Your Guide to Small Business Accounting

Accounting involves recording, classifying, reporting, and summarising financial transactions, generally with the help of accounting software. Accounting aims to provide financial information about your business to its stakeholders and regulators and for tax purposes. You can also use this information internally to decide how to allocate resources and manage risks. 

What is small business accounting, and why is it important?

Small business accounting is the process of tracking, recording, and analysing your company's financial transactions. Accounting is important for small businesses because you can gain insight into your company's finances and forecasting with accurate data. You can use this information to make your business's pricing, inventory, expenses, and growth decisions. You’ll need an accounting process to comply with your statutory business accounting requirements.

Learn the basics of small business accounting

Accountants communicate financial information, which can be a powerful tool for making business decisions. You must understand accounting and accounting terminology if you run or manage a business or are looking for jobs in an accounting department. 

Important accounting terms 

The accounting language is vital because it provides a common glossary for communicating your company's finances. Here are some of the primary accounting terms:

• Accounts payable are debts that a company owes to its suppliers.

• Accounts receivable is the money that other entities owe to your business.

• Assets are things owned that hold value.

• The chart of accounts is all the funds used by a business.

• Equity is the portion of the company owned by the shareholders.

• Expenses are the costs involved in operating the business. 

• The general ledger records all financial transactions made by a business.

• A journal entry is a financial transaction entry in the general ledger.

• Liabilities are company debts or owned items that will depreciate. 

• Revenue is income received by the company.

• A trial balance lists all account balances at a specific time.

Types of financial reporting

Financial reports are essential tools that help you make informed decisions for your company. You’ll produce three primary financial reports: the balance sheet, income statement, and cash flow statement. They all track financial metrics over a given period.

• The balance sheet overviews your company's shareholder equity, assets, and liabilities.

• The income statement shows your company's revenues, expenses, and net income.

• The cash flow statement tracks your company's inflows and outflows of cash

The two main accounting methods

Accrual and cash-basis accounting are two main ways of recording and reporting financial transactions in accounting.

Cash basis accounting

Cash-basis accounting records transactions only when cash changes hands. Revenue is recognised when received, and expenses are only recognised when paid. However, it can give a distorted picture of a company's financial health with limited insight into income and expenses.

Accrual basis accounting

In accrual-based accounting, your revenue counts when the transaction occurs, regardless of when the money arrives. Expenses get reported when they happen, even if the money goes out earlier or later. This method gives a more accurate picture of your company's financial situation, but tracking and managing can take more work.

Accounting vs bookkeeping

One of the main differences between accounting and bookkeeping is that accounting involves more than just recording financial transactions. It also includes you analysing, interpreting, and communicating financial information. Bookkeeping is primarily concerned with recording transactions.

Another way accounting and bookkeeping differ is that accounting is a broader field that covers a more comprehensive range of topics. You may be responsible for tax planning, financial statement preparation, and auditing as an accountant. On the other hand, bookkeepers are typically only responsible for recording transactions and keeping track of financial data.

Accountants also typically have more formal education than bookkeepers. Most accountants have at least a degree in accounting or a related field, while bookkeepers may gain employment with a certificate or diploma.

How you can establish a small business accounting system

Setting up an accounting system is critical to your business's success if you run a small business or a new accounting department. Your chosen accounting system depends on your business's size, status, complexity, and personal preferences. Here are a few key components of any small business accounting system:

1. Open a bank account: This is the first step in setting up any accounting system. A business bank account will help you track income and expenses and keep your personal and business finances separate.

2. Track your expenses: You must track your business expenses to deduct them from your taxes. You can track expenses using accounting software, Excel spreadsheets, or by keeping receipts.

3. Establish a bookkeeping system: A bookkeeping system will help you keep track of your income and expenses and prepare financial statements. You can hire a bookkeeper, use automated accounting software, or do it yourself.

4. Choose a method for accepting payments:  Several options exist, including cash, check, credit card, and PayPal. Choose the way that is best for your business.

5. Set up a payroll system if you have staff: You’ll need to set up a payroll system to pay wages. Choose from one of the many payroll services available, or do it yourself with accounting software.

6. Set up a system to pay tax obligations: When you have a small business, you pay taxes on your income and profits. You’ll have many tax obligations annually. You can adopt accounting software to help you calculate your taxes.

7. Calculate gross margins: Gross margin is the difference between the selling price of your product or service and the cost of goods sold. To calculate the gross margin, divide the selling price by the cost of goods sold. If you sell a product for £100 and it costs £50 to produce it, your gross margin would be 50 percent. Knowing your margin is fundamental to planning growth.

Small business accounting software explained

The most critical factors in your decision on accounting software for your small business are determining which features you need and how much you’re willing to spend. Compare the different options and find the best fit for your business.

The top three most popular accounting software platforms for small businesses are QuickBooks, Xero, and FreshBooks. While many other accounting software are available, these three are the most user-friendly, well-supported, and affordable.

When is it time to hire an accountant?

If you run a small business, you may ask yourself: Can I do my small business accounting? Generally, you’ll need to consider hiring an accountant when your business is growing, and you're starting to feel overwhelmed by the financial aspects of running your business. An accountant can help you keep track of your finances, prepare tax returns, and offer advice on financial planning and growth. They can enable you to get back to running the core activities in your business without the distraction of managing the finances.

Ready to learn more about accounting?

If you're a business owner looking to understand accounting better, many online accounting courses are available to learn the basics of accounting for your business. Many of these courses are self-paced, so you can build your competency at your own pace. Consider this Financial Accounting Fundamentals course offered by the University of Virginia or the Introduction to Finance and Accounting course offered by Wharton Online. 

To become a certified accountant, you’ll need to qualify. That means getting a relevant degree and experience and taking the ACCA qualification to advance your career. You might like to consider the Online Masters of Accounting (iMSA) offered by the University of Illinois Urbana-Champaign to advance further.