Beginners Guide to Bookkeeping

Are you making money from self-employment? If so, then you are required to keep good accounting records. IRS Defines Self-Employment Income, as income that is earned from carrying on a “trade or business” as a sole proprietor, an independent contractor, or some form of partnership.

Small businesses can hire a Bookkeeper, use a Bookkeeping service, or do their bookkeeping themselves manually or with the help of computer software. No matter what you decide you should have a basic understanding of bookkeeping principles.

Difference between an Accountant
and a Bookkeeper

Bookkeeping is the first part of the accounting process, so the work of a bookkeeper and accountant often overlaps. 

The difference between an Accountant and a Bookkeeper is an accountant is a professional who handles the bookkeeping and prepares financial documents like profit-and-loss statements, balance sheets etc. They perform audits of your books, prepare reports for tax purposes, and handle all the financial information that’s part of running your business.

Bookkeeping focuses on recording and organizing financial data, while accounting is the interpretation and presentation of that data.

Some small businesses will opt for an accountant depending on how complex their tax reporting and accounting needs are. An accountant’s services can get expensive for a small business. To cut costs some small businesses will use an accountant at the end of the year to audit their bookkeeping records and prepare their tax returns.

Getting Started:

In business, keeping records is crucial for a variety of reasons, including keeping track of the progress of a business, preparing tax returns, and keeping a record of receipts and deductible expenses which are all apart of the bookkeeping process.

Proper record-keeping for small businesses makes the process easier and keeps you compliant with the law. It will also help you in the long run, to be prepared in case of an IRS audit.

Most importantly, records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success. 

Opening a business checking account

You should always use a separate business checking account for business to keep track of income and expenses only. Do not use a personal checking account for business

Identify sources of your income

 Your records can identify the sources of your income. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income. 

Keep track of your deductible expenses

Unless you record them when they occur, you may forget expenses when you prepare your tax return.

Keep track of your basis in the property

Your basis is the amount of your investment in property for tax purposes. You will use the basis to figure the gain or loss on the sale, exchange, or other disposition of property, as well as deductions for depreciation, amortization, depletion, and casualty losses.

The Type of Records You Should keep

The business you are in affects the type of records you need to keep for federal tax purposes. Your business records must be available at all times for inspection by the IRS.

You will need all Documents to Support items reported on your tax returns. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination. 

Supporting Documents

Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents.

Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

The following are some of the types of records you should keep:

  • Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents for gross receipts include the following:
    • Cash register tapes
    • Deposit information (cash and credit sales)
    • Receipt books
    • Invoices
    • Forms 1099-MISC
  • Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for purchases. Documents for purchases include the following:
    • Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transfer
    • Cash register tape receipts
    • Credit card receipts and statements
    • Invoices
  • Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid and a description that shows the amount was for a business expense. Documents for expenses include the following:
    • Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transfer
    • Cash register tapes
    • Account statements
    • Credit card receipts and statements
    • Invoices
    • Petty cash slips for small cash payments
  • Travel, Transportation, Entertainment, and Gift Expenses
    If you deduct travel, entertainment, gift, or transportation expenses, you must be able to prove (substantiate) certain elements of expenses. 
  • Assets are the property, such as machinery and furniture, that you own and use in your business. You must keep records to verify certain information about your business assets. You need records to compute the annual depreciation and the gain or loss when you sell the assets.
  • Documents for assets should show the following information:
    • When and how you acquired the assets
    • Purchase price
    • Cost of any improvements
    • Section 179 deduction taken
    • Deductions taken for depreciation
    • Deductions taken for casualty losses, such as losses resulting from fires or storms
    • How you used the asset
    • When and how you disposed of the asset
    • Selling price
    • Expenses of saleThe following documents may show this information.
    • Purchase and sales invoices
    • Real estate closing statements
    • Canceled checks or other documents that identify payee, amount, and proof of payment/electronic funds transfer

Prepare your financial statements

You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business. 

  • An income statement shows the income and expenses of the business for a given period of time.
  • A balance sheet shows the assets, liabilities, and equity in the business on a given date. 

Prepare your tax return

Last but not least, you need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statement. 

2. Basic Accounting Principles

Accounting is the process used to identify, record, and communicate finances and financial activities in businesses and organizations. Accounting is often referred to as the “language of business”.

Accounting records and tracks financial transactions and business events showing what a business owns and what it owes others.

10 types of accounts for small businesses:

Cash

All your business transactions pass through the Cash account, often bookkeepers will use two journals, Cash Receipts and Cash Disbursements, to track the activity.

