Small Business Accounting Setup: The Ultimate Guide to Managing Your Finances
Accounting is a critical business task that every company has to contend with, regardless of industry, business model or sales method. Setting up your accounting correctly from the very beginning will save you a lot of headaches and hassle as you grow.
"You need to sit with a lawyer and CPA [and make] a plan," said Paul Miller, CPA and Managing Partner of Miller and Company LLP. "Which software am I going to use? Who is going to do the bookkeeping? Should I outsource it or is my CPA doing it?"
To help you answer all these questions and more, here is a step-by-step guide to establishing your business accounting processes and setting yourself up for financial success in the future.
Cash vs. accrual accounting: which method is right for your business stage?
There are two primary methods of tracking your business income and expenses: cash basis and accrual basis.
Many small businesses choose the cash accounting method because it's simpler: Income is recorded when a customer makes a payment, and expenses are recorded when you incur them. The accrual accounting method, on the other hand, requires you to record income when you invoice your customer, regardless of when they actually make a payment.
Each method has its pros and cons, and if your business earns less than $25 million in revenue, you can choose whichever one suits you best (businesses must use the accrual method beyond the $25 million mark). It's important to choose carefully, though, as you will need to stick with the same accounting method from year to year when you file your tax return.
How to open a dedicated business bank account (and why it matters legally)
Before you can begin thinking about your business's accounting practices, you'll want to open a dedicated business bank account and/or credit card, if you don't already have one. It's tempting to mix business and personal finances, especially if you're a sole proprietor, but keeping those finances separate will make it much easier to keep track of your income and expenses when tax time comes.
Reasons for opening a business bank account include:
- Asset protection: A dedicated business account provides proof that your company funds are separate from personal finances. The legal system looks at this type of proof when owners limit personal liability through an entity such as a corporation or limited liability company (LLC).
- Tax compliance: If your company undergoes an IRS audit, a business bank account helps prove that you run a business for profit, not as a hobby. It also makes it easier to verify deductions and track funds.
- Business credit: A bank account builds your company’s financial identity. It can improve business loans, corporate credit cards, or merchant services approval rates.
Miller advised choosing a bank with a good reputation for its small business services so you can establish a long-term vendor relationship.
"[Ask yourself], how well do they treat new businesses? What is my potential to get a loan from them? Who is going to be my credit card processor?" he told CO—.
How to build your chart of accounts from scratch
To keep your business finances organized, you'll need to categorize each transaction within your chart of accounts (COA). At the highest level, your income and expenses can be broken up into assets, liabilities, revenues, expenses, and equity.
Each of these "accounts" can be further divided into sub-accounts to help you better track your money. For instance, your expenses account may have multiple sub-accounts like advertising, office supplies, employee wages, payroll taxes, software subscriptions, and more.
Most small business accounting tools offer COA templates for quicker set up. Some will generate a chart of accounts based on your industry. For example, a construction firm may use Equipment Rental for Jobs as a cost of goods sold (COGS) expense, while a restaurant tracks food costs separately from kitchen hardware.
Any tax professional who helps your business will want to see your transactions categorized in this way, so it's good to get in the habit of organizing your finances into accounts early on in your business.
Choosing the right accounting software: top options for small businesses compared
Nearly every modern business uses some kind of accounting software to keep track of its income and expenses. While you can use spreadsheets or paper ledgers, these methods require a lot more manual effort, which increases your chances of making a mistake.
Today's accounting software programs are often affordable and user-friendly, and they come with convenient integrations and automation features to streamline your accounting processes. Your two main options are desktop-based downloadable programs or cloud-based software-as-a-service (SaaS) programs.
When choosing an accounting software, look for one that can grow with your business and offer top-notch customer service when you have questions or concerns. All-in-one accounting solutions that offer bookkeeping, invoicing, payroll, tax support and other features are great if you want the most value for your subscription price; however, you may want to invest in separate programs for invoicing or payroll if you need more robust help.
Top small business accounting options include:
- QuickBooks Online: Starting at $38 monthly, QuickBooks Online tracks income and expenses, automates bank reconciliation, and integrates with popular apps, including Shopify and Square. It also has built-in inventory tools and payment processing.
- Xero: Pricing ranges from $25 to $90 per month for Xero. It reconciles bank transactions, offers customizable performance dashboards, and forecasts cash flow for 30 to 180 days.
