How To Do Bookkeeping: A Step-By-Step Beginner’s Guide

Having a clear picture of your small business finances is important for ultimate success. Between filing tax returns, budgeting, and strategic planning, bookkeeping helps businesses track and organize their financial transactions. Even if spreadsheets and crunching numbers aren’t your strong suits, employing bookkeeping best practices or software can help streamline the process.

Read on for our guide to bookkeeping basics and essential steps for taking care of your small business finances.

What Is Bookkeeping & Why Does It Matter?

In a nutshell, bookkeeping is the process of tracking a small business’s financial transactions, including payroll, sales, expenses, and debt payments. Bookkeeping requires supporting documentation, such as invoices or receipts, to record transactions. Small businesses have the option of entering transactions by hand in a journal or using tools like Microsoft Excel or bookkeeping software for bookkeeping.

Effective bookkeeping provides financial information and reports to identify challenges and opportunities for growth. For example, bookkeeping could highlight a decrease in cash flow or compare profit margins between products to guide future sales and marketing strategies.

Bookkeeping also comes in handy for business taxes. For one, it helps track expenses that can be deducted from a business’s taxable income. Bookkeeping also provides a business’s total income and expenses, which is necessary to calculate net profit for filing taxes.

When applying for loans or financing, small businesses often need to submit financial documents to lenders for approval. Bookkeeping helps generate the requisite documentation, like a balance sheet and profit and loss statement, that businesses may need to access capital.

Finally, bookkeeping can help detect fraud and errors before they become a serious problem and cost to your business.

What’s The Difference Between Bookkeeping & Accounting?

Bookkeeping and accounting are sometimes used interchangeably. And although they are related, there is a difference in scope.

Accounting can be thought of as a catchall term for the processes related to financial transactions, including analyzing, categorizing, and summarizing small business finances. For a more in-depth look at small business accounting, check out our Accounting 101 guide.

Meanwhile, bookkeeping is the portion of the accounting process that simply focuses on tracking and recording a business’s financial transactions. Staying current on bookkeeping provides the up-to-date records and information needed for quarterly and year-end accounting reports.

How To Do Bookkeeping In 9 Steps

The importance of bookkeeping can’t be overstated. Every business is different and there’s not a one-size-fits-all approach to small business bookkeeping. To get started, this step-by-step guide will unpack the bookkeeping basics to help you get a handle on your small business finances.

Step 1: Divide personal and business expenses.

It’s not uncommon for business owners to fund their ventures with some of their own finances. After launching a business, it’s important to separate personal and business bank accounts and expenses.

In terms of bookkeeping, blending personal and business expenses can make taxes more difficult. This can cost businesses money from missed deductions and more time spent completing taxes. Also, the IRS may be more likely to audit a business owner’s personal finances in the event finances are combined. What’s more, mixing finances can impede a business’s credit since it’s harder to distinguish business income from personal income.

Step 2: Select a bookkeeping system.

In-house bookkeeping requires business owners to choose between the single-entry and double-entry methods.

• Single-Entry Bookkeeping: With single-entry bookkeeping, a transaction is recorded once, similar to a personal checkbook. Bookkeeping entries are notated as a positive or negative dollar amount and may be recorded in a two-column ledger to separate revenue and expenses. This system may be sufficient for small businesses that handle a low volume of transactions and with limited inventory and equipment.
• Double-Entry Bookkeeping: Most small businesses require the double-entry accounting method. The key difference is that two entries are made for each transaction. This involves a debit in one account and a credit in another. For example, purchasing $10,000 in inventory on credit would involve a debit entry in the inventory account and a credit entry in accounts payable. Double-entry bookkeeping helps ensure the ledger is balanced, which is useful for monitoring small business finances in real-time. This method is also beneficial for preparing financial statements and safeguarding against errors.

Step 3: Choose between cash-basis and accrual accounting.

Small businesses also have to decide on an accounting system when setting up their bookkeeping. This comes down to a choice between cash-basis vs. accrual-basis accounting.

• Cash-Basis Accounting: Under cash-basis accounting, businesses record transactions when money is exchanged. In this system, the ledger will show when the payment was received rather than when the bill was sent. Many small businesses go with cash-basis accounting due to its simplicity; it lets you know how much cash you have and precludes the need to track payables and receivables.
• Accrual-Basis Accounting: Businesses using accrual-basis accounting will record transactions as soon as the customer is billed. This is entered in a business’s accounts receivable for sales and accounts payable for purchases. Accrual-basis accounting is generally better suited for larger, more complex businesses that prefer a long-term view of their finances.

Step 4: Use accounting software.

Time is precious when running a small business. Instead of making entries in a ledger by hand, accounting software can fast-track bookkeeping tasks to reduce errors and let you focus on other aspects of your business.

With accounting software, businesses can automate double-entry bookkeeping when entering transactions. Many software programs can generate financial reports, handle billing, and file taxes, too. Choosing the right accounting software for your small business will depend on budget, desired features, ease of use, and which accounting method you opt for.

