Bookkeeping 101: Understanding the importance and best practices
Bookkeeping is essential to your organization's success. If you don't know where your money goes, how can you cut costs or find the right growth strategies? Yet a recent study showed that only 60% of business owners feel confident about bookkeeping.
If you're in that group, don't worry. In this guide we'll explain why bookkeeping matters, cover common mistakes and how to avoid them, and highlight bookkeeping best practices.
Before we dig into bookkeeping details, it's important to distinguish between bookkeeping and accounting. While these roles overlap, there are key differences. Bookkeeping is focused on managing transactions, while accounting analyzes the big picture — for example, tax compliance. The reports produced by bookkeepers are used by accountants, which makes setting a strong tone at the top important. Let's dive in.
Why does bookkeeping matter? Organized financial records create the foundation for accuracy, compliance and understanding performance. Here are a few more reasons why bookkeeping should be a priority at your company.
Banks ask for it Most businesses use debt financing for general operations, expansion initiatives and equipment purchases. One of the first pieces of information lenders request is your financial statements. This includes the balance sheet, income statement and statement of cash flows. If you're several months behind on bookkeeping, you risk sending inaccurate financial statements. Not only can this lead to legal issues, but it can also result in a reduced loan amount.
Prepared by EDEAL.AI
For example, say you haven't done bookkeeping for six months and relied only on transactions downloaded into your accounting software. Income may be misstated, transactions may be duplicated and inventory tracking may be inaccurate.
Overall, the reports you send your lender won't accurately reflect your financial condition. Not to mention, trying to catch up on bookkeeping records can take weeks, delaying the funding you may be counting on to keep the doors open.
Buyers ask for it With countless Americans breaking out of the 9-to-5 and striving to become their own bosses, now may be an opportune time to sell your business. You don't want outdated bookkeeping to be the obstacle. On average, selling a business can take six to ten months with smooth communication and document requests. Getting your bookkeeping records in order can take months, further delaying the sale.
In addition, financial statements generated by your internal bookkeeping team will be one of the main factors in a successful business sale. Buyers look for companies with growing sales, strong receivables control and stable cash flow. Even if you know your business meets these criteria, you still need to prove it to buyers through your financial statements — current AR aging schedules, income statements, balance sheets and bank statements.
Tax planning depends on it As your business grows, you may notice your tax liability growing too. Small business owners can pay nearly 40% in taxes, depending on your business structure. How do you feel about giving $40 of every $100 earned to Uncle Sam? The good news is there are strategies you can apply each year to reduce the tax burden.
However, these strategies depend on an accurate view of your financial system. For example, if you have excess income, you may decide to buy that new vehicle you need, or decide to defer excess income to the new year. The most effective time for tax planning is before year end, which is why bookkeeping matters throughout the year. You don't want to miss a chance to save on taxes because you neglected bookkeeping for the past nine months.
Prepared by EDEAL.AI
Large contracts require it Government contractors hold higher standards, requiring full compliance with federal regulations on billing and payment collection. Failing to meet these standards can prevent you from winning contracts in the future, hindering your organization's success. Even if you don't contract with government agencies, many clients will demand proof of financial stability before signing a large contract.
Why is that? Governments and clients with large contracts want to be sure you have the resources to do the work effectively. If you claim millions of dollars in machines but your balance sheet only shows $500,000, that's a serious issue. It's best to be ready to provide financial information before you bid on a large contract. Cash flow depends on it
Cash flow is one of the main reasons small businesses fail. Without regular bookkeeping, you have no idea what funds are coming in and out of your company. This can lead to delays in collecting receivables and missed payments to vendors, which hurts your business's financial health.
In addition, neglecting bookkeeping can be fatal for your business's longevity. Maybe your checking account shows $100,000 in cash, and you decide to buy a new machine for $20,000. What happens if you forget to enter $40,000 in outstanding checks and your true balance is only $60,000? Would you still have bought that machine?
Common bookkeeping mistakes and how to avoid them Now that we've covered why bookkeeping matters, let's look at some common bookkeeping mistakes and how to avoid them.
Neglecting bookkeeping until year end
By now you should understand the importance of keeping your books up to date. Unfortunately, when things get busy, bookkeeping is often the first thing to lose attention. Leaving your books unattended until year end can have serious consequences. First, it opens the door to more errors. It's much easier to remember a transaction from last month than one from six months ago.
