Best Practices in Setting Up Bookkeeping
Accounting Software Selection
While some businesses use Excel spreadsheets to perform and monitor their bookkeeping details, most use accounting software. Software can do a lot to automate your bookkeeping, which in turn maximizes bookkeeping accuracy and helps you manage both your and your employees’ time effectively.
Accounting software programs can streamline data entry, create invoices, manage accounts receivable and accounts payable, track expenses, accept online payments from your customers, create financial reports, and display them in multiple formats. Many can also perform time-tracking functions to manage your employees’ time per project or help you manage inventory. All of these functions will help you better manage your taxes and save you time and money at the end.
When selecting accounting software, look carefully at the features each offers. Most software websites offer overviews and demonstrations of their features.
Some widely available bookkeeping software programs are:
- QuickBooks
- FreshBooks
- Wave
- Zoho Books
- Zero
- Quicken
Some software will let you enter bookkeeping information using single-entry method, and others will require double-entry method. You’ll need to make a decision that fits best for your business needs and bookkeeping ability.
In single-entry bookkeeping, you make one entry for each transaction. Single-entry bookkeeping systems often use two-column ledgers, one for revenue and one for expenses. A single-entry system is analogous to an individual’s checkbook, in which amounts are entered as positive or negative, and the total appears at the bottom of the ledger.
You can use single-entry bookkeeping if your business is small and relatively simple. However, be aware that single-entry doesn’t work if you have inventory because there is no way to account for either the assets on hand or the cost of goods sold (COGS).
You also can’t track accounts payable and accounts receivable with it.
In double-entry bookkeeping, each entry is recorded as both a credit and a debit. For example, when you purchase equipment, you would enter the purchase as a credit to, record the payment method, such as cash, credit card, or loan. Then, you would also make a debit entry under fixed assets for the equipment purchased, as you now own them.
Double-entry bookkeeping can make it easier to keep track and find error. The debits and credits should match. If they don’t, the ledger needs to be reviewed until the discrepancy is found.
Deciding and executing the single-entry or double-entry method is not an easy task. Alternatively, business owners can also work with a firm that provides bookkeeping services or hire a bookkeeper
Create the Chart of Accounts
One of the first bookkeeping tasks your business needs to undertake is creating a Chart of Accounts (COA). A COA is a structured list of all the accounts business will use. A well created COA will help the organization and reporting of financial transactions. It serves as the foundation of the accounting system, allowing for the recording, classification, and summarization of financial data.
Every business activity needs to be recorded in the specific account created by COA to clarify and organize your financial accounts.
While there’s no one uniform way to create a COA, many businesses break the accounts into the five categories below, usually with names, numeric identifying codes, and a brief description:
1. Assets
Assets are everything your company owns, including:
- Cash in bank or on hand
- Petty cash accounts
- Accounts receivable
- Savings accounts
- Inventory
- Property, such as buildings or land
- Vehicles
- Investments
2. Liabilities
Liabilities are everything your company owes, including:
- Accounts payable
- Payroll tax obligations
- Sales tax obligations
- Credit card debt
- Loans
- Mortgage(s)
3. Owner's/Shareowner's Equity
Owner’s equity is the total remaining once your total liabilities are subtracted from your total assets.
Let’s say you started a small business. The total assets of your business, including equipment, inventory, and cash, amount to $500k. If your business has liabilities, such as loans and accounts payable, totaling $300k, you can calculate your equity. Subtract the liabilities from the assets: $500k (assets) – $300k (liabilities) equals $200k. Therefore, the equity in your business would be $200k.
4. Revenue
Revenue is income from your business. Some of the common accounts under Revenue are:
- Sales revenue
- Service revenue
- Interest income
5. Expenses
Expenses are items your small business pays for. These can include all the expense categories relevant to your business. Common expenses include:
- Rent/mortgage
- Office supplies
- Office equipment
- Employee salaries
- Employee benefits the company pays for, such as health insurance
- Contractor payments
- Taxes
- Marketing
- Advertising
- Storage and warehouse space rental
- Travel and meals
However you choose to set up your chart of accounts, they need to follow the guidelines of the Financial Accounting Standards Board (FASB) and Generally Accepted Accounting Principles (GAAP).
It’s also important to follow the same system year to year so that financial comparisons can be made and forecasting can be done.
Bookkeeping: Essential Transactions
1. Recording Daily Transactions
Once you’ve completed your COA, it’s advisable to record all revenue and expense transactions daily, as well as any transactions related to assets and liabilities. Daily transactions should be recorded chronologically.
The daily transaction record is then gathered and used to prepare the financial reports monthly, quarterly, and yearly basis.
There are multiple advantages to recording transactions daily. First, it allows small business owners a daily snapshot of their financial situation.
Second, it avoids backlogs of unrecorded transactions. Too large of a backlog can create chaos in your finances, where you don’t know how much money you have on hand or coming in. It can also potentially lead to unpaid invoices and bills, which can pose a risk to your business’s ultimate survival.
Third, daily transactions ensure a smooth and time-efficient compilation of larger financial records reflecting your weekly, monthly, quarterly, and yearly activity.
Many businesses record daily transactions in a general journal, kept chronologically. They are then gathered in a general ledger, which is a bookkeeping summary record using the COA’s categories.
The general ledger is what allows you to create the financial reports to monitor the finances of your small business.
2. Sending Invoices and Collection
Because income is essential to keeping every business afloat, you must be especially vigilant about your customer invoices being paid on time. Bookkeeping function includes sending invoices for payment shortly after products or services are sold. It also includes the checking of accuracy of the data on the invoices, including pricing, names and addresses, and account numbers, if applicable.
