Accounting is a necessary part of running a company. Business accounting is the practice of recording, analyzing, and reporting your business’s performance and financial status. Good accounting and bookkeeping practices are essential not only to knowing the financial state of your business, but also to staying legally compliant and making sound business decisions. Although this may seem overwhelming, you don’t have to be a certified public accountant (CPA) to understand the accounting basics that will help with your business’s success.
There are some terms that small business owners need to know to understand the basics of accounting.
Once you understand all these terms, you can start creating a balance sheet and managing your business accounts.
A balance sheet is a snapshot of your business’s financial health at a single point in time. These are useful documents because they can show your business’s net worth and liquidity by comparing your current assets and liabilities. This information is useful to investors, banks and financial institutions, third-party suppliers, customers, and regulators, such as government agencies or stock market regulators.
A balance sheet will show your business’s assets, liabilities, and equity. The foundational equation for a balance sheet is:
Remember from our definitions above that assets are everything your business owns and liabilities are everything your business owes. Equity is the company’s value after all liabilities are deducted, and it’s the portion of the company owned by the business owners or shareholders.
To produce a balance sheet, create two sections and list all assets on one side and all liabilities and equity on the other. You then compare the total amount of assets to the total liabilities plus equity and see if the numbers are in balance.
A cost-benefit analysis (CBA) is an evaluation process that measures the benefits against the costs of a decision.
To do a CBA, tally up all the costs of a decision and subtract that number from the estimated benefits of the decision. If the benefits are greater than the costs, arguably this is a good business decision. If the costs outweigh the benefits, it may not be a sound decision.
There are four basic steps to a CBA.
By conducting a CBA, you may discover costs and benefits that you wouldn’t otherwise have considered had you not sat down and gone through them all. While it may be difficult to make predictions about estimated benefits or to assign dollar amounts to intangible costs, it’s still worth the effort, and there are methods and software available to help determine values.
An accounting method is a set of rules used to decide when and how to report your business’s income and expenses. The two main types of accounting methods are cash accounting and accrual accounting. Some businesses are required to use the accrual method, so it’s important to check with the IRS before selecting your accounting method.
Under the accrual accounting method, you record and recognize transactions in your books once the sale is complete, even if you haven’t been paid.
The accrual method is common because it provides a more accurate representation of a business’s true profit by recording revenues and expenses at the time of the transaction. This method can also potentially reduce your tax burdens. Since expenses are accounted for at the time they are realized, you may be able to deduct some expenses before actually paying them.
On the other hand, the accrual method isn’t as simple as the cash method. The calculations are more difficult, and there are more rules and regulations. If you get a calculation wrong, you may be left with an inaccurate picture of your business’s financial state.
Under the cash accounting method, you record transactions only once you receive payment.
The cash accounting method is more straightforward and easier to understand than accrual accounting. It gives you a clear picture of the actual cash your business has on hand. There are no future estimations used in cash accounting.
A major disadvantage with cash accounting is that you don’t see the full picture of your business. Since you don’t include liabilities with this method, it may appear you have more cash than you actually do. There are also some restrictions set by the IRS on who can use the cash accounting method.
There are different ways to create your business’s financial statements. The generally accepted accounting principles (GAAP) are a set of rules, regulations, and guidelines that standardize the financial reporting process. The goal of GAAP is to create consistent and transparent financial reporting across companies.
The organization that oversees GAAP is the Financial Accounting Standards Board (FASB).
GAAP is required for all publicly traded and regulated companies. Even if your business isn’t required to use GAAP, it’s still useful. Under GAAP, you use the accrual method of accounting, so you have more accurate profit and loss reporting and a more realistic forecast of your projected revenues and expenses. Ultimately, GAAP can help generate financial statements that are accurate, complete, and comparable.
Bookkeeping is a part of accounting, but they’re not the same. Bookkeeping is regular recordation and organization of a business’s financial transactions. Accounting encompasses more and is the process of recording, analyzing, and reporting financial information. Accurate bookkeeping is essential to understanding your company’s financial position and gives you the information to make sound business decisions.
There are some basic steps for keeping good books for your business.
