The more you prepare your books, the easier recordkeeping will be.
1. Open a business banking checking account
Keep your business and personal finances separate. Opening a business checking account keeps your records organized. Check with your banking institution to find out what documentation you need to provide to open a business bank account.
Typically you would need the following information:
Social Security number
Employer Identification Number (EIN)
Organizing documents (e.g., articles of organization)
2. Decide on the accounting method you will use
Every business taxpayer is required to have an accounting method to report income and expenses. The two most commonly used methods are cash and accrual. Once you choose your accounting method, you must follow it consistently. Generally, you may not change your method of accounting unless you obtain permission from the IRS.
Due to its simplicity, the cash method is a popular choice for small businesses. To determine gross income, add up the cash, checks, and fair market value of property and services you receive during the year.
If you receive a check on December 28, 2011, but decide not to cash or deposit it until after December 31, 2011, you must still count the check as income in the year you received it.
Business expenses are usually deducted in the year they are paid. For example, you order office supplies in October 2011 and they arrive in December 2011. You send a check to pay for them in January 2012. Under the cash method, you should claim that business expense deduction on your 2012 tax return because that is the year you paid for the supplies. Certain businesses cannot use the cash method. In addition, special rules apply for the accounting of inventory.
With the accrual method, income is reported in the year in which all events that fix the right to receive it have occurred, and the amount can be determined with reasonable accuracy, even if income was received in a different year. For example, the accrual method calls for income to be reported when a service is performed. It doesn’t matter that the customer doesn’t pay until the following year.
Similarly, you deduct business expenses in the year the liability arises, regardless of when they are actually paid. Using the office supply example, under the accrual method, you may deduct the business expenses for supplies on your 2011 tax return, the year you ordered the supplies and they were delivered, even though you sent a check to pay for them in January 2012. You may deduct the expenses in 2011 because that is when you became liable for the expense
Hybrid accounting, is a mixture of accrual and cash-basis accounting. Like the cash-basis method, you record income when you receive it, and record an expense when you make a payment. Hybrid accounting uses both cash and accrual methods.
3. Determine how your business will get paid
Determine what kinds of payments you will accept from your customers such as:
For instance if you have a business online your might use Paypal or Etsy payments to receive money from customers.
4. Set up a chart of accounts
A chart of accounts (COA) consists of the following five account categories:
Start by making a list of everything the business owns, owe, the methods you will use to receive money earned, and the expenses you expect to incur in the course of your business.
5. Keep good records of your income and expenses
Tracking expenses is a crucial part of accounting and in the long run it benefits you by reducing your tax obligation. When keeping a record of your income and expenses, be sure to hang onto the following:
Bank and credit card statements
Proof of payments
Previous tax returns
Forms 1099 misc, 1099K, W-2
The more documentation you keep in your records, the better off your business and books will be. Organize accounting receipts and other documents by the month they occur.
6. Determine how you will record transactions
Manually recording transactions by hand is the most time-consuming option. And you should have a basic understanding of accounting before recording transactions in your books.
Hiring an accountant seems like a good option but it can get expensive for a small business on a budget.
Take advantage of accounting software and let it do the hard work for you. Free Accounting software such as GnuCash can be ideal for a small business on a budget.
7. Schedule a time to do your bookkeeping
Stick to a bookkeeping schedule a time when you will records your business transactions, daily, weekly or monthly. Don’t put off recording transactions to the last minute your will regret it!