Embarking on the journey of running a small business brings with it a world of opportunities and challenges. One of the essential aspects that can’t be overlooked is accounting. As a small business owner, understanding the foundational principles of accounting is crucial to ensuring your business’s financial health and growth. In this blog post, we’ll guide you through the initial steps of small business accounting, from simplifying expense tracking to choosing the right accounting method for your unique needs. By grasping these fundamental concepts, you’ll be better equipped to manage your business’s finances with confidence and precision.
Tracking and Categorizing Expenses:
Keep your chart of accounts simple and clean. Companies often end up with bloated charts where they have four different accounts to which they could code the water bill. This makes it harder to accurately gauge monthly expenses. If you have less than 20 employees and have subaccounts of subaccounts, your chart is bloated. Look for redundancies like “Office Supplies,” “Miscellaneous Supplies,” and “Supplies Expense,” and consolidate them.
Cash vs. Accrual:
Accrual is objectively better for the clarity and usability of financial statements, however, cash is easier. Cash ignores outstanding receivables and payables, which can make your balance sheet hard to interpret. Accounting software is often hard-coded to be one or the other – usually accrual, but cash ones are available. QuickBooks can do both and is a popular option for many small businesses, but the downside is that it can be a “one-size-fits-all” solution.
Keeping Personal and Business Finances Separate:
Your business should have its own bank account and credit card. Reimburse the company when you accidentally swipe your business card. To pay yourself, if you are a single-member LLC taxed on a Schedule C, simply move the money to your own bank before spending/saving and record it as a distribution from Retained Earnings. For everything else, go through the normal payroll/dividend/draw processes that your tax accountant recommends.
Monitoring Credit and High-Cost Expenses:
This depends on the size of funding you want and what documentation your bank and vendors will want. Some common elements considered are past and projected financials, personal guarantees from the owner, collateral, and the last few years of tax returns for the business and its owners. For credit from vendors, typically all you need are a few references from your other vendors. Therefore, it is advisable to maintain positive payment relationships with a minimum of three vendors to establish your creditworthiness. For high-cost expenses, ensure that you are classifying asset purchases correctly and creating a depreciation schedule if applicable. Business credit report agencies do exist but it is common for businesses to not have much external information available on them when compared to personal credit reporting.
Developing a Business Budget:
Many businesses get away without budgeting for decades through a naturally favorable difference between revenues and expenses. Some businesses make budgets but unfortunately, disregard them shortly after their creation. Effective budgeting is setting realistic expectations for the transactions that you can control and using that information to encourage wise financial decisions. It is common to find there are many expenses that you can’t control, but still significant ones that you can. Usually, this involves pulling a full expense report for a few months or a full year critically examining each category/vendor, and creating a reasonable monthly expectation. After implementation, remember that each transaction is its own value proposition irrespective of the budget, meaning that just because you are “over-budget” doesn’t mean that you shouldn’t invest in a good prospective client. Being “under-budget” doesn’t mean there is a good reason to spend the remainder of the budget on frivolous purchases. There’s a modern method called “Flexible Budgeting” where the budget is adjusted and normalized throughout its lifetime to some factor, usually sales, with the goal of giving more useful feedback during the budget’s lifetime to accommodate the divergence between projected and actual results.
Forecasting Future Income and Expenses:
Most forecasting techniques are created using prior period data and applying some growth percentage, which makes sense but there are some pitfalls. One of the better tools is called “What-If Analysis,” which looks at the range of plausible outcomes rather than just one outcome. If you have individual clients comprising a large percentage of your business, it could be catastrophic for you to lose that contract and you might find your business no longer viable without that major client. Key vendors can also pose risks if they drop the service or supply you need to perform your main operations. Other factors like lawsuits and natural disasters create unpredictability, though some of those risks can be hedged with various lines of insurance.
At Total Solutions, we understand that navigating the world of small business accounting can be complex. Our team of seasoned professionals is here to support you every step of the way. Whether you’re just starting or looking to fine-tune your financial strategies, don’t hesitate to reach out for expert guidance.