Accurate, up-to-date bookkeeping is the backbone of any successful small business. No matter what type of business you operate, an understanding of bookkeeping best practices is essential for keeping your business running smoothly, now and in the future. If learning the ropes of small-business bookkeeping sounds intimidating, have no fear. Here’s your introduction to bookkeeping: Discover the different options available to you, and why it’s so important to keep detailed financial records.
What Is the Role Of a Bookkeeper
It’s a common term that you’ve probably heard countless times before, but what is bookkeeping, really? Basically, bookkeeping is the part of accounting that’s concerned with the collection and organization of financial documents. Bookkeeping means gathering, organizing, and filing every bit of data related to your company’s finances. What sort of documents does bookkeeping cover? A bookkeeper is in charge of compiling:
- Invoices
- Receipts
- Payroll records
- Bill statements
- Bank and credit card statements
- Tax forms and returns
While accounting encompasses these data-gathering duties, this field also tends to involve analyzing the numbers and making profit and loss projections. However, bookkeeping as a term doesn’t necessarily include such long-term calculations and analyses. That said, good bookkeeping ensures that you have the numbers and data that you need to help your accountant make predictions about your business’ future, and diagnose your business’ financial health.
Why Your Business Needs Bookkeeping
Besides keeping your accountant happy, there are plenty of reasons why your small business needs bookkeeping. Accurate bookkeeping can help you prepare for tax season, stay on top of debts, and understand where your business’ profits and losses are coming from.
When your books are in good order, you can make sense of your overall income and look for places where you might be overspending. With this type of information at your disposal, you can focus your business activities toward your most profitable products and services, or cut back on unnecessary spending to save yourself some money. Good bookkeeping leaves you better equipped to make decisions that help your business grow and thrive.
Keeping detailed financial records is also helpful for securing investors. It reflects well on you as a business owner when you know exactly where all your money is going. Not only that, but keeping your books in order makes it much easier for you to paint a picture of your business’ current financial state, and its potential for future success.
Even if your business didn’t make much money this year, if you have the records to prove that your company is profitable overall, you can give investors the boost of confidence they need to make a decision about supporting you financially.
Good bookkeeping is also an essential way to understand your own business. It’s easier to gauge the overall health of your business when you can see the big picture. Say you run a restaurant and you introduced a new menu item six months ago. Have your profits risen in the past two quarters? If you’ve been keeping accurate records, your books should clearly show whether this profit is the result of more customers buying that specific item, or if you simply had more customers overall. If it’s the former, you might benefit from revamping your menu to angle toward similar products. If it’s the latter, perhaps you want to revisit a particularly successful marketing campaign. In this way, business bookkeeping makes these types of business decisions less of a gamble.
Finally, keeping proper records is essential for filing taxes. Knowing exactly how much you made and how much you spent on certain supplies and expenses during the year allows you to fill out a tax return that’s fair and accurate, and will earn you the deductions and rebates that you deserve.
Hiring an experienced accountant to do your bookkeeping for you can be helpful, especially in your first couple years of business when your focus might be diverted to other areas of your company. Talking to a professional is a great way to gain an understanding of bookkeeping essentials. Plenty of small-business owners also choose to do their own bookkeeping, so if you’re confident in your record-keeping abilities, this could be a low-cost option.
So what exactly are the essential elements of bookkeeping?
Preparing Financial Reports
Financial reporting makes up a large chunk of what bookkeepers do on a day-to-day basis. A detailed financial report usually includes the following three elements:
- Balance sheet
- Income statement
- Cash flow statement
So what are these elements? A balance sheet describes the overall value of your company, taking three main factors into account:
- The value of your assets (your cash and property)
- The value of your debts and liabilities
- The value of your equity (your stocks, or however much money you’ve invested into your company)
The formula for calculating a balance sheet looks like this:
- assets = (liability + equity)
The amounts on either side of the equation should be equal, or balanced — now you understand why it’s called a balance sheet.
An income sheet is exactly what it sounds like: It’s a record of all your income. An income sheet shows your gross profits and subtracts all the money you spent, to give you a total net income over a given time period. This total might be in the negative, if you spent more than you made. An income sheet needs to be detailed; it should include every single dollar and cent that you made or spent over your chosen time period.