- Zoho Books: For a low-cost, all-in-one platform, consider Zoho Books. It has a free plan for companies with $50,000 or less yearly revenue, and paid versions start at $20 per month. Zoho Books provides tools for managing inventory, budgeting projects, and automating invoice reminders.
- Wave Accounting: Create bookkeeping records and invoices with a free Wave plan or upgrade to a paid version to automatically import and categorize bank transactions, upload unlimited receipts, and accept deposits through estimates.
- Freshbooks: Choose between Freshbooks plans for freelancers, employers, and businesses with contractors. Pricing starts at $23 per month. It offers built-in time tracking tools and generates tax, financial, and accounting reports.
Schedule time to review your finances and reconcile accounts
Laying the foundation for your business accounting is only half the battle. Once your software and accounts are set up, you'll need to continually monitor your finances and ensure that every transaction has been properly recorded and categorized. Even if you use an automatic transaction import feature, you'll still want to set aside time each month to review and reconcile your business's financial accounts and ensure nothing was omitted or miscategorized.
Key financial reports every small business owner should review monthly
Small business owners should check three reports monthly: a profit and loss statement, balance sheet, and cash flow statement. In addition, reviewing a budget vs. actual report to see where your estimates were solid or not. Businesses who invoice customers should also run a monthly accounts receivable (AR) aging report.
Owners may view other financial reports like a stockholders’ equity statement quarterly. However, if your business is preparing to take a major step, like opening a new location, consider scheduling more time to review this statement monthly.
When to hire a bookkeeper vs. an accountant vs. doing it yourself
You don't have to handle accounting tasks by yourself, and in some cases, it’s better if you don’t, especially when dealing with compliance or taxes. That doesn’t mean you need a full-time accountant or bookkeeper. Instead, consider payroll and HR systems that offer expert support services.
"I recommend outsourcing [payroll], especially in the beginning," Miller noted. "Go with ADP or a similar service [to get] all the insurance and registrations taken care of."
Alternatively, you can outsource your bookkeeping and payroll needs to a specialized firm or consult with a financial adviser. These services provide guidance when you need it without increasing your headcount.
"You need to get the right legal and accounting advice before you launch your business," said Miller. "There are many [financial] items that need to be addressed … and it would be optimal if you have a person who can help you with all your needs."
Here’s what to consider before doing it yourself or hiring it out:
- DIY financials: DIY makes sense for startups with simple finances and free time to learn the ins and outs of accounting. Complexity increases as you add inventory, revenue streams, or employees. If you spend several hours weekly on basic accounting tasks, it may be time to outsource.
- Bookkeeper: Keeping a clean general ledger is more challenging when your business has multiple bank and credit card accounts, processes payroll, and handles many invoices and bills. A bookkeeper can run payroll, reconcile bank statements, and categorize expenses to ensure accurate financial reports.
- Accountant: As your business grows, an accountant provides additional support. Consider hiring when you want to apply for business loans, expand across state lines, or have complicated tax write-offs. Accountants prepare financial reports, provide year-round tax guidance, and assist with compliance.
Common small business accounting mistakes, and how to fix them
A seemingly small accounting error can snowball into a disaster. Cash flow problems might go unnoticed or expenses may not be recorded.
Avoid the following mistakes (or fix them as soon as possible):
- Recording e-commerce or marketplace payments incorrectly: Shopify or Amazon settlements may include refunds, platform fees, or shipping costs. Entering a lump sum payment as revenue may affect your margins. Avoid this mistake by syncing sales channels to accounting software.
- Confusing expense accounts with liability accounts: Small businesses may record sales tax or credit card transactions as expenses instead of liabilities. Expenses are what you pay to generate revenue, whereas liabilities are debts you owe. Ensure accuracy by reviewing entries for state tax payments, tax paid by customers, and credit cards.
- Failing to follow-up on past-due invoices: Late or missed payments may go unnoticed until a major expense is due and the funds aren’t there. Accounting and invoicing tools can automate alerts and follow-up reminders. Use these automations along with looking over your AR aging report monthly.
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
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The Columbia Montour Chamber of Commerce is a proud member of the U.S. Chamber of Commerce and an active part of the U.S. Chamber Federation of small and regional chambers, which routinely provides content like the article above. The content above does not constitute legal, accounting, tax, or other professional advice but is for general informational purposes. For accurate, complete advice, readers are encouraged to consult with qualified legal, accounting, or other professional advisors before making any decisions based on the information provided. If you need help finding qualified help, please contact the Chamber for a list of our members.