As a small business owner, you have a lot on your plate. Not only do you need to be knowledgeable about every aspect of your business, but you also need to keep on top of your finances. Learning about accounting for small business may not be the most exciting part of building your own, but it is essential in order to run your business and make it thrive.
Many small business owners struggle with understanding the basics of accounting – after all, they want to focus their time and energy on their idea and passion. To help you navigate such a complex subject, we put together this guide to cover the basics:
• The fundamentals of accounting for small business
• Getting started on your business finance process
• The difference between bookkeeping and accounting
• Whether or not you really need an accountant or a bookkeeper
• How to work with your accountant
• The importance of accounting software for small businesses
• How to automate everyday accounting and bookkeeping tasks
Treat this as your handbook for accounting 101: all the core information you need to know to better understand accounting for small businesses is on this page. Armed with this knowledge, you’ll be one step closer to running a successful small business.
1. The fundamentals of accounting for small business
As a new entrepreneur, you may not have a lot of experience with accounting and bookkeeping, and probably don’t yet have a dedicated finance team in your business. However, that doesn’t mean you can avoid learning the basics of accounting. High-level knowledge of the fundamentals of accounting is critical to inform decision-making in all aspects of your journey. It will help you properly run your business and work effectively with your accountant, who will become an important ally in your journey (more on that later).
That said, you don’t need to become a qualified accountant to understand and use basic accounting concepts. In fact, many small business owners start with a “do-it-yourself” approach to their finances at first, and then bring in a professional to help them with more complex aspects of compliance and – more importantly – strategic business advice.
1.1 Getting started on your business finance process
Many small business owners are not sure where to start when it comes to setting up their finance processes.
The first step (after you have decided if you’ll operate as an incorporated or unincorporated business, something your accountant will be able to discuss with you) is to open a business bank account. It doesn’t matter how small your business is – it’s important to separate your personal and business finances from the start. Having personal and business transactions together can lead to confusion and additional time being spent on record keeping. This could result in the financial performance of the business being incorrectly reported that may ultimately have tax implications.
At some point, you might consider opening a savings account for your business too, which can be helpful to organise funds and plan for future investments or even work as an emergency fund. A business credit card may also be good to help manage cash flow, which is important during the early stages of the business where large purchases may be made – but also as the business grows. Look out for business credit cards that offer incentives and perks.
Then you need to start recording all of your financial transactions – this is your bookkeeping. This includes recording all income and expenditure and accurately categorising between sales, expenses, assets and liabilities. Traditionally, this was done manually with a ledger or journal – but with legislative changes across the globe to keep some form of digital records, alongside the benefits of digital records accounting software is now used to automate the process. We will discuss this in detail further on.
Tracking your income and expenses in real-time will allow you to have visibility over your business’s health – which, ultimately, will help you make informed decisions at the right time. It will also ensure that you have accurate and up-to-date records to support compliance requirements – you don’t want to start your business missing deadlines and risking receiving penalties, after all.
1.2 Cash accounting vs accrual accounting
There are several different accounting methods used by businesses, but the two most common are accrual basis accounting and cash basis accounting. The main difference between these two methods is the timing of when transactions are recorded:
• Cash Accounting
Cash basis accounting records transactions when cash is received or paid out. This means that revenue is recognised when cash is received, and expenses are recognised when cash is paid out. For example, if a small business owner sells a product and receives cash payment at the time of sale, the revenue is recognised at that time. As with most things, the rules can vary depending on the region – in the UK, for example, cash basis accounting is not available to all businesses.
• Accrual Accounting
Accrual basis accounting records transactions when they occur, regardless of when cash is received or paid out. It refers to the recording of revenues a company has earned but has yet to receive payment for, and expenses that have been incurred but the company has yet to pay. For example, if a small business owner sells a product but allows the customer to pay later, the revenue is recognised at the time of sale, even though cash is not received until later. It may sound complex, but it’s not – if anything accruals accounting makes cash flow forecasting and budgeting easier and more accurate as you are accounting for unpaid invoices (income and expenses) and therefore any forecast or budget will reflect these transactions.
The accounting method used is often defined by legislation rather than choice – your accountant will advise you on this based on what best suits your business.
