Bookkeeping is essential to the long-term success of your small business.

Why?

Because you need to have an accurate picture of all the financial ins and outs of your business. From the cash you have on hand to the debts you owe. Understanding the state of your business’s finances means you will make better decisions for the future. Accurate bookkeeping also protects your business from taxes and penalties and saves you time.

1. Pick A Bookkeeping System

There are three main methods for setting up a General Ledger, which tracks your bookkeeping:

Spreadsheet (e.g., Excel - aka the cheapest option)
Desktop accounting bookkeeping software (e.g., QuickBooks Desktop - usually requires a high up-front fee but the software is then yours to keep.)
Cloud-based bookkeeping software (e.g., QuickBooks Online, Wave, Xero - you have to pay a monthly fee)

Alternatively, you can pay an accountant, bookkeeper, or outsourced accounting company to manage your accounts and ledger for you. Unless you’re specially trained in accounting principles, bookkeeping can be a challenging.

Next, decide if you going to use single-entry bookkeeping or double-entry bookkeeping.

Single-Entry Bookkeeping - is where you will enter each transaction once. If a customer pays you, enter that amount in your asset column only. This method work well if your business is simple. If you work out of your home, don’t have any equipment or inventory, and don’t venture too frequently into the realm of cash transactions, you might consider single-entry bookkeeping.

Double-Entry Accounting System - is how most bookkeeping is done. This is like Newton’s Law of Motion, but for finances. Newton’s law holds that “for every action, there is an equal and opposite reaction.” Likewise, in double-entry accounting, any transaction in one account requires an equal and opposite entry in another account. It isn’t physics, but for managing a business, it’s just as important.

You’ll record two entries for each transaction: a debit (Dr) and a credit (Cr). Debits and credits are recorded as journal entries in the ledger. The debit is usually recorded first (on the left), followed by the credit (on the right).

The thing that makes double entry tricky is that a debit doesn’t necessarily mean cash is flowing out; likewise, a credit isn’t necessarily money you’ve earned. The type of account defines whether a transaction is a debits or credits in that account. Double entry ensures your books are always balanced, which means you’ll be tipped off immediately if profits start dipping. Accounting software starts you off with double-entry bookkeeping.

2: Choose Your Accounts

Here’s the basics, there are five common types of accounts:

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)
Assets - which is 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)
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 account so you can record transactions in the appropriate categories.

3. Record What’s Happening

It’s crucial that each and every business transaction be 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 purchased a new point-of-sale system for your retail business. You paid $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).

4. Balance Your Books

The last step in basic bookkeeping is to balance your books. When you tally up account debits and credits (often at the end of the quarter) 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.

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 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.

5. Prepare financial reports

With you’ve books balanced, take a closer look at what those records 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 help you to make quicker financial decisions based on the immediate health of your business.

6. Be Consistent

Once a week, record all financial transactions. Make it a priority to balance your books regularly. Tackle your finances when your mind is fresh and engaged. 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.

How To Bookkeep Your Small Business