When you first start out as a business owner, you will have to wear many hats. You may find yourself launching a marketing campaign, ringing up purchases, designing your online store and managing accounting all in the same day.
However, if you’ve never done business accounting before, the learning curve can be steep. You may not even know what you don’t know.
Everyone starts somewhere and, while you may eventually hire an accountant, it can be helpful to know the basics so you can build a good partnership. Here are some accounting basics to help you familiarize yourself with this important business function.
[Read more: Starting a Business? How to Set Up Your Accounting Right From Day One]
Master the key documents
There are five documents that show you how your business is performing financially. When you can read and prepare these documents, you’ll be able to make better decisions and improve your business’s financial health. The documents you should know include:
- Income statement: This shows your company’s profitability — how much money your business has earned or lost.
- Balance sheet: This is a high-level view of your business's financial health at a single point in time.
- Profit and loss (P&L) statement: This provides a snapshot of your business’s income and expenses quarterly, monthly or yearly.
- Cash flow statement: This shows how and where you’re receiving and spending money through your business operations, investing or financing.
- Bank reconciliation: This reconciles your bookkeeping with your bank balance, helping you keep consistent records for tax purposes.
By understanding these documents, you can begin to see how your company is growing sustainably.
Learn the different accounting methods
“Accounting” isn’t just one process: There are a few different methods you can use to record financial transactions, including two approaches to recording your income and expenses. Your accounting system can be set up using either the cash basis or the accrual basis.
The cash basis method means that you record income and expenses when the cash transaction is complete. In contrast, accrual basis accounting records income when you make a sale and expenses when they are incurred. This creates a double-entry accounting system, with two entries for each transaction.
Tracking expenses can be as simple as keeping an Excel spreadsheet.
Most businesses use accrual-based accounting; however, if you have no cash flow, you may start with cash-based accounting and then switch approaches later on. “Cash basis accounting is easier, but accrual accounting portrays a more accurate portrait of a company's health by including accounts payable and accounts receivable,” wrote Investopedia.
Track your expenses
Modern POS systems make it easy to track sales, but it’s up to you to set up a way to track expenses. Keeping track of your expenses is fundamental to monitoring the growth of your business, building financial statements, keeping track of deductible expenses and preparing tax returns.
Tracking expenses can be as simple as keeping an Excel spreadsheet. Many small business owners do their own bookkeeping or outsource to a part-time bookkeeper. There’s also software that can help you track your expenses, including tools like Bench, Manager.io, QuickBooks, FreshBooks or Xero. Create a system for recording receipts too, in case there are any questions down the road with your tax return.
Get familiar with GAAP
GAAP stands for Generally Accepted Accounting Principles, which are the best practice accounting processes and strategies for businesses across the United States. The GAAP were set up by the Financial Accounting Standards Board (FASB) to create consistent quality and set the standard for accounting activities for companies of all sizes. Publicly traded companies are required by law to follow the GAAP; starting with a foundational understanding of these principles can benefit your business in the long run.
There are many more accounting terms that can easily become confusing when you dive deeper into bookkeeping and start working with an accountant. Be sure to check out our short glossary of accounting terms to learn more.
[Read more: 17 Accounting Terms To Know (Even If You Have an Accountant)]
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