In addition, you risk missing transactions, which leads to a higher tax liability. To avoid this common mistake, set aside time each month to reconcile your accounts. Write it on the calendar or set a reminder. A few hours each month can meaningfully improve the accuracy of your books.
Prepared by EDEAL.AI
Misclassifying income and expenses
Classifying your income and expenses matters. For example, meal expenses can only be recognized for tax purposes at 50%, while entertainment expenses aren't deductible at all. If you misclassify these expense items, you increase your taxable income. Also, interest income is taxed differently than regular sales income. You need to make sure you classify transactions correctly to produce accurate tax returns and financial statements.
When it comes to transactions downloaded from your bank, take the time to verify they're correct. Software often misclassifies transactions. Also, be careful when performing bank reconciliations. Don't be afraid to spend additional time to ensure classification accuracy.
Misclassifying employees and contractors
Employees and independent contractors are treated differently in the eyes of the IRS. Misclassifying an employee as a contractor can lead to additional taxes with serious penalties and interest. Before paying a new worker, review the General Rules defined by the IRS. It's a three-part test that helps you determine the worker type. Next, make sure your accounting software reflects the correct information. In most cases you'll need to note that the worker is an independent contractor. This will reflect the amount paid to the contractor on the 1099 report at year end.
Skipping sales tax
Sales tax became more complex after the South Dakota v. Wayfair decision. Even if you're not in e-commerce, selling across state lines may require you to file and pay sales tax in multiple states. When billing a customer, make sure you have the correct shipping address. This ensures sales are reflected in the correct state. To avoid missing sales tax, check your sales in each state monthly. Most accounting software offers a report you can use. Forgetting to review financial statements
Financial statements serve as your double check. Too often business owners neglect reviewing these reports until year end. After completing bank reconciliations each month, you should review core financial statements, including AR aging schedule, AP aging schedule, income statement and balance sheet. Incorporating these into your standard monthly process will improve your control and transparency over your company's financial condition.
Prepared by EDEAL.AI
Avoiding accounting software
As you've noticed, we've talked a lot about accounting software. Accounting software eliminates the need for routine data entry, letting you bring efficiency to your bookkeeping. Not only is it a cost-effective approach, but it also reduces your risk of human error. If you're not using accounting software yet, spend time finding the right program and making the switch.
Bookkeeping best practices
Taking on bookkeeping at your company can feel overwhelming, so we've compiled a list of bookkeeping best practices you can follow. Keep in mind that the processes that fit your company best depend on your industry, transaction types and strategic goals. Still, here's a starting point.
Review transactions
During the month, review your transactions. Your business's transaction volume will determine how often you should classify income and expenses. For example, if your business has only 50 transactions a month, you may only need to classify transactions once a week or once a month. However, if your business has thousands of transactions every month, daily classification may be necessary.
Monthly account reconciliation
Every month, when your bank and credit organizations send you statements, go into your accounting software and complete the reconciliation process. Reconciling your accounts matches what actually passed through the bank to the transactions currently in your cash journal. Analyze any discrepancies. It's not uncommon for banks to make mistakes — for example, mixing up check numbers or charging unknown fees.
Track AR and AP aging schedules
Another bookkeeping best practice is tracking accounts receivable and accounts payable aging schedules. These documents monitor how much customers owe you and how much your business owes third parties, like vendors. Tracking these reports is important for managing cash flow. For example, you may find that a customer has been overdue for three months. Knowing that, you can clarify when you can expect payment.
Plan taxes regularly
Tax planning is important to minimize your tax burden. Regularly — quarterly, for example — take time to forecast your income through year end. This is especially important if you need to make quarterly estimated tax payments. If you're not sure which tax-planning strategies work best for your business, turn to a qualified accountant.
Prepared by EDEAL.AI
Optimize your chart of accounts
Your chart of accounts determines how your transactions will be categorized. Optimizing your chart of accounts can produce greater clarity in your financial statements and help you plan growth efficiently. For example, say you have an office and a warehouse. If you have only one rent account, it can be hard to separate cost of goods sold from general and administrative expenses. By creating separate accounts for office and warehouse rent, you build greater clarity in the rent breakdown.
Set internal guidelines
Internal controls to minimize fraud risk and optimize your bookkeeping processes are essential. Take time to develop a plan for how bookkeeping should be done each month, including the role of every team member. You may decide one person handles accounts payable and another handles bank reconciliations. However, if you're in a growth phase and don't have enough staff to separate roles, consider outsourcing your bookkeeping.
