If you own a small business, you love to see sales soar. But at the same time, you know more sales come with more paperwork, including bills and invoices you need to track. This is when you need to start using a bookkeeping system.
Here’s how a small business bookkeeping system works, and ways it can help your business run smoother.
What is bookkeeping?
Bookkeeping is the practice of recording all of a business’s financial transactions, helping the owner gain an accurate picture of its financial condition. Bookkeeping is part of the general accounting function, which shows how money flows in each specific business account, such as sales, cost of goods sold (COGS), accounts receivable, and accounts payable. An accountant uses bookkeeping records to create financial statements presenting an overall view of a company’s financial health.
Traditionally, small business bookkeeping was done manually with a pen and notebook, which is time-consuming and prone to error. These days small business owners use one of the many computer bookkeeping or accounting software programs available to record financial transactions.
Why is bookkeeping important?
Bookkeeping is essential not just to the smooth operation of a small business, but it also can figure into whether the business survives. About 20% of new small businesses close within a year, and two-thirds don’t make it to 10 years, according to the Bureau of Labor Statistics. Among the most common reasons for failure is low cash flow, which can happen when a business isn’t diligently maintaining its accounts.
So your small business’s success probably will depend on a combination of vision, perseverance, and careful financial planning. Bookkeeping contributes to this in several ways:
Accuracy
Knowing your business’s financial health is essential to survival because most small businesses lack the resources of bigger companies; a few missteps can lead to a cash crunch.
Proper bookkeeping helps you accurately analyze how cash flows through your business and to see if you are making or losing money. Diligent bookkeeping makes it easier for you to detect and correct errors or fraud.
Efficiency
Tracking the flow of money helps you to see ways of improving your business’s operations.
For instance, bookkeeping could help you see money is tight when you let your customers pay within 60 days while your suppliers demand payment in 30 days. A possible solution: Tell customers to pay in 30 days, and ask suppliers to give you 60 days to pay, improving your cash flow.
Financing
Well-maintained financial records help lenders and investors to get a clear picture of your business’s condition—critical information they need when considering whether to provide you with additional funding.
Liability protection
You should separate your business and personal finances, helping to ensure the business’s debts and liabilities don’t become commingled with your own. Bookkeeping helps to make this separation clear. Your business also should have separate bank and credit accounts to avoid commingling with your personal accounts.
How to do small business bookkeeping
- Choose your bookkeeping method
- Choose your accounting method
- Create a journal, ledger, and chart of accounts
- Record every transaction
- Balance your books
- Prepare financial reports
- Establish a bookkeeping schedule
- Retain and store records
- Use technology
Here are the key steps for a small business to establish a good bookkeeping system.
1. Choose your bookkeeping method
You have two bookkeeping choices—single or double entry.
Single-entry bookkeeping records each transaction just once, either as income or expense. It is simpler, but it provides less information about a business’s financial position. For example, single-entry bookkeeping doesn’t recognize transactions impacting future or expected money flows such as accounts receivable and payable.
Double-entry bookkeeping, used by many businesses, records each transaction twice, once for the source of money and the other for the money’s destination. These entries are called debits and credits, and they must balance. This provides more accuracy and insight into the business’s financial position.
2. Choose your accounting method
The choice here also is simple: You can use either cash accounting or accrual accounting.
Cash accounting records transactions only when cash is actually exchanged. Simple small businesses such as freelancers with few transactions may find cash accounting suitable. For larger businesses with more transactions, accrual accounting becomes necessary along with double-entry bookkeeping.
Accrual accounting means transactions are recorded even if cash hasn’t yet changed hands. For example, sales on credit are recorded on an income statement along with cash sales, even though payment will be collected later. Similarly for expenses, they are recorded even if no cash is exchanged.
3. Create a journal, ledger, and chart of accounts
A journal, general ledger, and chart of accounts are necessary for double-entry bookkeeping.
The journal is the chronological list of a business's transactions. Each entry should include the transaction date, amount, and a brief description. Then the journal items are double-entered in the ledger as a debit and matching credit. Debits appear on the ledger’s left side, and credits on the right.
The chart of accounts lays out categories for the ledger in which debits and credits may be entered. The five basic accounts are assets, liabilities, equity, revenue, and expenses. Here is a chart of the account types and how debits and credits affect each:
| Account | How it increases | How it decreases |
| Assets | Debit | Credit |
| Liabilities | Credit | Debit |
| Equity | Credit | Debit |
| Income | Credit | Debit |
| Expenses | Debit | Credit |
4. Record every transaction
All financial transactions should have a journal entry, and a debit and credit in the ledger. Keep copies of receipts and any other documentation to verify transactions.
5. Balance your books
Regularly review the ledger to ensure the sum of debits on the left side equals the sum of credits on the right. This is called conducting a trial balance. If the debits and credits are not equal, it suggests there’s an error needing to be corrected.
Besides the trial balance, you should regularly review your business bank accounts to make sure they agree with your ledger, a process called reconciliation.
6. Prepare financial reports
Bookkeeping accounts are the basis for your financial reports, including the income statement, balance sheet, and cash flow statement. Diligent bookkeeping makes preparing these reports easier for you and your accountant.
7. Establish a bookkeeping schedule
Set a bookkeeping schedule, such as weekly or monthly, and stick to it. A bookkeeping or accounting software program or a hired bookkeeper can make this easier.
8. Retain and store records
Keep your business journal, ledger, and other records in a safe and secure place. If you have a bookkeeper and employees, establish rules and procedures for access and security.
9. Use technology
Software to automate and synchronize bookkeeping and accounting offers all sorts of benefits, especially if you do your own bookkeeping. It reduces the chances of errors, can help detect fraud, and frees you up to do more productive tasks. Artificial intelligence tools in accounting software can be used to automatically categorize income and expenses, reconcile accounts, detect anomalies, and generate financial reports.
💡Resource: Best Accounting Software for Small Business in 2024
Small business bookkeeping FAQ
Is there bookkeeping software?
Small business owners can choose from a wide variety of bookkeeping and accounting software products. Software can help a small business owner by automating tedious and time-consuming bookkeeping tasks. Costs usually include a one-time setup fee and a recurring subscription for continued access to the software.
Can a small business do its own books?
A small business can do its own bookkeeping if it has few transactions to record. Small businesses with many transactions and multiple accounts should consider using bookkeeping or accounting software or hiring a bookkeeper.
What is the best bookkeeping method for a small business?
It depends on the size and complexity of the business. A simple small business such as sole proprietor freelancer might only need single-entry bookkeeping. A small business with more moving parts such as inventory, receivable and payable accounts, and staff payroll probably should use the double-entry bookkeeping method.
This helps ensure all business transactions are properly categorized and ready for use in creating income statements, cash flow statements, the balance sheet, and any other other financial statements.
