So, you are finally there, all set to get your business up and running. You have already a robust business model, drafted a solid business plan, have your basics ready and want to take your business off the ground. Setting up and running a business is going to be a long journey.
But before you delve into it, have you addressed vital components? To carry on business profitably, many critical factors require your attention. One such key component is “accounting.”
Do you have a plan on how to manage your books yet?
If your answer is no, then this article is for you.
Don’t get me wrong, it is crucial to have a proper business plan in place, shop for the vendors, suppliers, create an exceptional customer support team, etc., and along with these, you should focus on accounting too. At the end of the day, books are the ones that will help you in the tracking of your finances right!
You may think that small business accounting will be easy; you have to track daily cash flow, and you are done. But that is not the case. Accounting is much more significant and essential for businesses out there, irrespective of their size.
In this blog post, we will cover all the basics of accounting that every entrepreneur should know.
Read our guide on : Top budgeting tips for small businesses
What is accounting?
When I said basics, I meant it. Let us talk about what accounting is in the first place.
Accounting is also known as the language of business.
It helps you document, process and communicate the financial information of your business to interested parties.
It is the process of recording and summarising financial transactions and analysing, verifying, and reporting the results.
It helps in analysing the financial health and business performance. Having the right accounting system in place is vital for every new business.
Basic concepts of accounting
Now that you know what accounting means let us delve deeper and understand some essential accounting concepts.
It is the first and foremost thing that you must understand in accounting. What is it?
Assets = Liabilities + Owner’s equity
Assets: Everything that your business owns
Liabilities: Everything your business owes
Owner’s equity: Capital investment, cumulated undistributed profits and reserves
Double-entry accounting is the most popular way to maintain accurate books. Usually, single-entry accounting will take care of your income and expenses, whereas with double-entry accounting, you will be including the assets and liabilities as well. This will give you a complete balance sheet.
Income and expenses will help you understand your business, but knowing assets and liabilities is essential when it comes to the overall financial picture. The machinery, equipment, loan, unpaid supplier bills and property related to business won’t directly bring income to the company just like sales do, but they are an integral part of the business.
They help in understanding the overall net worth of a business.
Journal entry keeps track of each accounting transaction. Examples of accounting transactions include paying staff wages, purchasing and selling goods on credit, recording stock, and taking a bank loan.
Usually, a journal entry has the following four components:
- Transaction date
- Debited amount
- Credited amount
- Transaction description
|1||24 Nov 2021||Asset||£1,000|
|Purchase of laptop for £1,000|
This is how it should be. As you can see, the debits are in the left column, and credits are in the right column.
Chart of accounts
It is a summary of all ledger codes.
The chart of accounts is divided into five sections
All accounting software come with a default chart of accounts.
Read our What is bookkeeping guide.
Accounting for small businesses
As you understand the basic finance concepts, let us know how to proceed with the accounting process.
The business bank account is a must
You should have a separate bank account for your business. If you don’t have any, get one from your local branch immediately.
This way, all of your business transactions stay in one place, making it easy for you to file the taxes.
Apart from that, having a separate bank account will come in handy when you are applying for a business loan.
Choose the right accounting system
Yes, businesses follow two different accounting systems, and you should pick one of them and follow it to the point once you are all set.
In the Accrual method, the bills, expenses, and income are recorded when they occur but not when cash is transferred. Confusing right!
Don’t worry; here is an example for you to understand.
You have an income of £5,000 and another £1,000 in unpaid customer invoices. You spent £500 in the month, and another £100 worth of supplier bills are unpaid.
In the Accrual method, the total profit is £5,400 (£5,000 + £1,000 – £500 – £100). Here the income, although it is not yet received, is added and also, the unpaid expenses are deducted, giving you a total profit of £5,400. It gives you a clear idea of your finances, but it disappoints once you check it from a cash flow perspective.
There is good profit on books, but you don’t have the cash that justifies it.
The cash method is quite the opposite of the first. Here any income or expense is considered as profit or loss only if cash has exchanged hands. Let us take the above example only, and according to it, your business’s total revenue is only £4,500 (£5,000 – £500). £1,000 of unpaid customer invoices and £100 as expenses aren’t considered yet as they aren’t received or paid in cash.
This cash method helps inaccurate tracking of your daily income.
Check our guide to read more about : accrual and cash accounting methods.
Pick the accounting software
Right small business accounting software makes a lot of difference in your business. Age-old accounting concepts will involve a lot of work and stationary too. Hence picking cloud accounting software will eliminate all these and makes accounting easy for you.
Consider all of these factors first and then proceed with the software.
Check financial statements
Financial statements will help in understanding and working around your business. So, always stay on top of them. Here are the important statements that you need to run for your business.
- Balance sheet: A balance sheet is where you will be reporting about your assets, liabilities and equity. It provides insights on what a company owns, what it owes, whom it owes, and the owner’s equity. It gives a complete overview of your business as of a moment in time.
- Profit and loss statement: It shows business performance. It usually includes a breakdown of revenue from multiple sources, direct costs, gross profit, administrative costs, finances charges and taxes..
- Cash flow statement: It tracks cash movement and is usually divided into operating, investing, and financing activities.
All of these financial statements are usually generated by accounting software.
This would be the most dreading task for every business owner out there. Filing taxes is important yet can be confusing. If you have the right team and tools in place, this might become easier.
Check our guide on : Our top tips for meeting your accounting deadlines effectively.
You do not pay tax on your revenue; instead, corporation tax is due on the business profits. This means you can claim a deduction for items like:
- Depreciation of furniture and infrastructure
- Rent and business rates
- Employee salaries
- Loan interest
- Travel expenses
- PR, marketing and advertising costs
If you are into research and innovation, the UK government offers you even more exemptions and tax credits taxes like R&D tax credits.
Check our guide on : How to calculate VAT.
Hire an accountant
Yes, you are on top of everything, but there comes a time when you have to take professional help to get your accounting done.
If you are hands-on with different types of work, then hire an accountant. It will reduce your work, save your time, and help you save taxes by claiming all allowances.
Don’t forget; the UK has one of the longest taxonomy in the world!
Check our guide on : 15 Ways an Accountant Can Help a Small Business Owner.
Every business out there is different, but one thing that is common among them all is accounting. No matter what type of partnership you have, or the size of your business, accounting remains the same and plays a key role.
However, modern entrepreneurs do not have to worry about any of these. Accounting can be organised and managed easily with the best accounting tools and various reliable small business accountants near me.