A Comprehensive Guide On Accounting For Business Owners
If you own a small company, chances are you started it to address a problem or provide a unique product, not because you’re an accounting expert (unless of course, your business is an accounting firm). Don’t fret, you’re not alone. According to a study, 60% of small-business owners feel they are not very knowledgeable about accounting and finance. However, unless you are able to nail your accounting, your route to development will most certainly be severely restricted in the long term.
Whether you like crunching statistics or consider yourself more creative, entrepreneurs cannot afford to ignore their company’s financial health. Learning the basics of company accounting is a worthwhile endeavor since it may save you a lot of time, money, and legal problems in the long run.
Accounting is an essential component of operating a company. It’s a job you’ll need to either master or outsource — or both. Let’s get started by going through some accounting terms.
Accounting Basics
Regardless of who handles your company’s accounting, it’s a good idea to grasp the fundamentals of accounting. If you can read and produce these fundamental papers, you’ll have a better understanding of your company’s performance and financial health, giving you more influence over your company and financial choices.
Accounting Documents for Beginners
Even if you work with a professional, consulting firm, or have employed a certified public accountant, we suggest that you understand the following papers and computations. They offer useful pictures and measurements of your company’s success.
1. Earnings Statement
An income statement demonstrates your company’s profitability and informs you how much money it has earned or lost.
2. Financial Statements
A financial statement is a snapshot of your company’s financial position at a certain moment in time. This statement will also show you your company’s retained earnings, which are the profits you’ve reinvested in the company (rather than being distributed to shareholders).
3. Profit and Loss Statement (P&L)
A profit and loss (P&L) statement is a snapshot of your company’s revenue and expenditures for a certain time period (e.g. quarterly, monthly, or yearly). This calculation will also appear on your company’s Schedule C tax document.
4. Statement of Cash Flow
A cash flow statement examines your company’s operational, financing, and investment operations to demonstrate how and where money is received and spent.
5. Bank Reconciliation
A bank reconciliation compares your cash expenditures to your total bank statements and aids in the consistency of your company records. (This is the procedure of comparing your book balance to your cash balance in your bank.)
Accounting Terminology
By getting a better understanding of how an effective accounting system works, business owners are able to use critical information to make profitable and strategy-backed decisions.
Here are the top 10 accounting terminologies that every business owner should be aware of:
Accounts Payable
Accounts payable are the funds owed by a company to its suppliers, vendors, or creditors for the purchase of goods and services on credit. Accounts payable is a liability on a company’s balance sheet because it is a short-term debt that must be repaid in full quickly to avoid default. When a restaurant receives a beverage order on credit from an outside supplier, this is an example of accounts payable. Accounts payable serves as a letter of credit to another company.
Accounts Receivable
Accounts receivable, the inverse of accounts payable, refers to money due to a company, usually by its customers, for products or services provided. When a beverage provider delivers a beverage order on credit to a restaurant, this is an example of accounts receivable. While the restaurant records the transaction as payable, the beverage supplier records it as receivable and a current asset on its balance sheet.
Accruals
Accruals are a kind of record-keeping adjustment that recognises a company’s expenditures and revenues before money is exchanged. Basically, accruals are expenditures and income that have not yet been recorded in a company’s records. Accruals have an impact on a company’s net income and must be recorded before financial statements are published.
Accrued interest, accounts receivable, and accounts payable are examples of accrual accounts. Before receiving bills for products or services, businesses record accumulated expenditures. Businesses show accumulated income for products or services for which they anticipate to be paid later.
Balance Sheet
Balance sheets are financial documents that provide snapshots of a company’s obligations, assets, and shareholders’ equity at particular points in time. Balance sheets are one kind of financial document that is used to assess a company’s financial health and value. Accountants construct balance sheets using the accounting equation, commonly known as the balance sheet equation: “Assets = Liabilities + Equity.”
Closing the Books
Closing the books, which refers to when accountants used physical ledger books to document transactions, implies accounting for all financial transactions within a certain time period. This contributes to the accuracy of businesses’ reporting for certain time periods, such as their income statements and balance sheets.
