How to Set Up a Small Business Bookkeeping System

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The IRS requires all businesses to keep basic financial records in order to accurately track gross receipts, purchases, expenses, and other transactions. The exact nature of your record-keeping system is up to you, but a well-designed small-business bookkeeping system will keep your financial information in good order, facilitate reporting, and scale with your business as you grow.

Choose Cash or Accrual Accounting

Businesses with revenues under $5 million per year may use either cash accounting or accrual accounting to track how money flows into and out of the business.

  • Cash accounting records revenues when the money is received by the business, and expenses when they are paid by the business. This is the same kind of accounting that individuals use when balancing their checkbooks.
  • Accrual accounting records revenues when they are earned, which may be long before the customer actually pays the business. Similarly, expenses are recorded when the business incurs them, not when it pays for them.

Nearly all new businesses are better off using accrual accounting, for two reasons. First, because the accrual method records transactions at the earliest possible moment, it allows businesses to track accounts payable and accounts receivable. That can provide a much more realistic view of the business’s profitability.

Second, once the business hits that $5 million per year in revenues, it’ll be required to use accrual accounting anyway. If the business is using cash accounting at that point, it will be forced to change accounting methods, which is an enormous hassle.

Set Up a Business Bank Account

A separate bank account for your business is a must-have for businesses of all sizes. Make sure that all business transactions flow into and out of this account, not your personal bank accounts. Similarly, never make personal transactions using your business bank account. We’ve written before about how mixing business and personal accounts can get you into trouble.

Having a dedicated business bank account solves a lot of problems:

  • First, you’ll know every transaction in that account is a business-related transaction.
  • Second, you can automatically import transaction information from your business bank account straight into your bookkeeping software. Separating your business and personal accounts means you won’t have to waste time separating business- from non-business expenses.
  • Third, keeping your business funds siloed away from your personal funds shows the IRS and other authorities that you are serious about maintaining your financial records in a businesslike manner.

Pick a Bookkeeping Software Package for Small Businesses

Technically, a business can manage its books using Excel. Theoretically, they could even do it with pen and paper. But, practically speaking, bookkeeping software is a must for all businesses. Manually typing or writing transactions day after day is a tremendous waste of time and energy, and such a manual approach is also highly error-prone. A basic bookkeeping software package is not terribly expensive and can more than pay for itself in the time you’ll save and the capabilities you’ll gain.

When choosing a bookkeeping software package, you’ll want to weigh factors such as the features needed, the budget available, and the software’s ability to scale with your business. Pilot uses QuickBooks Online, which is one of the best bookkeeping software platforms on the market but is also a bit pricier than its competitors.

Create a Chart of Accounts

The chart of accounts is a list of the accounts you have set up in your bookkeeping system to track all financial activities. This chart forms the skeletal structure that holds your entire bookkeeping system together.

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Most bookkeeping software packages will set up a basic chart of accounts for you, based on your entity type. But you’ll likely need to tweak this chart to better match your business’s specific needs. Each account should have an account name, a type (asset, liability, expense, and so on), a description, and a number.

Set Up an Expense Tracking System

If you want to keep accurate records, tracking your business expenses is a must. Transaction receipts generally come in either paper or electronic form. Paper receipts can be stored in something as simple as a shoebox, but it’s much better to keep those receipts organized — whether by date, in alphabetical order, or with some other system. Electronic receipts can live on your computer or in an online storage system, such as Expensify.

One easy way to simplify your expense tracking is to snap photos of all paper receipts using your smartphone, and then store those images along with your electronic receipts. You can do this manually or with QuickBooks’ dedicated receipt-photo feature. This means you won’t have to store paper receipts at all.

Whatever expense tracking system you choose, make sure it’s one that makes it easy for you to record receipts the moment you get them. Procrastinating on entering your receipts into your bookkeeping system means you’ll struggle to remember how to categorize transactions correctly at a later date, or when you face an audit. Teampay has some good advice on setting up a low-lift expense tracking system.

Prepare Your Bank Reconciliation Process

Having your transactions automatically imported from your bank is a wonderful time-saver, but it doesn’t eliminate the need for bank reconciliation. This is the process of comparing your monthly bank statement with your business’s Cash account in your chart of accounts, to confirm that both are accurate.

A typical reconciliation process goes as follows:

  • Take the bank statement and add any outstanding items, such as checks that haven’t cashed yet. Write the new total at the bottom of the statement.
  • Review the bank statement’s transactions to check for any errors. If you find an error, contact the bank immediately.
  • Adjust the Cash account within your bookkeeping software to reflect bank-generated transactions, such as service charges and interest payments.
  • Ideally, the corrected bank-statement balance and the corrected Cash account balance will now be identical. If not, you’ll need to dig into both the bank statement and the bookkeeping account transactions to figure out what’s causing the discrepancy.

In the event that your bank statement total and Cash account balance don’t match, finding the problem can be challenging. If you’re careful to reconcile your accounts each and every month, at least you’ll be able to narrow down your search to the transactions that have occurred in the past month. But if you haven’t been keeping up with your reconciling, you may need to bring in an accountant to help you find the problem or problems.

Set Up Your Reporting System

Reports help you assess your business’s overall financial health. Most bookkeeping systems have dozens of reporting options, but most of them won’t be important to your particular business. There are three basic reports that you’ll definitely want to generate and review on a regular basis.

Balance sheet

The balance sheet takes a snapshot of what your business owns and owes at any particular time. Balance sheets list a business’s assets, liabilities, and equity.

The balance-sheet report provides your company’s net worth and lets you easily compare assets with liabilities. This allows you to calculate your business’s solvency and liquidity ratios; these are potent ways to evaluate whether your business is in good financial shape.

Income statement

Also known as the profit and loss (P&L) statement, the income statement shows how profitable your business was over a certain period. This statement compares your business’s revenues (the money you made from selling your products or services) to your business’s expenses. If your business had more revenues than it had expenses, it was profitable; if not, it took a loss.

Reading your income statement can help you see which of your activities are most and least profitable, which can give you a sense for areas where you should consider expanding and others where you might want to get rid of that particular product or service, or at least restructure your approach.

Cash-flow statement

The statement of cash flows tells you how much actual cash your business received over a certain period. This differs from the income statement because income statements are generally prepared using accrual accounting, so the revenues listed on the statement may still be unpaid. Your business might have enormous income, yet be chronically short of cash to pay the bills.

Your cash-flow statement will show you whether you had a positive or a negative cash flow at a certain point. You can also compare your cash-flow statement to your income statement for the same period. If your cash flows are consistently lower than your income, it’s time to figure out why you’re having trouble collecting money.

Find out more about preparing and managing cash flow.

Getting help

Setting up a good small-business bookkeeping system can be an involved process, especially if you’re not an experienced bookkeeper. Rather than spending an enormous amount of time and effort on getting your books up and running, consider turning to Pilot for help. We’ll set up your bookkeeping system for you to ensure that your business is starting off right – and we’ll save you a huge amount of stress to boot.

Want someone to help you organize your bookkeeping system? At Pilot, we offer one of the best bookkeeping services around. Try Pilot.