You’re a doer. The type of person who dreams, then goes out and makes those dreams a reality. That’s how you started your small business and made that business grow. But when you live by Marcus Lemonis’ “Know your numbers” philosophy, you can make your business grow even stronger. Let’s say you bottle lemonade and had your best year on record. That’s awesome. It looks like you have enough money to hire another person, like you’d always wanted. But are you sure you can afford it? Maybe you look at your books and realize that you still owe a supplier $40,000. Now you can weigh that in before you hire another person and find yourself in a cash crunch. That’s the power of “knowing your numbers.”
You come to know those numbers through the process of small business accounting. It helps you plan, assess, and improve. It also helps you stay on top of the legal stuff, like filing all of the required forms with the government and making all of the associated tax payments. This article is by no means a comprehensive “how-to,” as that will flow from the specifics of your situation. But it’s a great overview that proves small business accounting isn’t magic. It’s just another clean, manageable process. It’s like Marcus always says, “You don’t have to be a genius to run a small business. But you better be smart enough to be willing to learn.” This article helps kick off that process.
Start by Opening a Bank Account for Your Business
You definitely want to open a dedicated bank account for your small business. The key word here is “dedicated.” This is all about isolating your business transactions. From there, just make sure you use your personal account strictly for personal matters, and your business account strictly for business. That might sound obvious at first. But a lot of people might think, “Wait a sec… I’m the only owner and I funded this business myself. This is technically all of my money anyway. What does it matter if I blur the line?” That’s a pretty common thought process, especially in the early days. But you really need a dedicated bank account for your business. That’s the only way you can rely on the accuracy of your small business accounting. And just to be perfectly clear, you definitely want accounting you can rely on. Let’s take a look at five reasons why reliable small business accounting is so important.
The Importance of Accounting
It Gives You a Sense of Your Company’s Financial Health
- When Marcus worked with a high-end meat distributor on the east coast, he looked at their books and realized that they didn’t have enough cash on hand. This put them in a situation where they weren’t going to be able to make payroll. If they couldn’t pay their people, they were in danger of actually shutting their doors.
A great bookkeeping system helps you plan your financial future in a ton of ways, but in this case, it could’ve helped them manage cash flow and spot trouble before it even cropped up.
It Improves Your Company’s Processes
- Small business accounting also helps with process improvement. For example, do people owe you money? Are you tracking that? Marcus noticed this exact problem with the meat company you just read about above. A close look at their books revealed their accounts receivable looked a little high. So, he dug a little deeper and realized there wasn’t a clear procedure for following up on bills and collecting on the money that they’re owed. A great bookkeeping system helps shine a light on those procedural things we can all tighten up.
It Allows for the Accuracy of Your Reporting
- Whether you’re doing your taxes, communicating with your partners, or navigating an audit, you need to make sure you’re passing along reliable information. If you don’t, you take on an unnecessary risk. What if you owe your partner money? How about a government entity? What if you underpay? That could result in penalties or even legal action. It’d probably never come to that, but you definitely want to give yourself that extra piece of mind. Small business accounting helps you file the right forms and pay the right government entities their share.
Small Business Accounting Helps You Communicate with Investors
- Let’s say you’re raising a little financing or looking to sell your company. Investors will want to take a close look at how great you’re doing so they know how big of a check to write you. What if you run a popular food truck, there’s always a line around the corner, and you do a ton of cash transactions? You need an accurate record of all that. You know you’re doing great, but your books need to be able to quantify that.
It Protects You Legally
- If someone takes legal action against your company, you want to make sure they’re just going after your company and not your personal assets. A separate bank account and airtight bookkeeping helps your lawyers protect you in court. If you’re going to explain to a court that you and your company are truly two separate entities, you need to have the paperwork to back that up.
Chart of Accounts
The way you get your small business accounting in order is by recording every single business transaction. You do that in something called your “Chart of Accounts.” That might sound like a technical term, but this is really just a ledger where you record all of your financial moves. You’ll typically have categories like assets, liabilities, equity, revenue, and expenses. Then you break each of those out into sub-categories that help you draw actionable insights. Let’s take a look at a few of those sub-categories, because once you see a few examples, you’ll realize that it’s all really intuitive and easy to digest.
- Assets might be broken out into cash, accounts receivable, and inventory.
- Liabilities will probably have line items for your company credit card balance and accounts payable.
- Equity will have all the money that each owner contributed along the way.
- Revenue usually details how much of each product you sold, how much you charged for shipping, and how much you offered in discounts.
- Expenses can be broken out into how much you spent on utilities, a company car, and taxes.
