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Small business accounting guide

Small businesses are the backbone of our country’s economy.

Owning and operating a successful small business is complicated. It is imperative that you have the proper structure in place—including comprehensive financial reporting systems.

At Padgett, we provide personalized, reliable accounting services for small businesses. Our team wants to ensure that entrepreneurs and small business owners have the knowledge and resources that they need to set the foundation for their company’s financial health. Here, you will find a condensed business accounting guide.

Comprehensive, accurate accounting is essential

For small businesses, maintaining comprehensive and accurate financial reporting systems is essential for long-term commercial success and stability. Among other things, a well-designed accounting process can help business owners make informed decisions, maximize profitability, and stay compliant with applicable state and federal regulations. The main reasons small businesses need accounting systems to operate effectively include:

  • Knowledge:

    For small business owners, knowledge is power. The right accounting practices will help small businesses track their income and expenses. This enables small businesses to make better financial decisions. With the most accurate and up-to-date accounting information, business owners and business managers can monitor their cash flow, identify areas where costs can be reduced, and plan for the future.

  • Compliance:

    Small businesses need to comply with state and federal regulations. Tax violations can result in penalties, fines, and even more severe consequences. Accurate accounting helps businesses keep track of their income, expenses, and tax payments, making it easier to file taxes correctly and on time. Beyond that, accounting systems can make it easier for small businesses to manage their payroll.

  • Decision-making:

    Small business owners are decision-makers. Accurate financial records provide business owners with valuable insights into their commercial operations. By analyzing the latest financial data, owners can identify opportunities to grow their business, make informed decisions, and prioritize spending.

Accounting for your small business:

1. Choose your business structure

Selecting a business structure is the first step in establishing your accounting system. A small business can be structured as a:

  • Sole proprietorship;
  • Partnership;
  • Limited liability company (LLC);
  • S corporation; or
  • C corporation.

Each legal structure has its own advantages and disadvantages. The decision will influence your financial documentation, tax obligations, and personal liability. A small business advisor can help you understand the accounting implications of entity selection.

2. Open All Necessary Business Bank Accounts

Every small business should have a dedicated bank account—potentially even multiple bank accounts. A business bank account is necessary to keep personal and commercial transactions separate. Your small business may benefit from a checking account(s), savings account(s), and even credit accounts. Setting up the right business bank accounts can make the accounting process simpler (if your personal and business banking isn’t comingled) and more effective (for example, if you already have a line of credit ready for potential cash flow shortages as you grow).

3. Get organized (Gather/preserve relevant financial records)

Small businesses should always keep detailed, well-organized records of all financial transactions. Among other things, this includes receipts, invoices, payroll records, tax documents, bank statements, and any other relevant financial information.

You should strongly consider implementing a document management system to store and easily retrieve these records. Accurate records can make a big difference.

4. Select the accounting method for your small business

It is important to be consistent. There are two primary accounting methods:

  • Cash accounting: This method records transactions when money changes hands. Until cash changes hands, nothing is officially recorded. Here, the focus is cash flowing in and out of your business.
  • Accrual accounting: In contrast, the accrual method records when the transaction occurs, irrespective of payment. Here, revenues are “matched” to the related expenses that are incurred in the period. This helps you evaluate your company’s profitability over time and against competitors.

Which accounting method is the better choice for your company? The answer depends on a number of case-specific factors. The size and nature of your business can help determine the best method. Small businesses often start with cash accounting due to its simplicity. But they may graduate to the accrual method to access more robust financial information.

5. Understand the accounting cycle

Broadly speaking, accounting systems track all the financial transactions that your business engages in. This goes beyond reporting sales and expenses. For example, you may purchase or sell assets, repay, or take on more debt, and pay dividends or receive additional case from investors.

Each period, your accounting system will generate reports that help owners evaluate financial performance. You may need to share this information with lenders and other stakeholders. Accounting information can be used to identify problems that require corrective action and opportunities to build value.

It’s especially important for growing and seasonal businesses to monitor cash flows regularly. Temporary shortages may happen because there’s generally a lag between when cash is paid to cover operating expenses and when cash is received from customers. A line of credit can help bridge the gap.

6. Manage income and expenses

Regularly tracking income and expenses is crucial for maintaining a healthy cash flow. A comprehensive financial reporting system will record all transactions, categorize them appropriately (e.g., utilities, payroll, sales revenue), and provide reports that allow you to review your company’s financial performance regularly. Managing income and expenses is a key element of an effective accounting system. Doing so will help your small business identify trends, manage costs, and maximize profitability.

7. Create and review monthly financial statements

There are three financial statements that should be prepared and reviewed: 1) the income statement, 2) the balance sheet, and 3) the statement of cash flows. These provide an overview of your business’s financial health showing income, expenses, assets, liabilities, and cash flow. Reviewing these monthly helps in making informed business decisions, spotting potential issues early, and planning for the future.

We encourage you to contact us with any questions.

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