Vigilant bookkeepers also monitor payment of the invoices and recording payment, as received. Be sure to set the terms for your customers. Many businesses require payment within 30 days, but some will allow 60 or even 90 days for preferred customers, depending on industry or sector practice.
If invoices have not been paid by the time set, the bookkeeper should generate past-due notices. After a certain period (usually 90 days or more), bookkeeper can send the account to collection and record that action.
3. Processing and Booking Payroll
Payroll itself is usually done by a dedicated payroll system, whether that is software, a payroll processing provider or a member of staff. But bookkeeping and payroll need to work closely together to ensure that payroll is processed and booked correctly.
The first step is to determine how many payroll-related accounts need to be in your COA and which category they fall under. The possibilities include:
Expenses
- Employee salaries
- Employee bonus
- Contractor Compensation
- Employee benefits for which you pay, such as health insurance
- Payroll taxes which can be broken out to each paying authority including Federal, State, and local
- Payroll processing expenses (if using a third-party service provider)
- Worker’s Compensation expense
Liabilities
- Employee wage payables
- Payroll tax payables which can be broken out to each paying authority including Federal, State, and local
All of these need to be booked correctly and on time in the accounts created by COA. Your bookkeeping and payroll systems need to work together harmoniously to ensure that all these expenses and liabilities are booked and paid on time.
Failure to have sufficient cash driven by the income or assets of the company to pay Payroll expenses can have very negative repercussions on your business. First, failure to make your payroll for employees and contractors can lose you the talent you depend on to run the business. Let’s face it: most of us work for money. Failure to receive it can cause your workers to quit or look actively for other jobs. Recruitment and retention can become a major problem both in the present and going forward. Failure to pay employees and contractors on time can also affect your standing in the business community.
Second, meeting your payroll tax obligations is a very important part of your business. The Federal government such as Internal Revenue Service (IRS), or state and local authorities can and will levy fines for payroll taxes that are not calculated and reported correctly or not paid on time. The fines can be steep and negatively affect your cash flow. In addition, unpaid taxes accrue interest, which can also put a damper on your available cash flow.
In the worst-case scenario, problems with your payroll taxes can trigger an audit, which can take time and energy away from the business.
Finally, bookkeeping and payroll functions have to work together to uncover any financial discrepancies and to effectively resolve them during reconciliation if any surface.
Check out our Complete Guide to Payroll to learn more.
4. Reconcile Account Balances
What is Reconciliation?
Reconciliation is the process of checking that all internal accounting figures are complete and consistent with external figures received, such as bank statements. Are any entries booked in your ledger but not showing in your bank statements? Are any figures showing on bank statements but not in your business ledger? Reconciliation can also include checking a general ledger to see that all entries are complete and consistent with the system in use.
The overall purpose of financial reconciliation is to ensure accuracy and completeness in your bookkeeping. It can also serve to catch fraud or other forms of unethical business behavior.
What Kind of Accounts Need Monthly Reconciliation?
Many businesses perform financial reconciliation of all balance sheet categories — assets, liabilities, and owner’s (or shareholders’) equity — monthly, at the close of the month’s business.
5. Balance the Books: Generating the Trial Balance
There’s a reason why the term “balancing the books” is so well known. Transactions are only part of the story.
The list of general accounts with their debit and credit balances is known as the “trial balance.” Because the total sum of debit must equal to the total sum of credit, if you add all general accounts balances in trial balance together, your sum should arrive at zero. This is where the term “balance the books” come from.
If your debits and credits don’t balance, you need to review the trial balance to find the error. It may be mathematical error or unrecorded (or misrecorded) transactions. Trial balances are usually run every reporting period to ensure the accuracy of bookkeeping, and becomes the foundation of all financial statements.
6. Monthly Adjustments
There’s one final step before the creation of official financial statements. It’s making any necessary adjustments on the book that is not from the cash transactions.
For example, if you made a loan payment for the month and booked it against the loan balance via daily transaction booking, the monthly adjustment will be needed to break out the payment from the principal portion to interest. Similarity, if you have a fixed asset (such as vehicle) on your book, the monthly adjustment will need to be made to book the depreciation for the month.
7. Creating Financial Statements
Once the trial balance has been reviewed and any necessary monthly adjustments are made, it is ultimately used to generate official financial statements for the company. These are generally done every quarter and every year, but they can also be done every month if you prefer.
There are three basic types of financial statements:
- Balance Sheet: An overall summary of the company’s financial position at certain date.
- Income Statement: A record of income and expense during the certain period
- Cash Flow: A record of cash inflow and outflow, often divided into operating, investing, and financing flows.
Financial statements are important to small businesses for several reasons. First, they record your business’s financial life and serve as a universal language for other businesspeople. For example, if you want to attract investors, they’ll want to see your financial statements for multiple years to ascertain your overall financial management and health.
Second, lenders will require several years of financial statements if you want to obtain a loan. They may additionally want to see financial statement projections several years out to see your business forecasts. This allows them to make judgments about revenue and profit growth to determine whether you can repay loans.
Third, financial statements are invaluable forecasting and strategy tools for the business owner. You can plan your future growth goals by examining the growth rates you’ve already reached. You can also develop one-year, five-year, and 10-year forecasting plans by estimating from your financial records, as contained in your financial statements.
Fourth, financial statements allow you to plan for several factors that can impact your immediate business plan. These include seasonality, changes in Cost of Goods Sold (COGS), salary growth, pricing trends, margins, etc.
Pre-Qualify Today!
Download the Guide
Jump to Chapter