It all gets really specific. There’s a sub-category for every nook and cranny of your business. Do you have too much money tied up in inventory? Do your sales justify that much inventory? In those moments when you don’t have all the answers, a chart of accounts helps you find them.
Bookkeeping: Who Does This? And Where Do They Do It?
You might hear people use the terms “bookkeeping” and “accounting” interchangeably. But there’s a small difference worth mentioning. Bookkeeping is the actual process of recording transactions in the chart of accounts you just read about above. Accounting then takes an extra step, using that information to generate reports and financial statements. In other words, bookkeeping gives you all of the source material you use to do your accounting. So, they’re attached at the hip. You need one to do the other. They’re part of the same process of tracking everything, and of course, knowing your numbers.
You either do your bookkeeping in a spreadsheet or in software like Quickbooks. When you use a spreadsheet, like Microsoft Excel, it’s cheaper. It’s also a manual process that forces you to engage a little more. When you use professional software, it might be a little more expensive, but you also get something in return for that investment. It suggests your charts of accounts, which might be helpful if you’re new to the process. It can also kick out some pretty sophisticated reporting. It even helps you generate and track invoices, process payroll as well as creating checks and payments for outstanding expenses.
Some people do this themselves by hand or through spreadsheets, which might seem like the cheapest option at first glance. But think about the time value of money. Get a sense for your own hourly rate, then ask yourself if your time is more valuable spent elsewhere, like closing deals. This thought exercise leads some people to delegate their bookkeeping to a professional who can do this cheaper, faster, and better. For some, this means hiring a freelancer. Others hire a full-time employee. But handing this over to a specialist might help you get your books right the first time, and liberate you to play to your strengths. If you do hand this over to someone else, you’ll want to put a few checks and balances into place. Your accountant can give you a list of safeguarding procedures to implement such as having an approval process for all outgoing funds, checks and credit card payments.
A Few Examples of Accounting Nuance
As you’re trying to decide who’s keeping your books and doing your accounting, you should know that it’s a nuanced field. Whoever does it, or advises you, will definitely need the proper training. To give you some idea, below are a few of the many factors you’ll need to keep in mind along the way.
Cash vs Accrual Accounting
- You usually need to pick a lane and do one or the other. Investopedia, a prominent financial publication, has a really simple way of breaking it down. They explain that accrual accounting recognizes transactions when they happen. Cash accounting recognizes transactions when the money actually exchanges hands. They go on to explain that while cash accounting might be simpler, the accruals method gives you a better sense for a company’s financial situation. For example, what if you have a ton of cash, but owe a supplier $2 million that you just haven’t paid yet?
The accrual method accounts for all of that context. You might be legally required to use one or the other depending on where you’re based, so make sure you look into that.
Employees vs. Contractors
- One big part of bookkeeping is tracking how you’re paying your team. A big decision is always whether your team is full-time or freelance. Full-time employees are deeper in the workflow of your company, create efficiency, and are always available. You have them fill out a form called a W4, which collects their tax info, so you can pass it along to government entities. Freelance contractors are an on-demand labor force, which is great because you’re only paying them when you’re really busy and can really justify it. They fill out a similar tax form to the full-time employees, but theirs is called a W9.
- This is a very custom decision you’ll have to make based on the consistency of your workload. But when you’re running that math, you also want to factor in the tax implications. Whether your team is full-time or freelance, each path triggers state, federal, and local taxes. Some are paid by you. Others are paid by the freelancer. Some are paid quarterly. Others are annual. But all of them have their own paperwork and filings — the specifics of which will flow from where you and your contractors are doing business. So, make sure you see the complete picture when you’re making the “full-time vs freelance” decision. A payroll company and accountant can help you break it all down.
- Some states might charge you just to operate. California, for example, charges you $800 every single year to base an LLC out of the state and to keep that LLC active. That’s even before you sell anything. So, look into whether your state has something similar to make sure you’re completely above board. Further, you’re often responsible for collecting state tax on every single transaction on behalf of the government. Let’s say you sell tennis balls online through Shopify. You’re doing great, so that means you’re shipping tennis balls to all 50 states.
Some states charge tax according to where the goods originate. Others states charge tax based on where those goods end up. If you do a lot of interstate commerce, you’ll want to meet with an accountant on the front end to ensure a smooth launch. It’s definitely not complicated once someone shows you how to do it. But that clarity usually begins with a custom professional review. Once you get huge, you’ll be glad you took the time to get this right.