1.3 Business Accounts
Once all your transactions are recorded, you or your accountant will need to categorise these transactions (these are not the same as bank accounts). The most common categories – often referred to as nominal ledger accounts – that are used in business are cash, income (sales) and expense accounts, bank accounts, accounts receivable, accounts payable, inventory, taxes payable and equity.
• Cash is the actual money that a business has on hand, either in the form of physical cash or money in a bank account. This account is used to record all cash transactions, including cash received from customers and cash paid out for expenses.
• Sales represents the income received from your business activity.
• Expenses refers to the operational cost that is paid to earn business revenues. It means the outflow of cash in return for goods or services. Examples of expenses include rent, rates, insurance, accountancy fees, and motor expenses.
• Accounts receivable is money owed to the business by customers who have purchased goods or services on credit. This account is used to track the amount of money owed to the business and when payments are expected to be received.
• Accounts payable is the money that a business owes to vendors or suppliers for goods or services that have been purchased on credit. This account is used to track the amount of money owed to each vendor and when payments are due.
• Inventory represents the products or goods that a business has on hand for sale. This account is used to track the cost of the products or goods and how much is available for sale.
• Taxes payable is the amount of taxes that a business owes to the government, such as corporation tax, sales tax (VAT/GST), or payroll taxes. These accounts are used to track the amount of tax owed.
• Equity represents the owner’s stake in the business, which includes any money invested in it as well as any retained earnings. This account is used to track the financial value of the business and how much the owner has invested in it.
Each account serves a specific purpose and is used to track different types of financial transactions within a business.
If your small business raises invoices to collect payments from customers, you will need to set up your invoicing process. If you’re using an accounting software (we talk about this below), the system will probably provide you with this functionality. There are strict rules regarding what must be included in your invoices, depending on your business type and region you’re based, so make sure to check that in advance.
Among other necessary details, your invoices should include the business name, logo, a description of the products sold or services rendered, the date the transaction was completed, the total amount of money owed and the payment due date. You may also want to link to your business’s T&Cs for details such as any fees that may be incurred for late payments or other issues.
1.5 Financial statements
Your business is set up and running, and you’ve been recording and categorising all your transactions – well done! This will make it much easier for you to generate financial statements – a regular requirement to provide a clear picture of your financial performance and position.
The two most common financial statements that small businesses typically generate are:
1 – Income statement: Also known as a profit and loss statement, the income statement provides information about a business’s revenue, expenses, and net income or loss over a specific period of time – such as a month, quarter, or year. The income statement is used to assess a business’s profitability and how effectively it is managing its expenses.
2 – Balance sheet: The balance sheet provides a snapshot of a business’s financial position at a specific point in time. It lists the business’s assets (cash, inventory, equipment), liabilities (such as loans and taxes), and equity (retained earnings and owner’s investments). The balance sheet is used to assess a business’s financial health and solvency.
There’s also a cash flow statement, that may not be needed for your compliance requirements but is still of value for internal purposes. It provides information about a business’s cash inflows and outflows over a specific period of time, listing the sources of cash (from operations and financing activities, for example) and the uses of cash (such as investments and payments to suppliers). The cash flow statement is used to assess a business’s liquidity and ability to meet its financial obligations.
Your financial statements show your business’s financial activities and performance. They’re used by investors, creditors and analysts to check a business’s financial health and earnings potential.
1.6 What’s the difference between cash, revenue and profit?
Cash, revenue, and profit are important financial terms for small businesses to understand. Here’s a brief explanation of each term and how they differ:
• Cash: As mentioned before, cash represents the actual money that a business has at the moment, whether it’s physical cash or money in a bank account. This is the amount of money that a business can use to pay its bills, make investments, or distribute to owners.
• Revenue: Revenue is the total amount of money that a business earns from sales of goods or services. This also includes cash sales as well as sales made on credit that will be collected at a later time. Revenue is a key metric for measuring a business’s sales performance and growth.
• Profit: Profit is the amount of money that a business earns after deducting its expenses from its revenue. This includes all the costs associated with producing and delivering its products or services, such as salaries, rent, and materials. Profit is a key metric for measuring a business’s profitability and financial health.
1.7 Gross margin
Gross margin is a key financial metric that measures a business’s profitability and represents the percentage of total revenue that is left over after accounting for the direct costs associated with producing the goods or services you’re selling. As a small business owner, it’s important that you need to know your gross margin because it provides insight into how effectively you’re managing your costs and generating revenue.