Accounts Receivable

If your company sells products or services and doesn’t collect payment immediately, you have “receivables,” or money due from customers. It is important that you track Accounts Receivable and keep it up to date and send timely and accurate bills or invoices.

Inventory

Unsold products must be carefully accounted for and tracked. The numbers in your books should be periodically tested by doing physical counts of inventory on hand.

Accounts Payable

accounts payable records what the business owes to others such as vendors. Good record keeping will help you to keep track of money going out and to pay timely payments and avoid paying someone twice! And possibly save you money since some business will offer a discount on timely payments,

Loans Payable

If you’ve borrowed money to buy equipment, vehicles, furniture, or other items for your business, this account tracks payments and due dates.

Sales

The Sales account tracks all incoming revenue from what you sell. Recording sales in a timely and accurate manner is critical to knowing where your business stands at a given point in your business.

Purchases

The Purchasing Account tracks any raw materials or finished goods that you buy for your business. This account is used in calculating “Cost of Goods Sold” (COGS), which is subtracted from Sales to determine your company’s gross profit.

Payroll Expenses

Payroll expense is the amount of salaries and wages paid to employees in exchange for services rendered by them to a business. The term may also be assumed to include the cost of all related payroll taxes, such as the employer’s matching payments for Medicare and social security. Keeping this account accurate and up to date is essential for meeting tax and other government reporting requirements.

Owners Equity

Owner equity tracks the amount an owner (or owners) puts into the business. Also referred to as net assets, owners equity reflects the amount of money an owner has once liabilities are subtracted from assets.

Retained Earnings

The Retained Earnings account tracks any company profits that are reinvested in the business and are not paid out to the owners. Retained earnings are cumulative, which means they appear as a running total of money that has been retained since the company started. This account is very important to investors and lenders who want to track how the company has performed over time.

The Five Basic Types of Accounts in Accounting:

  • Assets, what the business owns
  • Liabilities, what the business owes
  • Revenues or income, money earned by the business, usually through sales
  • Expenses necessary to run the business
  • Equity is liabilities, subtracted from assets = the business net worth

Basic Accounting Equation

Accounting is more about learning concepts and methods than about adding and subtracting numbers. If you understand the basics you’ll be well on your way to understanding accounting. There are a few basic accounting terms that are important to understand.

The first term is account

An account is a record in the accounting system used to collect and store business transactions.
Examples of accounts an organization may use are
……Sales,…
…Equipment,…
…Office Supplies,…
…Utilities,…

Think of an account as a way to store like information. For example, if you had a large container of fruits, oranges,
apples, and peaches to sort, each type of fruit would be sorted into a different carton that would represent its own account.

You would have one account for each type of fruit. After you had emptied the large container of fruits by sorting each fruit
into its carton, or account, you could then total the amounts in each account. Then, you would know how many oranges,
apples, and peaches, are in each account and could easily determine the cumulative amount of all accounts.

The Second Term is Transactions

Another important term is “transaction”. Transactions are events that effect an organization financially or cause some kind of financial change. Examples of a transaction that an organization might record in their accounting system are the purchase of office supplies such as paper, or a payment to the utility company for the prior month’s electric bill.

The Basic Accounting Equation is

…...Assets……equal Liabilities……plus Equity.
This equation represents the relationship between these three categories. This basic equation guides organizations when
recording and reporting their financial transactions. If you are new to accounting it is important to memorize this
fundamental concept.

Assets, liabilities and equity

Assets, liabilities, and equity are 3 accounting terms used to identify what an organization owns and what it owes others.

Assets are an organization’s resources or what it owns. (e.g., accounts receivable, inventory)

Liabilities are claims on the organization or what it owes others. (e.g., accounts payable, loans)

Equity or capital, which is also referred to as net assets. Equity is what remains after all liabilities or debts of the organization are paid. If you take the organization’s total assets and subtract its total liabilities you would then know how much equity remains.

This basic equation provides a way to measure a company’s profitability or lack of profitability. It also states assets must always equal liabilities plus equity. In accounting, this equation should always be followed and the rules of the equation should never be broken.

3. Debits and Credits

Debits and Credits

Debits and Credits are apart of The Accounting Equation. Transactions are entered using debits and credits. Debits and credits can be the most confusing part of bookkeeping for beginners. Assets equal liabilities plus owner’s equity. Debits equal credits. Debits and credit increase and decrease account balances. The total debits must equal the total credits. This method provides a check and balance system.

