Small-Business Bookkeeping Basics: Here’s What You Need to Know

Before we dive in, let’s define what bookkeeping actually is.

Basically, bookkeeping is the process of recording and organizing a business’s financial transactions, and a bookkeeper is a person responsible for that process. Bookkeeping is the primary way business owners can figure out if their business is profitable: keeping an eye on your numbers lets you identify financial challenges early on and address them before they blossom into full-fledged crises. Bookkeeping also helps you identify areas of profit expansion—areas you might not have noticed without clear financial reports you can interpret easily.

In general, a bookkeeper records transactions, sends invoices, makes payments, manages accounts, and prepares financial statements. Bookkeeping and accounting are similar, but bookkeeping lays the basis for the accounting process—accounting focuses more on analyzing the data that bookkeeping merely collects.

In the world of bookkeeping, an account doesn’t refer to an individual bank account. Instead, an account is a record of all financial transactions of a certain type, like sales or payroll.

There are five basic types of accounts:

• Assets, which are the cash and resources owned by the business (e.g., accounts receivable, inventory)
• Liabilities, which are the obligations and debts owed by the business (e.g., accounts payable, loans)
• Revenues or income, which is the money earned by the business, usually through sales
• Expenses or expenditures, which is the cash that flows out from the business to pay for some item or service (e.g., salaries, utilities)
• Equity, which is the value remaining after liabilities are subtracted from assets, representing the owner’s held interest in the business (e.g., stock, retained earnings)

Bookkeeping begins with setting up each necessary account so you can record transactions in the appropriate categories. You likely won’t have the same exact accounts as the business next door, but many accounts are common. The table below shows some frequently used small-business accounts and their types.

Knowing the accounts you need to track for your business is one thing; setting them up is another. Back in the day, charts of accounts were recorded in a physical book called the general ledger (GL). But now, most businesses use computer software to record accounts. It might be a virtual record rather than a hard copy, but the overall file is still called the general ledger.

There are three main methods for creating a GL:

• Spreadsheet software (e.g., Excel)
• Desktop accounting bookkeeping software (e.g., QuickBooks Desktop)
• Cloud-based bookkeeping software (e.g., QuickBooks Online, Wave)

Spreadsheet software is the cheapest option; Google Sheets doesn’t cost a monthly fee, but trying to craft your own general ledger in a spreadsheet program can spiral quickly into disaster.

Desktop bookkeeping software usually requires a high up-front fee, but the software is then yours to keep. With online, cloud-based bookkeeping software, you have to pay a monthly fee to keep your online subscription, but it’s a much lower cost than that of desktop software.

Alternatively, you can pay an accountant, bookkeeper, or outsourced accounting company to manage your accounts and ledger for you.

You’ve created your set of financial accounts and picked a bookkeeping system—now it’s time to record what’s actually happening with your money.

It’s crucial that each debit and credit transaction is recorded correctly and in the right account. Otherwise, your account balances won’t match and you won’t be able to close your books.

To record a transaction, first determine the accounts that will be debited and credited. For example, imagine that you’ve just purchased a new point-of-sale system for your retail business. You paid for the system, which cost $2,000, in cash.

The transaction will affect two accounts: cash (an asset account) and equipment (also an asset). Because you’re decreasing your cash and increasing your equipment, you would record a $2,000 debit (on the left) for the equipment account and a $2,000 credit for the cash account (on the right).

Note that journal entries don’t include specific details about the item, vendor, or biller; you just track debits and credits by account.

The last step in basic bookkeeping is to balance and close the books. When you tally up account debits and credits—often at the end of the quarter or year—the totals should match. This means that your books are “balanced.”

You have been recording journal entries to accounts as debits and credits. At the end of the period, you’ll “post” these entries to the accounts themselves in the general ledger and adjust the account balances accordingly.

For example, if over the course of the month your cash account has had $3,000 in debits (increases) and $5,000 in credits (decreases), you would adjust the cash account balance by a total of $2,000 (as a decrease).

Follow this method to adjust the balances for each account in your ledger. At the end of this process, you’ll have what’s called an “adjusted trial balance.” When you combine accounts types, the adjusted balances should meet the accounting equation:

Assets = Liabilities + Equity

If two sides of the equations don’t match, you’ll need to go back through the ledger and journal entries to find errors. Post corrected entries in the journal and ledger, then follow the process again until the accounts are balanced. Then you’re ready to close the books and prepare financial reports.

Now that you’ve balanced your books, you need to take a closer look at what those books mean. Summarizing the flow of money in each account creates a picture of your company’s financial health. You can then use that picture to make decisions about your business’s future.
Here are some of the most common financial reports created in bookkeeping:

• Balance sheet. This document summarizes your business’s assets, liabilities, and equity at a single period of time. Your total assets should equal the sum of all liabilities and equity accounts. The balance sheet provides a look at the current health of your business and whether it has the ability to expand or needs to reserve cash.
• Profit and loss (P&L) statement. Also called an income statement, this report breaks down business revenues, costs, and expenses over a period of time (e.g., quarter). The P&L helps you compare your sales and expenses and make forecasts.
• Cash flow statement. The statement of cash flow is similar to the P&L, but it doesn’t include any non-cash items such as depreciation. Cash flow statements help show where your business is earning and spending money and its immediate viability and ability to pay its bills.

Bookkeeping software helps you prepare these financial reports, many in real-time. This can be a lifeline for small-business owners who need to make quick financial decisions based on the immediate health of their business.

At least once a week, record all financial transactions, including incoming invoices, bill payments, sales, and purchases. And make it a priority to close your books regularly too. You may do this every month, but at the very least, balance and close your books every quarter.

Another pro tip? Make sure to tackle your books when your mind is fresh and engaged—say, at the start of the day before you open your doors rather than late at night, after you’ve closed up shop. You want to be at your best when you’re looking at figures that explain your business’s profitability and help you chart a course for progress.

Plus, doing the books earlier in the day can help you minimize the temptation to put off bookkeeping until the next day . . . and then the day after that.

Proper record-keeping for small businesses makes the process easier and keeps you compliant with the law. You never want to waste time chasing down last month’s missing invoice, and you certainly don’t want to find yourself in trouble with legal requirements. Visit SBA.gov to find out more about how small businesses can stay legally compliant.

Unless you’re specially trained in accounting principles, bookkeeping can be a challenging task. So consider getting help—whether by hiring a bookkeeper, outsourcing to an accounting service, or using accounting software.

Whether you take on your small-business bookkeeping yourself or get help from an expert, understanding the basics will help you better manage your finances. You’ll save time chasing receipts, protect yourself from costly errors, and gain valuable insights into your business’s potential.

Want more bookkeeping tips? Expand your bookkeeping knowledge by brushing up on the most common bookkeeping errors (and how to avoid them).

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