Marcus always tells small business owners to “Know your numbers,” because those numbers tell you a story. Much of that story is told through your Profit and Loss Statement, sometimes known as your Income Statement. In a broad sense, it tells you how much money you’re making. You see how much money you brought in, how much it cost you to hit that number, and how much profit you ended up with when it’s all said and done. The biggest thing, as always, is context. If you lost money one year, ask yourself why.
Is it because your business model slowly changed and now you no longer have a margin? Or is it because your business model is great, but you had a one-time cost you’ll never have to worry about again? This sort of review is huge for seeing the big picture, especially when you’re sniffing out trends year-to-year. But as useful as this is for your internal purposes, it’s also important for your external reporting. You probably owe a few different government entities taxes on a quarterly basis. The amount you owe is based on your income statement. So, in order to settle up with the government, you’ll need an accurate, up-to-date income statement.
A Process for Kicking Off Your Small Business Accounting
You’ve just taken in a lot of information, but this is a great opportunity for something Marcus really loves: process. Take it one step at a time, and remember, this only seems like a lot because it’s new. After you make it through a year of small business accounting, it’ll all start to feel like a breeze. Here’s how to get started:
1. Planning Meeting – Meet with a professional accountant and gain an understanding of all the forms you need to file, which entities you’re filing with, and when those forms are due.
2. Bookkeeping – After you get a handle on the above, you’ll have a sense for whether you can handle bookkeeping yourself or you need to loop in a professional. But this step is where you actually assign your bookkeeping responsibilities to a designated person, and figure out whether they’ll be using Quickbooks, or another system you prefer.
3. Accounting – This is where you take all of the transactions you’ve logged in your chart of accounts and generate reports like your income statement. This will help you draw actionable insights that help improve your operation, but also, figure out how much money you owe the government and investors.
4. Filings and Payments – Your planning meeting with an accountant will give you a sense for all of the key forms you need to file and by which dates. You use these forms to tell the different entities how much money you made, then pay them whatever their share is.
As always, keep a meticulous record of every form and every payment you make along the way.
5. Process Improvement – You took the time to generate some great reports, so make sure you understand everything they have to offer. A professional can help with this, or maybe you’ll even want to take an online class or two. These reports are a wealth of information and can help you make some really profitable tweaks heading into next year.
6. Rinse and Repeat – You’ll go through the same process each year, so track everything in intimate detail. Log every date, set reminders, and save every form. Then you’ll have a really clean, easy-to-follow roadmap for the following year.
What’s at Stake
A rock-solid accounting approach isn’t just good for your business. It could also keep you out of serious trouble. Bookkeeping is at the center of a lot of fraud cases. The CEO of Tyco, Dennis Kozlowski, didn’t do a great job separating his personal finances from those of his company. He spent company money on $6,000 shower curtains, a $30 million home, and a $2 million birthday party for his wife. He basically disguised personal expenses as business expenses, which is known as “misappropriating company funds.” Time Magazine reported that this landed Kozlowski in prison for 25 years, so make sure your company’s books are always squeaky clean.
Enron was another famous case of wonky bookkeeping, and according to CNN, they exaggerated earnings when reporting to shareholders. Companies inflate earnings to convince people that they’re doing great, which artificially drives up their stock price. But it also led to Enron’s downfall. So, talk to your team about the importance of accurate bookkeeping – not just so you can grow, but so you can grow the right way. This will most likely never be an issue for you, but it’s important to explain the real-world implications of “creative bookkeeping” to your team.
Do you remember your first day of high school? Or your first day in the real world? Or your first day running a business? It all seemed like a lot, but once you got the hang of it, everything was a piece of cake. That’s a great way to think of small business accounting. It’s not hard. It’s just new. So, embrace the challenge, because it’s like Marcus always says, “You don’t get anything. You have to earn it.”
This article is informational only and subject to errors or omissions. As with any legal or regulatory advice, please consult your legal counsel or tax advisor to make sure you are in compliance with all and any federal, state, city or county rules and regulations. More
- How does your business currently keep track of their numbers?
- Which tips from the above can help you better know your numbers?
Morah, C. (2020, March 7). Accrual accounting vs. cash basis accounting: what’s the difference? Retrieved from https://www.investopedia.com/ask/answers/09/accrual-accounting.asp
Time.com. (n.d.). Top 10 crooked CEOs. Retrieved from http://content.time.com/time/specials/packages/article/0,28804,1903155_1903156_1903152,00.html
CNN.com. (2020, April 24). Enron fast facts. Retrieved from https://www.cnn.com/2013/07/02/us/enron-fast-facts/index.html