The costs you list on an income sheet might include business expenses, maintenance and rental fees, and employee salaries. Your income can comprise all your sales, as well as any money you made from foreign exchange or business-related investments.
A cash flow sheet is very similar to an income sheet. The difference is that a cash flow sheet only shows cash transactions — basically, all of your business expenses and sales. It doesn’t include things like interest accruals from investments, which might not show up immediately in your business-transaction records.
In combination, a balance sheet, income sheet, and cash flow sheet provide an accurate picture of not only how much money your business is making and spending, but exactly where that money is coming from and going.
As a business owner, you’ll most likely have to create a complete financial report at least once a year, for tax purposes. However, there are plenty of reasons to make quarterly, or monthly financial statements as well. Frequent financial reports are a great way to check on your budget, and figure out where you can make adjustments if necessary.
Now you know what’s involved in a financial report. But what about the process? How do you consolidate all that financial information into a useful document?
Bookkeeping Methods
Manual Bookkeeping
There are two main methods of bookkeeping: manual and automatic. Manual bookkeeping is the “traditional” way of going about preparing and documenting your business’ financial records. In this method, you might use a pen-and-paper ledger, or an offline program like Microsoft Excel or Word to record income, expenses, interest, and any of the other cash flow items that appear in a financial report. The manual method can work if you prefer a hands-on approach, but it can also be time consuming, and it leaves more room for human error.
Automatic or Online Bookkeeping Method
Automatic or online bookkeeping, on the other hand, uses software that takes care of most of the calculations and data entry for you. A program like Quickbooks cloud accounting software, for example, can help you track income and expenses much faster than you could with a traditional ledger.
It’s also possible to link your cloud accounting software to other financial programs that your business uses, like your online banking or mobile payment application. With all your software linked through the cloud, payments that you make and receive can be automatically recorded to a digital ledger. The software program can then make the calculations for you, giving you an accurate picture of your total income and spending that’s updated every time your money moves.
Quickbooks cloud accounting software also has options for payroll, expense tracking, and inventory. A program like this makes it a lot easier to check your records on your laptop or smartphone even when you’re out of the office.
Single-Entry Versus Double-Entry
You’ve probably heard these terms before, but what exactly is the difference between single-entry and double-entry bookkeeping?. It’s in the name: In single-entry bookkeeping, each transaction is recorded as a single entry in a ledger, while in double-entry bookkeeping, a transaction is recorded twice. For example, if you make a $30 sale, in the double-entry system that transaction could be recorded as a gain in your income ledger, and as a deduction to the total value of your inventory.
Single-entry bookkeeping is simpler — you only have to record each transaction once. This can be sufficient for very small businesses that aren’t incorporated. For example, if you work full time but have a side business selling handmade jewelry, single-entry bookkeeping is probably enough to record your profits and expenses from that side business, so you can claim the amounts on your taxes.
However, if your business is incorporated, or if it’s your sole source of income, the single-entry method just won’t cut it. The double entry method leaves less room for error, making it the better choice for balancing complex books. Plus, it’s really not that much more complicated. With the help of cloud accounting software for small-business bookkeeping, you can pretty much automate the process.
Cash Versus Accrual
Both the single-entry and double-entry methods can work in tandem with cash or accrual bookkeeping. To understand the difference between these two methods, take this example. Say you ordered some new machine parts from a manufacturer. You ordered the parts in January, and the manufacturer sent you an invoice that same month. However, you don’t actually pay the fee until you’ve received the parts, in February.
In the cash method of accounting, you record the transaction only when the money has actually changed hands. So, even though you received an invoice in January, you’d record the expense as a cash transaction in February, on the date that it was paid.
In the accrual method, on the other hand, you would record the expense in January, on the date that you received the invoice — regardless of when you ended up paying for the parts.
So which of these methods should you use in your bookkeeping to get the best, most accurate picture of your spending habits? That may depend on the size and complexity of your business.