It might sound complex, but calculating gross margin for a small business is a fairly simple process:
- Determine your total revenue. This is the total amount of money that your business has earned from sales.
- Determine your Cost Of Goods Sold. COGS is the direct cost of producing or acquiring the goods or services that you sell. This includes the cost of materials, labour, and any other expenses directly related to producing the goods or services.
- Subtract COGS from total revenue. This will give you your gross profit.
- Divide gross profit by total revenue. To calculate your gross margin, divide your gross profit by your total revenue and multiply by 100 to get a percentage.
Here’s the formula for calculating gross margin:
Gross Margin = (Total Revenue – COGS) / Total Revenue x 100%
So for example, if a small business has a total revenue of £100,000 and COGS of £50,000, the gross profit would be £50,000. Dividing the gross profit by total revenue and multiplying by 100 would yield a gross margin of 50%.
A higher gross margin indicates that a business is able to sell its goods or services at a higher profit margin, which can help increase profitability and fund growth initiatives. Conversely, a lower gross margin indicates that a business may be struggling to control its costs or facing competitive pressures that are limiting its pricing power.
By calculating gross margin on a regular basis, you can have greater visibility into your business’s financial performance and make informed decisions about pricing, cost control and growth strategies. This is especially important in periods of inflation. If you don’t keep track of your GP% as prices go up, you could find your profit is falling and as a result may need to revisit your prices.
Gross margin can also be used to compare the financial performance of similar businesses in the same industry, providing a useful benchmark for competitiveness and profitability.
Business finance and accounting can be complex and it’s easier for new business owners to fall into a rabbit hole trying to understand it all at the same time. Don’t overwhelm yourself. By understanding the key financial and accounting terms we discussed above, you can better manage your business, have more control over its finances and make informed decisions about your operations and growth. Then look for a professional bookkeeper and/or accountant to help you with more complex issues as you go.
2. The difference between bookkeeping and accounting
It can be confusing to know what distinguishes bookkeeping from accounting since the words are often used interchangeably. While both may fall under the finance umbrella, they’re not the same. Bookkeeping and accounting are closely related but refer to different tasks within the financial management of a business.
Namely, what is the difference between bookkeeping and accounting?
Bookkeeping is the day-to-day process of recording and maintaining a business’s financial transactions, such as sales, purchases, receipts, and payments. It also includes tasks such as reconciling bank statements and managing accounts payable and accounts receivable. It covers pre-accounting too. The purpose of bookkeeping is to maintain accurate and up-to-date financial data that will later be used for accounting and financial reporting.
Accounting, on the other hand, is the process of classifying, analysing and reporting this financial information recorded in the books (which, these days, is likely to be an online accounting software – more on that below). This includes tasks such as preparing financial statements, creating budgets and analysing financial performance. The purpose of accounting is to use financial data to provide insights into the financial health of the business – which business owners can use to make informed decisions and better plan for the future.
In short, bookkeeping records financial transactions, while accounting analyses and interprets financial data. Both are essential for the financial management of a business – while bookkeeping forms the foundation for accounting, it is only one piece of the puzzle. To get a complete picture of your business’s finances and successfully manage it, you need both bookkeeping and accounting.
3. Do I need an accountant or a bookkeeper for my small business?
As a small business owner, you may be wondering if you need an accountant or a bookkeeper (or both). Let’s start by making it clear: all businesses need bookkeeping, so somebody either internal or external will have to undertake this task. It’s often a bookkeeper, although sometimes an accountant can be responsible for that as well. Whether you need to hire someone externally for your bookkeeping and accounting needs though will depend on the size and complexity of your business, as well as your own personal accounting knowledge.
If your business is relatively new and small, you may be able to get by doing your own bookkeeping and using accounting software in the beginning. However, if your business is growing and becoming more complex, you’ll want to consider hiring an accountant to help you keep track of your finances, prepare financial statements and provide valuable advice that can help you on tax planning and other decision-making matters.