To keep a scale in balance, items of equal weight must be placed on both sides of the scale. The accounting equation works much in the same way. Equal values of a transaction must be placed on both sides of the equation using debits and credits to keep the equation in balance. Also, if the transaction affects only one side of the accounting equation, the effects of the debits and credits would cancel each other out.

Debit amounts are always entered on the left side of an account Credit amounts are always entered on the right
side of an account.

Note: The terms debits and credits by themselves do not mean decrease or increase. In accounting, these terms must be associated with the account types to have meaning

For example: on an asset account, cash is debited. It’s increased. In an owner’s equity account, capital stock is credited. It’s also increased. There is both a debit and a credit for the transaction, and we have increased accounts on both sides of the accounting equation by an equal amount, thus keeping the accounting equation in balance.

To understand the relationship between debits and credits, the various accounts, and the accounting equation, when cash is borrowed from a bank, cash is increased with a debit, and notes a payable liability is increased with a credit.

It’s crucial that each debit and credit transaction is 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 enter transactions correctly it’s important to know if a debit or credit increases or decreases the account’s balance. Learning the normal balance for each account type will help you with this process.

Account Category Normal Balance

Account typeDebit . .Credit
AssetIncreaseDecrease
LiabilityDecreaseIncrease
RevenueDecreaseIncrease
ExpenseIncreaseDecrease
EquityDecreaseIncrease

4. Entering Transactions and Preparing Financial Reports

Everything is recorded in a journal using debits and credits. Two different methods used is bookkeeping to enter your business transactions are single-entry bookkeeping and double-entry bookkeeping,

Single-entry Bookkeeping

With single-entry bookkeeping, you enter each transaction only once. If a customer pays you a sum, you enter that sum in your asset column only. This is not a good method for small business accounting unless your business is simple— say you work out of your home, and the business does not use any equipment or have inventory and you do not many cash transactions, you might consider single-entry bookkeeping, But it is not recommended.

Single-entry bookkeeping gives a one-sided picture of transactions recorded in the cash register. In double entry, changes due to one transaction are reflected in at least two accounts. In a single entry, there is no method for error correction or detection.

Double-entry Bookkeeping

Double-entry bookkeeping on the other hand is an accounting technique that records a debit and credit for each financial transaction occurring within a company. … Companies benefit greatly from using double-entry bookkeeping because it aids inaccurate financial reporting and reduces errors and fraudulent activity.

Double entry, states that every financial transaction has equal and opposite effects in at least two different accounts. Using debits and credits as an example of double-entry accounting, if you were going to record sales revenue of $1200 you would need to make two entries: a debit entry of $1200 to increase the balance sheet account called “Cash” and a credit entry of $1200 to increase the income statement account called “Revenue.”

Recording Transactions

To record a transaction, you must first determine the accounts that will be debited and credited.  For example, imagine that you’ve just purchased new equipment for your business. You paid $500, in cash for the equipment.

The transaction will affect two accounts:
Cash (an asset account) and
Equipment (an asset account).
Because you’re decreasing your cash and increasing your equipment, you would record a $500 debit (on the left) for the equipment account and a $500 credit for the cash account (on the right).

When you tally up account debits and credits—often at the end of the quarter or year—the totals should match. This means that your books are “balanced.”

Balancing The Books

Balancing the books occurs at the end of the period, you’ll “post” the debit and credit entries to the accounts themselves in the general ledger and adjust the account balances accordingly.

For example, if over the course of the month your cash account has had $4,000 in debits (increases) and $5,000 in credits (decreases), you would adjust the cash account balance by a total of $1,000 (as a decrease). Follow this method to adjust the balances for each account in your ledger. 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’ll 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. Always consult your account before making any changes to your records.

Financial Reports

Once the books are balanced the next step is to, summarize the flow of money in each account. Some of the most common financial reports created in bookkeeping are:

  • 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.
  • 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.

Bookkeeping can take time away from your business and unless you’re experienced in accounting principles, bookkeeping can be a challenging task. Getting help—whether by hiring a bookkeeper, outsourcing to an accounting service, or using accounting software it will give you more time to focus on your business.

Bookkeeping With Free Gnucash Accounting Software

Starting and running a business is a business in itself and it can be overwhelming. You’re busy trying to perfect your craft or trade, and keep your customers happy and returning. Small Business Bookkeeping can take valuable time away from your business. And unless you’re experienced in accounting principles, bookkeeping can be a challenging task.