The cash method of bookkeeping is undeniably easier. By recording cash transactions when the money actually changes hands, you can simply cross-reference your bank statements with your bookkeeping records to ensure accuracy. That said, the cash method also has the potential to be slightly misleading — if you were late on a bill payment one month, for example, your records might end up showing a large sum paid for utilities one month, and nothing at all another month, leading to confusion. This method also doesn’t account for inventory loss. Maybe you ordered some supplies but didn’t end up using them. Recording just the cost of those supplies with the cash method might give you an inaccurate picture of how much you are — or should be — spending on supplies.
The accrual method is a bit more difficult, in that your bank statements might not reflect the amounts on your income sheet. However, the accrual method is the required method for large corporations in Canada, and besides that, it tends to provide you with a more accurate picture of your overall finances. Quickbooks accounting software can help you ease into the accrual method of accounting by ensuring that your records are accurate, based on information from your credit card or payment apps. If you plan on growing your business in the future, you’ll probably want to get used to using this method.
Which Financial Records Should You Keep?
An obsession with documentation is a good trait to have as a small business owner. You probably already know the importance of keeping all your receipts and invoices. But are there other sources of data that you might be overlooking? Make sure you’re keeping the following:
- Receipts
- Invoices
- Payroll records
- Bank and credit card statements
- Investment statements
- Tax returns
And don’t just keep them jumbled in a box. Take the time to organize your records, whether that means buying a filing cabinet or breaking out the label maker. Saving your records in the cloud also ensures that they’re easily accessible in a digital format from any device. Making sure your records are well-organized can save you a big headache if you’re ever subjected to an audit.
As a business owner, you’re required to keep financial and tax records for six years after the tax year in which they were received; it’s a good idea to keep these archived records in both paper and digital formats for added security. Records older than six years can be securely disposed of by hiring a professional document shredding company. For digital records, Quickbooks allows you to easily delete or condense historic transaction data to save you storage space and secure sensitive financial information.
Getting Money Back at Tax Time
Everybody hopes for a big tax return come springtime. As a small-business owner, solid bookkeeping is the best way to ensure that you get the most out of your return. If you’re hiring an outside accountant to do your taxes, providing that accountant with detailed financial records not only makes the job go faster, but keeping track of every bit of money that came through your business during the year can open up opportunities for tax deductions and returns that you may not have considered.
In Canada, there are a wide variety of categories that can potentially be claimed as business expenses, including but not limited to:
- Insurance fees
- Property tax
- Meals and entertainment costs
- Accounting fees
- Travel
- Supplies
It can be difficult to remember all of these items offhand, but if you keep detailed books, at the end of the year you have a record of every item that you spent money on, and you can then check that record against the list of deductible business expenses from the Canada Revenue Agency, and know exactly what amounts you can and can’t claim.
At the beginning of the year, take a look at the list of deductible expenses and determine which categories you’re most likely to spend money in. Consider creating a labelled file folder for each of these expense categories. This way, when you make a purchase, you can immediately file the receipt in the applicable expense category, saving you time when you need to make your expense calculations.
Bookkeeping over the course of a few years also makes it easier for you to estimate how much tax you’ll owe. If your profits and losses remain somewhat stable over a few years, you can get an idea of how much you’ll need to set aside each year for taxes, or how much you should be charging your customers for GST or HST.
Each province in Canada has a different threshold for when a business owner is required to pay taxes by quarterly installments, instead of as a lump sum at the end of the year.
- In Quebec, the annual threshold is $1,800 in net tax owings
- In all other provinces and territories, the annual threshold is $3,000 in net tax owings
In all cases, your business needs to exceed the threshold for taxes for two consecutive years. For example, imagine you run a business in Ontario, and last year you owed $3,500 in taxes after filing. You check your financial records and find that business has been slower this year, and your estimated net taxes owed will only be $2,900 this year. In this case, you can still pay your taxes as a lump sum at the end of the year. However, if your business was steady this year and you once again owe over $3,000, you’ll need to start paying by quarterly installments.
If you’re paying your taxes in installments, quarterly and even monthly financial reports can really come in handy. A clear picture of your income within a specific quarter makes it easy to figure out how much tax to pay for that three-month period.