Accounting for small business is much more than debits and credits, profit and loss and a simple balance sheet. It’s a series of meticulous processes that require a great deal of focus and attention to detail. So while it may be tempting to download a bookkeeping app from the internet, these tools lack the sophistication and keen eye that comes from years of experience. It’s much easier for a business owner to outsource their accounting and bookkeeping to a professional.
After all, while you may be able to handle your own accounting and bookkeeping for a while, the prime focus of every business owner is often on other goals, instead of spending the time and energy concentrating on numbers. The cost of hiring a good accountant and/or bookkeeper is often a small price to pay for the peace of mind that comes from knowing that the numbers are accurate and the business is legally compliant.
When you do decide to hire an accountant or a bookkeeper, make sure to choose someone who is experienced and reputable. Ask for recommendations from other small businesses in your industry, or check out online reviews.
3.1 Working with your accountant
Once you’ve found a good accountant and/or bookkeeper, develop a good working relationship with them so that they can help you grow your business. As we mentioned before, their role expands beyond just compliance. Your accountant can be your small business’s best ally, providing you with the knowledge and expertise to navigate the often-complicated world of business finance.
There’s a lot that an accountant can do for you and your business – here are just some of the ways they can help:
1. Tax Preparation and Planning: An experienced accountant can help you prepare your taxes in a way that minimises your tax liability and maximises any available tax deductions. They can also help you plan for future taxes, so you don’t get caught off guard by unexpected liabilities.
2. Financial Reporting: Your accountant can help you understand your financial statements and use them to make better business decisions. They can also provide insight into areas where you may be overspending or not generating enough revenue.
3. Cash Flow Management: Your accountant can help you manage your cash flow so you have the funds you need when you need them.
4. Business Planning: Your accountant can help you develop a business plan that will guide your decision-making and ensure that your business is on track to meet its financial goals.
As a small business owner, you might be considering the cost of hiring an accountant and/or bookkeeper – but that’s in fact an investment into your business since they provide you with the peace of mind that your numbers are accurate and the business is compliant. More than that, you get expert advice from a professional who understands your business and wants to help you achieve your goals.
For your business to succeed and grow, you of course also need to do your part. Keep your bookkeeping up to date (automating is a good solution) to ensure your finances are always in order and listen to their advice. Remember: you, your business data, your accounting software and your accountant’s advice make up the finance super team for your small business.
4. The importance of accounting software for small business
More and more countries are now encouraging digital record keeping and the use of an online, cloud-based general ledger for your accounting and bookkeeping. It’s understandable: in a world where technology is changing the way we live and work, it’s just natural that business finances follow the same path. It’s understandable that small business owners might feel a bit insecure about it at first, though.
Investing in quality accounting software is an important decision for any small business owner, but if you’re unsure where to start, don’t worry. Your accountant will be able to suggest the best software for your business and probably provide a bit of training too, so you know how to use it properly and get the most out of it.
1 – Improved accuracy: Online accounting software can provide real-time visibility into a small business’s financial position, which can help to identify and correct errors more quickly.
2 – Enhanced security: A modern accounting software can provide better security than manual paper records as your data is often stored using bank-level encryption – reducing the risk of loss or theft. Cloud-based software also typically includes automatic backups, which can help to ensure that financial records are not lost in the event of a disaster or system failure.
3 – Easily accessible: If you or your accountant ever need to check past information, it’s much easier to do so on a software that allows you to search for it quicker than going through folders and folders of old paperwork.
4 – Easier collaboration: Cloud-based accounting software enables small business owners to collaborate with their accountants or other team members more easily as you can access financial records remotely, reducing the need for physical meetings.
5 – Better decision-making: With up-to-date financial information and reports, small business owners can make more informed decisions about their business. Online accounting software can provide insights into cash flow, profitability, and other key financial metrics, allowing accountants to provide better advice and small business owners to make strategic decisions based on accurate and timely data.
6 – Increased efficiency: Once you have a cloud-based accounting software set up, you can start looking for other tools that help you automate most accounting tasks, saving you a lot of time and reducing the risk of errors. Let’s chat about this.
4.1 Automating everyday accounting and bookkeeping tasks
In today’s business world, there are many bookkeeping and accounting tasks that can be automated. Finance automation can save small business owners time and money, and allow them to focus on other aspects of their business. It’s also beneficial for their accountants, as they can focus on more important and valuable work than manual data entry, for example.