We’re not talking about bank accounts, but rather your accounts for assets, liabilities, income, expenses, and equity. You need to be able to record each transaction in the appropriate account.
Have a system in place to track and organize each account through the use of a ledger. A ledger is a centralized place to collect and record all account data — for example, a book or bookkeeping software.
Your bookkeeping method can be either single-entry bookkeeping or double-entry bookkeeping. Single-entry is when you enter each transaction only once in one account. With double-entry bookkeeping, you record the transaction twice: once as a debit and once as a credit. This keeps your books in balance.
It’s important to keep records of all your transactions. This can be a receipt, invoice, purchase order, or some other type of financial record of the transaction.
Whether it be weekly, monthly, or quarterly, look at your debits and credits to see that the totals match.
While you can do your own bookkeeping, you also have the option of using a bookkeeping software, hiring your own bookkeeper, or outsourcing the task to an accounting service.
Business credit is a company’s ability to obtain financing. Having credit allows your business to
purchase what it needs to operate, such as products or services.
Dun & Bradstreet, Inc. (D&B) is a corporation that provides data on companies and uses that information to create commercial credit reports.
It’s important to find out whether you have a business credit profile with D&B because one can be created without you knowing. For example, if you have overdue invoices, the vendor could report this to D&B establishing an unfavorable file for your business. Lenders often look at D&B reports to determine your business’s eligibility for financing. To know if you have a credit profile, visit D&B’s website and search with your company’s information to see if your business is listed.
To create business credit, you first need to establish your business as an independent legal entity, such as a corporation or limited liability company (LLC). The next step is to apply for a tax identification number, also known as an Employer ID Number (EIN), which is essentially a social security number for your business. Once these steps are complete, you can apply for business credit.
To maintain good credit, fulfill all business obligations on time and regularly monitor your business credit reports and scores for accurate reporting.
Your business credit reports not only impact your ability to obtain financing, but they can also affect your interest rates, payment terms, and insurance premiums. Other parties can pay to access your credit reports without you even knowing, so you want to check that they’re accurate and up to date.
The most commonly used business credit agencies are D&B and Equifax. If you already have a credit file with the agency, you will know by doing a search for your business on their website. From there you can order a business credit report to review. If you don’t have a file yet, you can open one by applying for a Data Universal Number System (DUNS) number through D&B. A DUNS number is a nine-digit identification number assigned to your business. This will open up a credit file with D&B.
Just as you can use D&B or Equifax to check your own credit report, you can also use those agencies to request the credit report of a potential client or vendor. Depending on which credit report service you choose, you may need to pay a fee.
While accounting may seem like an overwhelming task, it’s necessary to the success of your business. Having an understanding of the accounting basics will hopefully help you decide if you need to bring in the professionals. There are plenty of resources available, such as software programs or hiring bookkeepers and accountants.
When you use ZenBusiness to form a corporation or LLC, you will receive a free accounting consultation with one of our experts. We provide recommendations on your accounting, bookkeeping, and tax needs during your first year of business. Let us help you get your business off on the right foot, so you can grow with confidence.
While it’s possible for you to do your own accounting, the expertise and skills of an accountant can be incredibly beneficial as your company grows. Accountants are trained in the best accounting practices and procedures and can analyze financial data. These professionals can also develop financial strategies and produce detailed financial reports.
According to the latest survey by the National Small Business Administration (NSBA), small business owners spent more than 40 hours per year preparing and filing federal taxes.
The cost of an accountant varies based on their experience and the work you’re asking them to do.
Small business owners typically choose the cash method of accounting because of its simplicity. Businesses that have inventory for sale to customers must generally use an accrual method for sales and purchases. However, small business taxpayers with gross receipts of less than $25 million a year may use a cash method for sales and purchases.
For those who choose or are required to use the accrual method, keep in mind that there are software programs that can help you with this more tedious method of accounting.
Commingling personal and business funds can be a nightmare come tax time. Having to go through and decipher which transactions were for yourself and which were for your business can be a painstaking and time-consuming task. The IRS actually recommends that small business owners open a separate bank account, even if they’re not required to.
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