reporting.
For example they will help you understand things such as which products make you the most money, which customers aren’t worth doing business with, and which geographical markets really don’t pay for themselves.
In summary, keeping a good set of small business financial books, will more than pay for itself with what you learn about your business, and will give you the power to make decisions in confidence that will improve your business profitability.
Next week we will be talking about how to report income from small businesses properly. Also, we will be talking about how to deduct your home office expenses from your tax returns. Tax season is coming soon, so you better be prepared. It’s a No-Brainer 😉