Bookkeeping might sound straightforward, but when you’re deep in the details of reconciling transactions, it often feels more complex than just “seven easy steps.” However, to help you grasp the essentials of bookkeeping, here are the first seven steps you need to navigate to get your financial system running smoothly.
Step 1: Separate Your Business and Personal Expenses
The foundation of managing your business finances begins with a simple action: open a business bank account to keep your business and personal expenses distinct.
Why is this crucial? Liability is a significant reason. If you operate as a corporation or an LLC, failing to maintain a clear boundary between personal and business finances could expose you to personal liability for your business’s debts.
Additionally, mixing expenses can lead to headaches during tax season or while managing your books. Important business expenses might get lost in your personal account, causing you to miss vital deductions. This could also lead to your CPA spending more time sorting through your finances, ultimately costing you more money.
Step 2: Choose a Bookkeeping System
You’ll need to select between two primary bookkeeping methods: single-entry and double-entry bookkeeping.
- Single-entry bookkeeping involves recording each transaction once as either an expense or income, with separate tracking for assets and liabilities. This method is suitable for beginners or those still operating at a hobby level, as it’s straightforward and quick for basic bookkeeping tasks.
- Double-entry bookkeeping is more comprehensive and suited for established businesses. Each transaction is recorded twice in a journal—once as a debit and once as a credit—providing a more accurate picture of your finances.
Most modern accounting software utilizes double-entry accounting, which is what professional bookkeepers or accountants will typically use.
Step 3: Choose an Accounting Method: Cash or Accrual
When establishing your bookkeeping process, another vital decision is whether to adopt a cash or accrual accounting method.
- Cash accounting records transactions only when money changes hands. For instance, if you bill a customer today, that income won’t appear in your ledger until the payment is deposited in your account. Many small businesses prefer this method due to its simplicity and clear view of cash on hand.
- Accrual accounting records income when billed and expenses when invoiced, regardless of when payment occurs. This method gives a more realistic view of your business’s financial position over time and is generally better for larger, established businesses.
Step 4: Choose the Right Tools
Categorizing each transaction is crucial for effective bookkeeping. This practice helps your bookkeeper identify more deductions and simplifies your life in the event of an audit.
If you fail to categorize transactions, an unmarked receipt for lunch six months later could leave you guessing whether it was a client meeting or a team celebration.
Transactions generally fall into five categories: assets, liabilities, equity, revenue, and expenses. From there, you’ll break them down into subcategories. For instance, in an ice cream shop, you might categorize transactions as “revenue – ice cream sales” or “expenses – ice cream ingredients.”
You have several options for bookkeeping tools:
- Cloud accounting software like QuickBooks, Xero, or Wave can be powerful but may also overwhelm beginners if you’re not familiar with them.
- Spreadsheets can be a straightforward solution, especially with templates like our free Excel Income Statement Template.
- If you prefer to outsource your bookkeeping, consider using a service like K9 Bookkeeping. We can handle your bookkeeping, prepare monthly financial statements, and even file your taxes.
Step 5: Ensure Your Transactions Are Categorized
Every transaction must be categorized and recorded accurately. Proper categorization not only helps catch deductions but also minimizes the work you have to do if an audit arises.
If you’re handling your bookkeeping, it’s wise to consult with a professional during setup to ensure your accounts align with industry standards and CPA expectations.
Step 6: Choose a System for Storing Your Documents
During tax season, it’s your responsibility to validate all your expenses, making it essential to keep supporting documents like receipts and records organized.
While physical receipts can fade or smudge, digital records are accepted by the IRS. Use a cloud-based system like Dropbox, Evernote, or Google Drive to keep your documents safe. Alternatively, apps like Shoeboxed are specifically designed for receipt tracking.
If K9 Bookkeeping manages your bookkeeping, you can easily upload and store digital receipts and documents in our platform.
Step 7: Organize Your Deductions
The IRS stipulates that deductions must be both ordinary (common in your industry) and necessary for your business. For instance, while pens are a standard expense for writers, a $900 pen might not qualify as necessary.
Even if an expense meets these criteria, you may not be able to deduct all of it. For example, working from your dining room table does not allow you to deduct your entire rent. The IRS provides a comprehensive guide on business deductions to consult if you’re unsure about what you can deduct.
Step 8: Make Bookkeeping a Habit
As a busy small business owner, it’s easy to let bookkeeping slide. To avoid this, establish a routine.
Set aside a specific day each month for bookkeeping tasks. Use this time to enter missing transactions, reconcile bank statements, review the previous month’s financial statements, and make any necessary adjustments to your accounting processes.
If you find yourself behind on bookkeeping, consider hiring a professional to help you catch up. K9 Bookkeeping is here to assist you with that!