One task that can be automated is invoicing. There are plenty of online invoice tools you can try, and they are usually very straightforward to use. Automating your invoicing saves you time by eliminating the need to manually create and send invoices to your customers. It’s also easier to categorise and store them when there is consistency in how they are produced.
Another task that can be automated is expense management. Tracking expenses manually can be time-consuming and difficult to keep up with, but automating this task can make it much easier. Dext Prepare, for example, allows you to easily scan, categorise and store receipts, invoices and bank statements anywhere. You can then publish the data straight to your accounting software. Not only it saves you hours every month but gives you the peace of mind that all your financial records are safely stored and easily accessible whenever you need them.
A third task that can be automated is creating financial reports. If you use a cloud-based accounting software such as Xero or QuickBooks, you probably already have this option (if you’re unsure, your accountant can help you). Financial reports are important for understanding the financial health of your business, but they can be time-consuming to create manually due to the volume of data and its complexities. Automating this task can save you time and ensure that your reports are always accurate, so you and your accountant can spend more time analysing the useful insights they provide and planning your next move.
New payment platforms and sales channels offer a great opportunity to reach more customers and increase revenue. That’s especially important for online businesses, although not exclusively since physical stores are now using mostly digital payments such as POS systems. However, the higher the volume of transactions, the harder it is to keep track of all sales data from all these different channels. A digital commerce-focused tool that can automatically fetch and organise your sales transaction data can save you time and money.
Dext Commerce, for example, does that in real-time, saving you from having to deal with never-ending spreadsheets. It integrates with your main accounting software and allows you to easily split out sales, fees and refunds, as well as allocate the right taxes, whatever the region – your accountant can tell you how important this is! It’s a great tool to ensure your digital sales data is nice and tidy and gives you a clear picture of how your business is performing.
Automating bookkeeping and accounting tasks can save small business owners time and money. But it’s important to choose the right software and tools for your needs and to make sure that you understand how to use them properly. Your accountant or bookkeeper can help you choose the right software and set it up correctly so that you can start reaping the benefits of accounting automation, regardless of the size of your business.
Want to learn more? Check out our Comprehensive Guide to Business Accounting Automation!
To sum up
As a small business owner, you may be wearing many hats and trying to learn a bit about every aspect of running your business. However, one thing that you cannot afford to neglect is the importance of having up-to-date and accurate financial records. Having a good understanding of accounting principles is essential to properly running your business and effectively working with your accountant.
The first step any business owner needs to take is to get organised. This means setting up a system for tracking income and expenses, which you can do with a simple spreadsheet or accounting software (a much better option). Once you have a system in place, you can begin to track the KPIs that are important to you – for example your cash flow. This will give you a better understanding of where your money is going and where you may need to cut back.
Then you may want to consider creating a budget. This will help you keep track of your spending and ensure that you are not overspending in any one area. A budget should include both fixed and variable expenses. Fixed expenses are those that stay the same each month, such as rent or salaries. Variable expenses are those that can vary, such as utilities or fuel costs.
Once you have a handle on your business finances, you can then begin to look at all your expenditures and ensure that you are spending the right amount in the right areas. Cutting out unnecessary spending will ultimately improve the bottom line (profitability).
Depending on the size and complexity of your business, you may not want to hire an accountant or a bookkeeper at first – but this is definitely something you will need to consider in the long term. A bookkeeper will help you keep your financial records in order, which is the foundation for anything else you want to achieve. Your accountant (who can also act as a bookkeeper) will be your main ally to help you stay compliant, save money and plan for the future by periodically reevaluating your business finances.
To increase efficiency for your accountant – so they have more time to dedicate to those valuable insights and advice -, you should invest in the appropriate online accounting software for your company. A few other accounting automation tools can also benefit you immensely as they save you tons of time on everyday admin tasks whilst keeping your records safe and accurate. This not only increases your efficiency but also saves you money in the long term.
By taking the time to understand the basics of accounting for small business and setting up your finances properly from the start, you will be in a much better position to achieve your personal and business goals.
We have recently released an extended guide with all this information and much more that you can download and read at your own pace. Whether you’re just starting out or looking to brush up on your skills, it covers everything you need to know. Get your free copy of Accounting 101 – The Ultimate Guide For Small Business Owners now.