Getting started Ready to take bookkeeping seriously at your business? Getting started can be hard, which is why our team at Edeal Inc. is here to help. Contact us today to schedule your free consultation.
Bookkeeping is essential to your organization's success. If you don't know where your money goes, how can you cut costs or find the right growth strategies? Yet a recent study showed that only 60% of business owners feel confident about bookkeeping.
If you're in that group, don't worry. In this guide we'll explain why bookkeeping matters, cover common mistakes and how to avoid them, and highlight bookkeeping best practices.
Before we dig into bookkeeping details, it's important to distinguish between bookkeeping and accounting. While these roles overlap, there are key differences. Bookkeeping is focused on managing transactions, while accounting analyzes the big picture — for example, tax compliance. The reports produced by bookkeepers are used by accountants, which makes setting a strong tone at the top important. Let's dive in.
Why does bookkeeping matter? Organized financial records create the foundation for accuracy, compliance and understanding performance. Here are a few more reasons why bookkeeping should be a priority at your company.
Banks ask for it Most businesses use debt financing for general operations, expansion initiatives and equipment purchases. One of the first pieces of information lenders request is your financial statements. This includes the balance sheet, income statement and statement of cash flows. If you're several months behind on bookkeeping, you risk sending inaccurate financial statements. Not only can this lead to legal issues, but it can also result in a reduced loan amount.
Prepared by EDEAL.AI
For example, say you haven't done bookkeeping for six months and relied only on transactions downloaded into your accounting software. Income may be misstated, transactions may be duplicated and inventory tracking may be inaccurate.
Overall, the reports you send your lender won't accurately reflect your financial condition. Not to mention, trying to catch up on bookkeeping records can take weeks, delaying the funding you may be counting on to keep the doors open.
Buyers ask for it With countless Americans breaking out of the 9-to-5 and striving to become their own bosses, now may be an opportune time to sell your business. You don't want outdated bookkeeping to be the obstacle. On average, selling a business can take six to ten months with smooth communication and document requests. Getting your bookkeeping records in order can take months, further delaying the sale.
In addition, financial statements generated by your internal bookkeeping team will be one of the main factors in a successful business sale. Buyers look for companies with growing sales, strong receivables control and stable cash flow. Even if you know your business meets these criteria, you still need to prove it to buyers through your financial statements — current AR aging schedules, income statements, balance sheets and bank statements.
Tax planning depends on it As your business grows, you may notice your tax liability growing too. Small business owners can pay nearly 40% in taxes, depending on your business structure. How do you feel about giving $40 of every $100 earned to Uncle Sam? The good news is there are strategies you can apply each year to reduce the tax burden.
However, these strategies depend on an accurate view of your financial system. For example, if you have excess income, you may decide to buy that new vehicle you need, or decide to defer excess income to the new year. The most effective time for tax planning is before year end, which is why bookkeeping matters throughout the year. You don't want to miss a chance to save on taxes because you neglected bookkeeping for the past nine months.
Prepared by EDEAL.AI
Large contracts require it Government contractors hold higher standards, requiring full compliance with federal regulations on billing and payment collection. Failing to meet these standards can prevent you from winning contracts in the future, hindering your organization's success. Even if you don't contract with government agencies, many clients will demand proof of financial stability before signing a large contract.
Why is that? Governments and clients with large contracts want to be sure you have the resources to do the work effectively. If you claim millions of dollars in machines but your balance sheet only shows $500,000, that's a serious issue. It's best to be ready to provide financial information before you bid on a large contract. Cash flow depends on it
Cash flow is one of the main reasons small businesses fail. Without regular bookkeeping, you have no idea what funds are coming in and out of your company. This can lead to delays in collecting receivables and missed payments to vendors, which hurts your business's financial health.
In addition, neglecting bookkeeping can be fatal for your business's longevity. Maybe your checking account shows $100,000 in cash, and you decide to buy a new machine for $20,000. What happens if you forget to enter $40,000 in outstanding checks and your true balance is only $60,000? Would you still have bought that machine?
Common bookkeeping mistakes and how to avoid them Now that we've covered why bookkeeping matters, let's look at some common bookkeeping mistakes and how to avoid them.
Neglecting bookkeeping until year end
By now you should understand the importance of keeping your books up to date. Unfortunately, when things get busy, bookkeeping is often the first thing to lose attention. Leaving your books unattended until year end can have serious consequences. First, it opens the door to more errors. It's much easier to remember a transaction from last month than one from six months ago.