Step 5: Categorize transactions.

Every transaction needs to be categorized by account when entered in the ledger. Transactions can be categorized within the following five account types:

• Assets: This includes what a business owns (equipment, cash, inventory, bank accounts) and money that is owed, known as accounts receivable.
• Liabilities: Anything that has to be paid by a business in the future, such as debt on a loan or accounts payable for a vendor’s services, represents a liability.
• Equity: The value of an owner’s interest in the business is known as equity. In bookkeeping, equity is calculated as the difference between assets and liabilities on a business’s balance sheet.
• Expenses: This includes money spent by the business for operations, such as payroll and utilities.
• Revenue: This represents money a business receives in sales or payment for services.

Generally speaking, businesses further categorize accounts within these five types. For example, assets accounts could include cash, vehicles, equipment, and designated bank accounts for different departments. Account categories can be tailored to a business’s unique needs and makeup.

Categorizing each entry will help bookkeepers make deductions later on, understand how money is moving in the business, and streamline the audit process. If you use accounting software, you’ll likely have flexibility or hands-on support setting up your account categories, known as a Chart of Accounts.

Step 6: Reconcile your business accounts.

Reconciliation is the process of comparing the general ledger with other financial records, such as bank statements or receipts, to ensure they are complete and accurate. It’s not uncommon to find slight differences due to service charges, delayed payments or deposits, and accrued interest in business bank accounts. However, larger or unexplained discrepancies could indicate fraud, errors, or manipulated financial data. Journal entries in the general ledger need to be adjusted when transactions span multiple accounting periods or if unrecognized income or expenses are identified.

Generally, businesses reconcile their accounts on a monthly basis, at minimum. This helps provide an up-to-date measure of cash balance, which is especially important for small businesses with less cash flow. Using accounting software can help review and reconcile transactions on a daily basis to stay on top of your business finances.

Step 7: Run financial statements.

Once you’ve balanced the books, financial statements will offer further insight into a business’s financial well-being. At a minimum, businesses should prepare the three following financial statements:

• Balance Sheet: This statement reports a business’s assets, liabilities, and equity to give a snapshot of its finances at a specific point in time. Typically, assets are listed on the left column, and liabilities are recorded on the right. Subtracting liabilities from assets will determine equity.
• Cash Flow Statement: This document measures how well a business manages cash flow during a specific period of time. Cash flow statements are organized into three sections: operating activities, investing activities, and financing activities.
• Profit & Loss Statement: This shows how much money a business has earned after expenses have been accounted for, and is also known as an income statement.

Bookkeeping and accounting software can usually generate such reports seamlessly if the general ledger is complete. Businesses completing their ledger by hand will have their work cut out for them tallying totals for each account type to create financial statements.

Step 8: Store your records.

When tax time rolls around, you’ll want to have quick access to financial records to verify expenses. Even if you’re bookkeeping by hand, it is advisable to make digital copies of receipts, invoices, and other financial documents to avoid damaged or lost records. Depending on your small business structure, storing records may be necessary for compliance with state and federal business laws.

Step 9: Prepare tax deductions.

If your business is making a profit, you can deduct eligible operating expenses from the business’s total taxable income. Recording deductions every month can help avoid missing write-offs and the stress of digging up old receipts.

The IRS requires expenses to be both ordinary and necessary to be deductible. Ordinary means that it is a common or acceptable expense for your type of business, while necessary refers to an expense’s appropriateness. Some possible small business tax deductions include rent, advertising, insurance, and employee salaries and benefits. If you are unsure whether an expense qualifies for deduction, consult IRS Publication 535 for further guidance.

Final Bookkeeping Tips For Small Businesses

Doing your own bookkeeping takes practice and planning. Here are some additional tips to help implement this step-by-step guide for your small business.

1) Brush up on accounting terms.

Bookkeeping and accounting have their own jargon that can take time to become familiar with. To save you time browsing google search results, keep our guide to accounting terms and concepts handy when tackling bookkeeping tasks. We’ve provided concise definitions for common bookkeeping and accounting terminology, listed A to Z.

2) Keep an up-to-date general ledger.

Regularly and frequently recording transactions in the general ledger can help business operations and decision-making. For instance, entering debts and expenses right away better ensures that bills are paid on time. This can avoid late fees and improve relationships with vendors. Also, promptly recording revenue allows businesses to make quick and informed decisions based on their current cash balance.

Final Thoughts

Small business owners handle many aspects of their businesses in-house. When it comes to bookkeeping, the best accounting software can help automate and streamline many bookkeeping tasks to save time and stress. New businesses may prefer starting out with free accounting software to get a better sense of their bookkeeping needs.

And while no one knows your business like you do, getting support from a bookkeeper or accountant may be a good idea if these tasks are eating up too much time and hurting other aspects of your business. Check out our article, When to Hire an Account For Small Business, to learn if it’s the right move for you.

Bookkeeping FAQs