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Small business accounting 101

Almost half of American private-sector workers are employed by small companies.

In a highly competitive, turbulent economic environment, building a successful small business is challenging. A company’s finances matter. It is essential that you have comprehensive accounting practices in place.

At Padgett, our team helps to build the financial foundation for small and mid-sized companies. With many decades of experience, we are proud to provide cost-effective, reliable accounting services for small businesses nationwide. In this article, you will find an overview of accounting fundamentals for small businesses.

Business owners follow accounting principles to understand their financial situation and communicate financial performance to lenders and other stakeholders. Maintaining accurate and up-to-date accounting is not merely a good practice for small businesses—it is an absolute necessity. Indeed, it is the bedrock upon which financial stability is built and the lens through which potential future growth can be viewed.

With accurate accounting, small business owners and operators will have the clearest snapshot of their company’s financial health. Without it, businesses may overlook potential pitfalls or miss out on lucrative opportunities. Small businesses do not want to make decisions today with yesterday’s information.

Small business accounting is much easier with separate, dedicated company bank accounts. Depending on the entity structure and state, a separate bank account may be a legal requirement. But even if a dedicated business bank account isn’t required, it is strongly recommended because it helps to ensure that personal and business finances are distinct. Separate bank accounts make it easier to manage funds and avoid confusion. Some small businesses may benefit from multiple accounts. Having the right structure of business bank accounts for your business will help to simplify bookkeeping, taxes, payroll, and other accounting issues.

Careful and systematic tracking of income and expenses is a fundamental aspect of accounting. It is a practice that not only helps to ensure that small business owners are fully aware of their company’s profitability but also helps with other key financial matters, such as tax preparation. For small businesses trying to stay competitive, it is imperative that they keep track of every penny that comes in (such as sales and other income) or goes out, including expenditures like:

  • Commercial loan repayments and interest;
  • Asset purchases;
  • Payroll;
  • Operational costs; and
  • Other miscellaneous expenses.

Fortunately, small business owners can leverage a wide range of tools and technology—from professional help to accounting software—to make the process more efficient and effective.

Bookkeeping is the basis of accounting. It is important to understand the distinction between the two.

Broadly speaking, bookkeeping involves recording daily financial transactions, such as sales and purchases, systematically. It is the first step in the financial reporting process. A comprehensive bookkeeping system is the backbone of successful small-business accounting. Remember, bookkeeping is a systematic recording of all financial transactions, including purchases, sales, receipts, and payments. It provides a chronological record of every financial activity, making it easier to review and analyze the financial health of your business.

Accounting is broader. It involves classifying, summarizing, interpreting, analyzing, and communicating financial transactions. Accounting provides financial insights and forecasts. A broader view of your finances is what helps your business grow and build value over time.

Choose an accounting method

We recommend that every small business select—and stick with—one accounting method. Two main accounting methods are used for small and mid-sized businesses in the United States: 1) cash accounting and 2) accrual accounting. Here is an overview of the key things to know about these two methods:

  • Cash accounting for small businesses:

    This is a simple and intuitive method. It can be especially effective for businesses that get paid when goods/services are rendered and need to closely track cash flow. With this type of system, a business records revenue when cash is received and expenses when they are paid. Cash accounting provides a clear picture of how much actual cash your business has on hand at any given time.

    As an example, imagine that a customer purchases a product. The revenue will be recorded by the small business when the payment is actually received, not when the sale is made. Along the same lines, expenses are logged when the cash is paid out, not when the obligation is incurred.

  • Accrual accounting for small businesses:

    Accrual accounting records financial events based on obligations or earnings rather than when the actual exchange of cash happens. Revenues are recognized when earned, and expenses are recognized when incurred, regardless of when the money changes hands.

    As an example, imagine selling a service on “credit” through a contract—the revenue is recorded when the sale is made, not when the future payment is received. Expenses are treated the same way.

    This method can provide a more accurate picture because it matches revenue to the related expenses incurred in the period. This reduces earnings fluctuations, which helps business owners evaluate profitability over time and against competitors. In fact, some lenders may require small business borrowers to use this method to get a clearer understanding of financial results.

Even with the best tools and systems, accounting can be a complex task, especially for entrepreneurs without a financial background. You do not have to figure out small business accounting on your own. Padgett provides effective small business accounting services to companies across the United States. Our network of reliable and experienced financial professionals will not only help to ensure compliance with accounting standards, tax laws, and payroll regulations but also free up your time to focus on what you do best—building and growing your business.

We encourage you to contact us with any questions.

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