Accounting for Small Businesses: What Entrepreneurs Should Know

Accounting for Small Businesses: What Entrepreneurs Should Know

The majority of small business owners do not work as accountants. However, they must learn the fundamentals of accounting regardless of whether they have experience in product development, human resources, management, or anything else.

The good news is that accounting for small businesses is comparatively easy. Companies with a single state of operation and a straightforward corporate structure have three accounting priorities:

1. Keep your personal and business finances separate

Mixing personal and business funds together is one of the messiest accounting errors small business owners can commit. Although many business owners contribute their own capital during the startup phase, business income and expenses must be kept apart from personal ones.

2. Strong organisational structure 

Starting with a strong organisational structure is the best course of action. Create a separate legal entity for your business, such as a S corporation or LLC. Create a business checking account to serve as your central financial account and use it to pay yourself a salary each month. Open a business savings account as a contingency or investment fund and get a business credit card for expenses you can’t or don’t want to pay in cash. Keep track of any personal items that are used for work.

3. Clearly classify the workers

You have two options when putting together a team: permanent employees, or contractors. The IRS defines employees as people you have long-term business relationships with, behavioural authority over, and financial control over. 

Contrarily, contractors are individuals who work for your company on a project-by-project basis while maintaining autonomy over their own work schedules and professional decisions.

4. The consequences for misclassifying employees

The consequences for misclassifying employees are severe. The employer of misclassified contractors must pay $50 for each W-2 form in addition to fees of 1.5% of wages and 40% of FICA taxes that it failed to deduct from the employee. 

Additionally, the employer is responsible for covering the full amount of FICA taxes due for each employee. If the IRS determines that the misclassification was done on purpose, the employer faces fines of up to $1,000 per employee or a year in jail.

5. Prior to hiring, calculate your total labour costs

If you choose to employ people, be aware that you’ll be responsible for more than just their salaries. You’ll need to come up with the money for their benefits and payroll taxes at least once a month. These expenses accumulate more quickly than many small business owners anticipate. Only 43% of people who handle their own payroll are confident in their ability to pay their employees on time, according to a survey by OnPay. The remaining businesses either have unfinished business or are overly eager to grow.

Avoid putting yourself in a position where you have to reduce compensation after hiring. Your employees will feel cheated if you reduce their pay and benefits, even if you were generous with them initially. High turnover is unaffordable for small businesses especially for their initial hires.

6. Produce profit and loss statements regularly.

An essential accounting tool that summarises your company’s earnings and outlays for a specific time period is the profit and loss statement. They must be released once every three months by all publicly traded companies. P&L statements are a great way to determine whether you’re on track to meet your financial goals, even though small business owners aren’t legally required to produce them.

7. To create a P&L statement, adhere to these steps:

  • Add up all the money you made during the quarter.
  • List each expense for your business. To calculate operating profit, deduct all costs from gross profit.
  • You can determine whether your company made a profit or a loss for the quarter by deducting interest and taxes from the operating profit.

Despite the value of individual P&L statements, quarter-to-quarter comparisons are even more crucial. Do your operating costs increase? Despite increasing sales, is your profit declining? Such insights come from comparing P&L statements to one another.

8. Get a receipt at all times

A sizable portion of your business’s expenses are tax deductible. accounting services 16 categories are listed by Bench as having either a full or partial tax deduction for expenses. These costs include office rent, advertising campaigns, and meals with clients. However, you require receipts for tracking and verification in order to claim them.

9. Receipts for donations

One area where small business owners frequently forget to get a receipt is for donations. Although organisations with specific organisational structures, such as LLCs and partnerships, cannot deduct charitable donations as business expenses, the owner frequently can. Request written confirmation of the time spent from recipients of in-kind donations, and use evidence to support the fair market value of any property donations you make.

10. Pay close attention to the accounts receivable

Even though managing accounts payable is crucial, unlike accounts receivables, they do not determine whether the business will survive. The business cannot function if there is no money coming in the door. Review the percentage and overall amount of unpaid revenue each month. In general, you shouldn’t have any past-due accounts for more than 10% to 15% of your receivables. Contact those clients each week. If you want to continue working with them, don’t arbitrarily send them to collections. You also can’t let them take advantage of you.

11. Monthly finance charge

Introducing fines for late payments is one solution. Decide on a finance charge per month that is 1% or 2% of the principal. For instance, if you choose to charge 2% on a $5,000 initial charge, you would add $100 to the invoice for each month it is unpaid. Be sure to make this clear to clients up front: Not only is this important legally, but the threat of fines is frequently sufficient to deter sluggish payment practices in the first place.

12.  Submit accurate and timely invoices

Although it’s a necessary part of running a business, issuing invoices can be tedious and time-consuming. Additionally, mistakes can make it harder for you to get paid. It is crucial that you send out accurate invoices on a regular basis because of this.

The invoices must be sent promptly and should include specific information about the transactions in a detailed manner. To improve your chances of getting paid, send reminders via email and/or text after the fact. You can identify customers who don’t pay on time and reward those who always pay on time by keeping thorough and accurate records of your invoices.

13. Be aware of tax filing deadlines

You pay taxes as an individual once a year. But the majority of small businesses are required to submit quarterly estimated tax payments. Both self-employment tax (which includes social security and medicare taxes) and income tax on your company’s profits are paid in three-month intervals.

To determine whether you must pay quarterly taxes, follow these steps:

  • The amount of federal taxes you anticipate owing this year will be less after deducting your federal income tax withholding. You are exempt from making quarterly payments if that sum is less than $1,000.
  • Add 0.9 to the total federal tax you anticipate paying this year. There is no requirement to make quarterly payments if you have deducted at least that amount.
  • In the previous year’s return, compare your withholding amount to the total federal income tax you paid. You don’t need to pay those quarterly taxes if it’s at least as much.

14. Establish your own payment terms

Large businesses typically transfer funds two to three months after receiving an invoice under terms like net-60 or even net-90. By conducting business in the same manner, your small business can manage its cash flow. Consistency is the secret. Say you pay on a 30-day net basis. At the time of service, be sure to make it clear that you will pay your vendors in 30 days. 

Don’t pay early because the vendor might expect it the next time; don’t pay late because they might decide not to do business with you again.

  • Make sure their revenues outpace their costs.
  • Maintain orderly books
  • Tax obligations

15. Use accounting software

For many small businesses, accounting software used to be prohibitively expensive. However, you can now access powerful accounting software for a monthly fee (or even free). Accounting software has a tonne of features and services for small business owners, including ones for tracking sales, budgeting, inventory management, financial statements, payroll, and taxes. It is also getting easier to use.

Cloud-based accounting software frequently integrates with many of the other business software programmes you use, in addition to automating processes and accurately tracking and balancing your books. Sharing data between programmes can cut down on errors and save you time compared to manually entering data into your accounting programme.

Nevertheless, small business accounting can be challenging for executives without any financial experience. To stay on track, use these 15 accounting tips.