Accounting Software can take the headache out of manual bookkeeping. Computerized Accounting does not necessarily require bookkeeping knowledge but it is a good idea to have basic knowledge.

Bookkeeping is all about income and expenses. Income reporting benefits the government and is used to determine how much money you owe. Business expenses it is what you use to reduce your tax obligation. The more legitimate expenses you have the less taxes you will pay. What good bookkeeping does is give you a clear picture of income and expenses so there are no misunderstandings or loss deductions.

Accounting Software does the hard part for you, they transfer the right numbers to the right accounts and make sure those numbers get put on the proper side of the account, the debit side or the credit side.

Using accounting software can not only save you time and money, but it can offer you valuable insight into your business. Which helps you prepare financial reports, many in real-time. This can be a lifesaver for small-business owners who need to make quick financial decisions based on their business financial status.

Save Time and Money With GnuCash Free Accounting Software

Gnucash is a free product that has been around since 1997 and is a good alternative to Commercial accounting software programs. For Small businesses on a budget, Gnucash can be a lifesaver. It doesn’t have all the bells and whistles of Quickbooks, an industry-standard accounting software but it gets the job done!

While GnuCash is well suited for personal finances, it is also powerful and versatile enough to keep track of all your business financial needs, from the simple to the very complex. Fortunately, GnuCash makes running the business so easy, that you can focus on the heart of what you do.

GnuCash can take care of the day-to-day operations, it is an excellent and powerful program for a free product. It is designed to be easy to use yet powerful and flexible, enough for small business bookkeeping.

It allows you to track bank accounts, income, and expenses, A/R, A/P, budgeting, and payroll. It is based on professional accounting principles to ensure balanced books and accurate reports. Do reporting with ease, to help you service your customers better and make things easy at tax time.

It is one of the few financial software packages that support global currencies and best of all, GnuCash is easy to learn and use!

Taxes for Small Businesses (Overview)

Your business will need to meet its federal, state, and local tax obligations to stay in good legal standing. Your business structure and location will influence which taxes your business has to pay. Your business is legally required to pay taxes and keep accounting records on a consistent yearly schedule called a tax year.

Most businesses choose their tax year to be the same as the calendar year. You select your tax year the first time you file for taxes but can change it later with permission from the IRS.

  • Calendar tax year if you don’t have special accounting needs for your business.
  • Fiscal tax year if you want your 12-month accounting cycle to end in a month that isn’t December.
  • Short tax year if your business wasn’t in existence for an entire tax year, or you changed your accounting period.

If your business doesn’t have much reporting or bookkeeping, you might be required to use a calendar tax year. Check with the IRS for detailed rules about tax years.

ESTIMATED TAXES

Taxes must be paid as you earn or receive income during the year, either through withholding or estimated tax payments. If you are in business for yourself, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax but other taxes such as self-employment tax and alternative minimum tax.

If you don’t pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.

You are also expected to make quarterly estimated tax payments for the current tax year. Some exceptions do apply. Estimated tax due dates.

ANNUAL BUSINESS TAX RETURN FILINGS

Every business owner is responsible for paying business taxes. All businesses except partnerships must file an annual income tax return. Partnerships file an information return. The form you use depends on how your business is organized.

Federal Business Taxes

Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. Your payments of SE tax contribute to your coverage under the social security system. Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and hospital insurance (Medicare) benefits.

Generally, you must pay SE tax and file Schedule SE (Form 1040 or 1040-SR) if either of the following applies.

  • If your net earnings from self-employment were $400 or more.
  • If you work for a church or a qualified church-controlled organization (other than as a minister or member of a religious order) that elected an exemption from social security and Medicare taxes, you are subject to SE tax if you receive $108.28 or more in wages from the church or organization.

You also pay tax self-employment tax on net earnings. If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C to figure net earnings from self-employment.

State Business Taxes

You are also required to file annual state tax returns for your business with the State Revenue Office.

Your state income tax obligations are determined by your business structure. For example, corporations are taxed separately from the owners, while sole proprietors report their personal and business income taxes using the same form.

If your business has employees, you’ll be responsible for paying state employment taxes. These vary by state but often include workers’ compensation insurance, unemployment insurance taxes, and temporary disability insurance. You might also be responsible for withholding employee income tax. Check with your state tax authority to find out how much you need to withhold and when you need to send it to the state.

Local Business Taxes

Depending on your business location and local city requirements, a local city tax return and a business privilege tax may apply. Check with your local city clerk’s office for full details on their tax requirements for small businesses doing business in the city where your business resides.