Closing the books is easy for companies that use cash basis accounting, but it is more difficult for those that use accrual basis accounting. Year-end closure is a term used by accountants to describe the process of closing the books at the ending of the fiscal year.
Credit
Accountants who use double-entry bookkeeping systems assign numbers to each company transaction and record them in two accounts: credit and debit. Credits are financial entries that can enhance or reduce the value of an equity or liability account. Credits are provided on the account’s right side. Moreover, it’s crucial for debts to equal credits in order to ensure that account is in balance.
Debit
A debit is an accounting entry made on the left side of an account, and which is the inverse of a credit. Debits are used in double-entry accounting systems to either raise or reduce expenditure or asset accounts.
Equity
Equity, also known as stockholders’ equity or owners’ equity, is the quantity of funds left over after a company sells all assets and pays off all debt, as expressed by the equation “Equity = Assets – Liabilities.”
Equity is a measure of a company’s financial health and may include both physical assets like cash or land and intangibles like patents, copyrights, and brand awareness. It resides on a company’s balance sheet as a record. As there are no shareholders, sole proprietorships solely utilise the phrase owners’ equity.
Inventory
Inventory refers to a company’s goods and raw materials utilised in the production of the products it sells. It is recorded as an asset on a balance sheet. Finished products, raw materials, and works-in-progress are all included in inventory. In general, owing to the danger of obsolescence and storage expenses, businesses should avoid keeping significant quantities of inventory for extended periods of time.
Return on Investment
Return on investment (ROI) evaluates an investment’s efficiency, including the amount of return on investment compared to its cost. Accountants may also use ROI to evaluate the effectiveness of several investments. To calculate ROI, subtract the investment cost from the current value of the investment and divide the result by the investment cost. ROI, a common measure, assists investors in selecting the finest investment options.
A Step-by-step Accounting Guide For Entrepreneurs
Now that you know the basics, here’s a comprehensive guide that you need to follow to ensure your business’s accounts are set-up properly.
1. Create A Bank Account
After you’ve officially registered your company, you’ll need a place to keep your profits. Having a separate bank account keeps records separate and makes life simpler when it comes to tax time. It should be noted that LLCs, partnerships, and corporations are obliged by law to maintain a separate business bank account. A separate account is not required by law for sole owners, although it is strongly advised.
Begin by establishing a company checking account, followed by any savings accounts that will assist you in organizing money and planning for taxes. Put up a savings account, for example, and set aside a portion of each payment as your self-employed tax withholding. Next, you should think about getting a company credit card to start establishing business credit. To prevent commingling personal and corporate assets, corporations and limited liability companies must use a separate credit card.
Do your research before approaching a bank about establishing an account. Compare charge structures and shop around for business accounts. Most corporate checking accounts have greater fees than personal banking, so pay careful attention to how much you’ll owe.
You must have a business name and be registered with your state or province in order to establish a business bank account. Check with your bank to see what papers you need bring to the appointment.
2. Keep Track Of Your Expenditures
Learning to monitor your expenditures efficiently is the basis of good company record keeping. It’s an important stage since it enables you to track your company’s development, create financial statements, keep track of deductible expenditures, prepare tax returns, and back up what you declare on your tax return.
You should create a system for managing receipts and other essential documents from the start. This method may be as basic and old-school as using a FiloFax, or as sophisticated as using a service like ShoeBoxed. The IRS does not require American shop owners to retain receipts for expenditures under $75.00, but it is a good practice to develop.
You should pay special attention to the following kinds of receipts:
- Meals and entertainment: Holding a business meeting at a café or restaurant is a wonderful choice; however, be sure you thoroughly record it. Record who attended and the purpose of the dinner or excursion on the reverse of the receipt.
- Out of town business travel: The IRS and CRA are on the lookout for individuals who claim personal expenditures as company expenses. Fortunately, your receipts offer a paper record of your company operations while you’re gone.
- Vehicle-related costs: Keep track of where, when, and why you utilized the car for business purposes, and then apply the proportion of usage to vehicle-related expenditures.
