How to Do Business Accounting from Scratch
When you start a new business, you’ll have to learn to do a variety of business tasks, one of which is business accounting. While you may use the services of an accountant to handle bigger accounting tasks such as taxes, you’ll probably be handling the books on a day-to-day basis yourself.
Your first step is to learn the basics of accounting. Fortunately, we’ve put together this handy guide to get you on your way.
Obtain an EIN
An employer identification number (EIN) is like a social security number for your business and allows the IRS to identify your business. You’re required to have one if:
- You have or plan to hire employees
- You have an LLC with more than one member
- Your business is a partnership or corporation
The only business entities that do not require an EIN are a sole proprietorship or single member LLC with no employees.
If you have employees, you’ll also need to obtain state and local tax identification numbers.
Your EIN and other tax identification numbers will be used for tax purposes.
Open a Business Bank Account
It’s extremely important to keep you business and personal finances separate, even if you’re operating as a sole proprietorship. It will make your accounting and taxes much easier. Almost all banks offer business accounts. You may need to provide certain business documents and your Employer Identification Number (EIN) when you open your account.
Consider Accounting Software
According to Statista, more than 60% of small business owners use accounting software. When you use software, you still need to understand accounting basics, but accounting software can make it much easier to organize your books, do calculations, and generate reports.
There are any number of accounting software options on the market. QuickBooks is one of the most popular options, but you should shop for software that best meets your needs. Most software companies offer a free trial so that you can check out the functionality and features.
Besides using software, you can find a host of online tools that can help you calculate various accounting numbers and ratios. For example, you might need to calculate revenue growth over a specific period of time.
That’s just one example, but you can generally find online calculators for just about any accounting number or ratio that you might need.
Choose Your Accounting Method
Your accounting method will affect how you keep your books and your taxes. There are two methods to choose from:
- Cash Accounting: With this method, you’ll account for revenue and expenses when the cash actually comes in or goes out. It’s the simpler of the two methods.
- Accrual Accounting: This method recognizes revenue and expenses when they occur, whether cash changes hands or not. For example, if you make a purchase from a vendor but don’t pay for 30 days, you’ll record the transaction on the actual date of the purchase.
The accrual method is recommended by most CPAs because it gives more accurate information about how your business is doing at any given time.
Keep in mind that if you choose one method but want to change it later, you’ll need authorization from the IRS. You can learn more about accounting periods and methods in this IRS publication.
Create Your Chart of Accounts
Whether you use accounting software or just an old-fashioned spreadsheet, you’ll need to set up a chart of accounts where you’ll record your transactions. There are five accounts to include:
- Assets: Your assets are anything that your business owns at any given time. This includes cash, accounts receivable, equipment, inventory, and even things like office furniture.
- Liabilities: Liabilities are what your business owes to other parties, including accounts payable, credit card balances, or bank loans.
- Revenue: Revenue is income that your business receives from sales.
- Expenses: Expenses are simply your costs of doing business. These include things like rent, utilities, wages you pay, or any other costs that your business incurs.
- Equity: Your equity is your assets minus your liabilities. The equity number represents your financial interest in the company.
If you use accounting software, whenever you record a transaction, these accounts will be updated. If you do your accounting manually, you’ll have to update the accounts manually.
These accounts are managed in a general ledger, which can be on paper, in spreadsheet form, or within your accounting software.
Set Up Payroll
If you have employees, you’ll need to set up a payroll accounting system to calculate withholdings, payroll taxes, and other deductions from employee wages. Payroll and payroll taxes are quite complex, so it’s highly recommended that you use a payroll software or service to handle the process for you.
The Accounting Cycle
The accounting cycle is the eight steps that you’ll take in any accounting period to account for all transactions.
- Identify transactions: You’ll need to identify each transaction that occurs in a day that needs to be recorded. Any financial event, whether it’s a sale, a purchase, a refund, or some other financial event, is a transaction.
- Record transactions: You’ll record each transaction that occurs in a journal.
- Posting: Each transaction then needs to be accounted for in your general ledger. This means updating all of your accounts – assets, liabilities, revenue, expenses, and equity.
- Unadjusted trial balance: You’ll check the debits and credits to all your accounts to make sure that the debits and credits are equal. This is called a trial balance.
- Worksheet: You’ll create a worksheet that will be used to analyze your transactions to see where any errors were made that made the debits and credits unequal.
- Adjusting journal entries: At the end of the accounting period, you’ll make adjustments to your accounts as needed based on any errors found in the worksheet.
- Financial statements: You’ll create an adjusted trial balance based on the adjustments made in the previous step, then create your financial statements, which we will discuss more below.
- Closing the books: You’ll make closing entries to your revenue and expense accounts, including transferring net income to retained earnings. Retained earnings are kept in the business rather than being paid to shareholders as dividends. Then you’ll do a post-closing trial balance to make sure your debits and credits are equal. Now you’ll be ready to start all over again for the next accounting period!
There are three financial statements that come from your accounting that will give you valuable information about your business. If you go to an investor or lender for capital, they will analyze your financial statements. The three types are as follows:
- Income statement: A detailed summary of your revenue and expenses that tells you your gross and net profit for the business. This statement is also known as a profit and loss statement.
- Balance sheet: A summary of all your assets and liabilities at any given time, with your equity total calculated at the bottom.
- Cash flow statement: A summary of your actual cash inflows and outflows during the period with your total cash on hand as the total at the bottom.
As you can see, accounting for small businesses is complex and time-consuming. Fortunately, there are many accounting software options on the market that can make your life as a business owner easier. It will save you time that’s better spent on growing your business.
If you have an accountant for tax purposes, it’s advisable to consult with them about their recommendation for accounting software and the best way for you to handle your accounting needs. Good accounting is essential to the success of your business.