A Beginner’s Guide to Bookkeeping
Keeping your books in order is a key piece to running a healthy, successful business. Without bookkeeping, you’re driving blind like a car without a gas gauge. Sure, the car is driving fine, but who knows how long before you have to pull over and wait for a friend to bring a jerrycan?
In this article, we’ll take a look at what bookkeeping really involves, why you should do it, and how to start getting your books in order.
What is bookkeeping, exactly?
Bookkeeping is the process of tracking all of your company’s financial transactions, so you can see exactly where your business is spending money, where your revenue is coming from, and what you’ll be able to claim as tax deductions.
This should be done at regular intervals throughout the year. It may seem tedious, especially when you could just throw a box of receipts at your accountant at tax time. But keeping your books up to date between tax filings serves the very real purpose of offering real-time snapshots of your business’ financial health.
How is bookkeeping different from accounting?
Bookkeeping and accounting both help your business stay financially healthy, but they serve different purposes.
Bookkeeping is how you keep track of your finances. Accounting is how you interpret those financial records for strategic purposes.
Bookkeeping includes things like entering your expenses into a spreadsheet and filing your receipts.
Accounting might include activities like, tax planning, financial forecasting for the upcoming year, or creating annual financial reports at year end. Learn more about the differences between bookkeeping and accounting here.
Why it’s important to stay on top of your bookkeeping
It ensures that you don’t miss out on deductions
You might not know the entire small business tax code in and out, and you don’t have to.
But the more information (and supporting documents) your CPA has at tax time, the more deductions you’ll be able to legitimately claim.
It can help you secure a business loan
Thinking of expanding your business? If you need financing of any kind, having well-kept books gives lenders or investors a clear idea of your business’ current financial state, and allows them to make financial projections about your company’s ability to pay off your loan in the future.
It helps you to catch banking errors quickly
If you wait until the end of the year to reconcile your financial transactions, then you won’t know if the bank made a mistake until you’re buried in paperwork at tax time. It can be more difficult to reconcile an overcharge with your bank months later, than if you’d caught it right away.
It gives you a clear picture of where your money is going
You may be able to see your bottom line by glancing at your bank balance, but the ups and downs in your account are also telling a story. Are sales up? Are your shipping costs too high? Who knows? Your bookkeeper does. Paying attention to your financial statements is a great way to get to know the story of your business.
Bookkeeping in 7 steps
When it comes to the actual work of bookkeeping, here’s what the process looks like.
Step 1: Separate your business and personal expenses
First thing’s first—to track your business finances effectively, it’s important to permanently separate them from your personal finances.
Why? Liability—if you’re running a corporation or limited liability entity and there isn’t sufficient distance between your personal and business finances, there’s a chance that you could be held personally liable for any debts incurred by your business.
Plus, you’ll want to pull your hair out when it’s time to reconcile bank statements, and you have to try to remember if that restaurant expense was with a client or not.
Step 2: Choose a bookkeeping system
There are two main bookkeeping methods: single-entry, and double-entry. There’s no right or wrong, it’s just a matter of picking the system that’s right for your business, and sticking with it consistently.
Single-entry is a simple system that might work for you if your bookkeeping is very straightforward. Entries are recorded one time, as either an input or output. Especially if you’re doing your own bookkeeping, this is likely the approach you’ll want to take.
Double-entry is more complex, but also more robust. First, all transactions are entered into a journal, and then each item is entered into the ledger—you guessed it—twice, as both a debit and a credit.
For example, if you own an ice cream shop, each time you sell a pint of ice cream, the sale is entered as a credit to your “cash” account and as a debit to your “ice cream” account (more on accounts later). Debits and credits entered in the ledger should always add up to zero. The IRS has published a handy list of guidelines to help you understand the ins and outs of double-entry.
Using the double-entry method is complicated at first, and may require the help of a trained bookkeeper.
Step 3: Choose an accounting method—Cash or Accrual
It’s important to choose either a cash or accrual accounting method before you start your books.
If you’re using cash accounting, you only record transactions when money has exchanged hands. So if you billed a customer today, those dollars wouldn’t enter your ledger until the customer paid you.
Using the accrual accounting method, you would record the income when you bill the customer, rather than waiting for them to pay you. So at the end of the tax year, you’ve recorded all income that you earned during that year, even if you haven’t collected it yet.
Same goes for deductions. You deduct them when you’re billed, not when you pay. If your company has inventory, in most cases you’ll be expected to use the accrual method.
Step 4: Categorize your transactions
Every transaction you make needs to be categorized when it’s entered in your books. This helps your bookkeeper catch more deductions, and will make your life easier if you get audited.
Six months later, an unmarked receipt for lunch at a restaurant might not mean much to you. Was it a client lunch? Did you treat your employees after a successful quarter?
The way you categorize transactions will depend on your business and industry. Generally speaking, your transactions fall into five account types—assets, liabilities, equity, revenue, and expenses. Individual line items are then broken down into subcategories called accounts. In our ice cream shop example, some accounts in your ledger might be “revenue-ice cream sales”, “expenses-ice cream ingredients”, etc.
The actual work of categorizing will depend on your bookkeeping solution. If you’re doing it all yourself, you could make a note on each receipt. If you’re using an online bookkeeping service like Bench, you’ll just have a conversation with your bookkeeper, and they’ll take it from there.
If you’re going to be doing your own bookkeeping, it’s worth talking to a pro when you set up your system, to make sure the accounts you create align with your industry standards and CPA expectations.
Step 5: Organize and store your documents
At tax time, the burden’s on you to show the validity of all of your expenses, so keeping supporting documents like receipts and records is crucial.
Diamonds may be forever, but the ink on your expense receipts is not. Since the IRS accepts digital records, it’s smart to use a cloud-based system like Dropbox, Evernote, or Google Drive so you never have to deal with smudged receipts. You can also use apps like Shoeboxed, which are specifically made for receipt tracking. Plus, let’s face it, that overflowing shoebox has got to go.
Step 6: Organize potential deductions
The IRS’ golden rule on deductions is that they must be both ordinary (a common expense in your field of work), and necessary to your business. For example, pens would be an ordinary expense for a writer, but a $900 pen might not fall into the category of “necessary” (well, it definitely wouldn’t).
Even when an expense is ordinary and necessary, it may not work out as a one-to-one deduction on your taxes; just because you mostly work from your dining room table, doesn’t mean that you can deduct your entire monthly rent. Luckily, the IRS has made a comprehensive guide on business deductions.
Step 7: Make it a habit
It’s easy to fall behind on your bookkeeping when you’ve got other things happening. To stay on track, try setting a finance date with yourself (or your business partner) once a month to get it done. If you do happen to fall behind, Bench can help you get caught up in no time.
Should you go it alone or work with a professional?
There are a ton of options out there for how to handle your books. They fall into two basic categories: doing it yourself or having them done by someone else.
The DIY approach
If your business is starting out as a side hustle with a limited budget, taking a DIY approach is a great way to get started. If you go this route, a consultation with a CPA or bookkeeper to help you set up your books will ensure you don’t end up with a year of books that have to be re-done by a professional.
Your DIY bookkeeping can be handled using a simple spreadsheet, or you can work with one of the many online bookkeeping programs available.
Outsourcing to a professional
If you have a larger business, or if your bookkeeping duties just keep getting pushed to the side, it might be time to hire a professional. Our bookkeepers here at Bench can do your books for you, and we’ll give you simple software to keep track of your finances.
If you have a lot of physical financial records or prefer meeting face-to-face, you might also hire a freelance bookkeeper or a firm in your area.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.