- Receipts for presents: When it comes to presents like concert tickets, it counts if the gift giver attends the event alongside the receiver. If they do, the cost will be classified as entertainment rather than a gift. Make a note of these information on the receipt.
- Receipts for home office: Similarly to car costs, you must determine what proportion of your house is utilized for business and apply that amount to home-related expenses.
Starting a company from home allows you to keep your overhead low while still qualifying for certain unique tax advantages. You may deduct the part of your house utilized for business, as well as your internet connection, mobile phone, and transportation to and from work locations and errands.
Any expenditure that is utilized for both personal and commercial purposes must be recorded. For example, if you own one mobile phone, you may subtract the proportion of time you use it for business. Gas mileage is completely deductible; simply retain all receipts and keep a diary of your business miles (where you’re going and why you’re there).
3. Create An Accounting System
Before we get started on creating a bookkeeping system, it’s important to understand what bookkeeping is and how it varies from accounting. The day-to-day practice of documenting transactions, classifying them, and reconciling bank statements is known as bookkeeping.
Accounting is a high-level procedure that examines company development and makes sense of the data collected by the bookkeeper via the creation of financial statements. As a new company owner, you must decide which accounting technique to employ:
You may do it yourself by using software such as Quickbooks or Wave. You may also use a basic Excel spreadsheet. You may hire a part-time or outsourced bookkeeper who is either local or cloud-based. When your company becomes large enough, you may employ an in-house bookkeeper and/or accountant.
With so many choices available, you’re certain to discover an accounting solution that meets your requirements.
4. Establish A Payroll System
As a new business owner, you will most likely be a one-person operation. However, maybe you will engage a part-time employee or a freelancer to create your logo. You must immediately determine if that person is an employee or an independent contractor.
For workers, you’ll need to establish a payment schedule and verify that you’re withholding the appropriate taxes; there are many services that may assist you with this. Keep track of how much you’re paying each independent contractor. At the end of the year, American company owners may be required to submit 1099s for each contractor (you’ll also need to have their name and address on file for this!).
5. Research About Import Taxes
Depending on your business model, you may intend to buy and import goods from other countries to sell in your shop. When importing goods, you will almost certainly be subject to taxes and customs, which is important to keep in mind if you operate a dropshipping company. These are taxes levied by your nation on entering products. Take the time to study about importing products into the United States, as well as the related taxes, so that you are aware of the laws from the start.
In addition, if you are importing products, a duty calculator may assist you estimate the taxes and prepare for expenses.
6. Determine Your Tax Responsibilities
The tax responsibilities of a company vary based on its legal form. If you work for yourself (sole proprietorship, LLC, partnership), you will report business revenue on your personal tax return. Corporations, on the other hand, are distinct tax entities that are taxed separately from their owners. As an employee, your earnings from the company are taxed.
In place of the withholding that an employer would usually perform, self-employed individuals must withhold taxes from their earnings and submit them to the government. If you own an American business and owe more than $1,000 in taxes this year, you must pay estimated quarterly taxes.
7. Determine Gross Margins
Improving your store’s gross margin is the first step toward increasing your total revenue. To calculate gross margin, you must first determine the expenses of producing your goods. To better grasp this, let’s define Cost of Goods Sold (COGS) and gross margin.
- Cost of Goods Sold (COGS): These are the direct expenses spent in manufacturing a company’s goods for sale. This covers both direct labor and material expenses.
- Gross Margin: This figure reflects the total sales income retained after deducting all direct expenses incurred by the company in producing the product or service.
Conclusion
Starting a company may be a daunting task, but if you follow this checklist, you’ll have your new store’s finances in order from the start. These activities will all contribute to the success of your company, now and in the future, from establishing the appropriate kind of bank account to calculating how much you’ll earn in each product. If you find all of this too overwhelming or feel that it’s taking away your focus from actually expanding and building your company, you could consider outsourcing to a small business accountant like CharterCPA.
Contact us today for a comprehensive quote and to understand how we can help your business reach its true potential!
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