In addition, you risk missing transactions, which leads to a higher tax liability. To avoid this common mistake, set aside time each month to reconcile your accounts. Write it on the calendar or set a reminder. A few hours each month can meaningfully improve the accuracy of your books.
Prepared by EDEAL.AI
Misclassifying income and expenses
Classifying your income and expenses matters. For example, meal expenses can only be recognized for tax purposes at 50%, while entertainment expenses aren't deductible at all. If you misclassify these expense items, you increase your taxable income. Also, interest income is taxed differently than regular sales income. You need to make sure you classify transactions correctly to produce accurate tax returns and financial statements.
When it comes to transactions downloaded from your bank, take the time to verify they're correct. Software often misclassifies transactions. Also, be careful when performing bank reconciliations. Don't be afraid to spend additional time to ensure classification accuracy.
Misclassifying employees and contractors
Employees and independent contractors are treated differently in the eyes of the IRS. Misclassifying an employee as a contractor can lead to additional taxes with serious penalties and interest. Before paying a new worker, review the General Rules defined by the IRS. It's a three-part test that helps you determine the worker type. Next, make sure your accounting software reflects the correct information. In most cases you'll need to note that the worker is an independent contractor. This will reflect the amount paid to the contractor on the 1099 report at year end.
Skipping sales tax
Sales tax became more complex after the South Dakota v. Wayfair decision. Even if you're not in e-commerce, selling across state lines may require you to file and pay sales tax in multiple states. When billing a customer, make sure you have the correct shipping address. This ensures sales are reflected in the correct state. To avoid missing sales tax, check your sales in each state monthly. Most accounting software offers a report you can use. Forgetting to review financial statements
Financial statements serve as your double check. Too often business owners neglect reviewing these reports until year end. After completing bank reconciliations each month, you should review core financial statements, including AR aging schedule, AP aging schedule, income statement and balance sheet. Incorporating these into your standard monthly process will improve your control and transparency over your company's financial condition.
Prepared by EDEAL.AI
Avoiding accounting software
As you've noticed, we've talked a lot about accounting software. Accounting software eliminates the need for routine data entry, letting you bring efficiency to your bookkeeping. Not only is it a cost-effective approach, but it also reduces your risk of human error. If you're not using accounting software yet, spend time finding the right program and making the switch.
Bookkeeping best practices
Taking on bookkeeping at your company can feel overwhelming, so we've compiled a list of bookkeeping best practices you can follow. Keep in mind that the processes that fit your company best depend on your industry, transaction types and strategic goals. Still, here's a starting point.
Review transactions
During the month, review your transactions. Your business's transaction volume will determine how often you should classify income and expenses. For example, if your business has only 50 transactions a month, you may only need to classify transactions once a week or once a month. However, if your business has thousands of transactions every month, daily classification may be necessary.
Monthly account reconciliation
Every month, when your bank and credit organizations send you statements, go into your accounting software and complete the reconciliation process. Reconciling your accounts matches what actually passed through the bank to the transactions currently in your cash journal. Analyze any discrepancies. It's not uncommon for banks to make mistakes — for example, mixing up check numbers or charging unknown fees.
Track AR and AP aging schedules
Another bookkeeping best practice is tracking accounts receivable and accounts payable aging schedules. These documents monitor how much customers owe you and how much your business owes third parties, like vendors. Tracking these reports is important for managing cash flow. For example, you may find that a customer has been overdue for three months. Knowing that, you can clarify when you can expect payment.
Plan taxes regularly
Tax planning is important to minimize your tax burden. Regularly — quarterly, for example — take time to forecast your income through year end. This is especially important if you need to make quarterly estimated tax payments. If you're not sure which tax-planning strategies work best for your business, turn to a qualified accountant.
Prepared by EDEAL.AI
Optimize your chart of accounts
Your chart of accounts determines how your transactions will be categorized. Optimizing your chart of accounts can produce greater clarity in your financial statements and help you plan growth efficiently. For example, say you have an office and a warehouse. If you have only one rent account, it can be hard to separate cost of goods sold from general and administrative expenses. By creating separate accounts for office and warehouse rent, you build greater clarity in the rent breakdown.
Set internal guidelines
Internal controls to minimize fraud risk and optimize your bookkeeping processes are essential. Take time to develop a plan for how bookkeeping should be done each month, including the role of every team member. You may decide one person handles accounts payable and another handles bank reconciliations. However, if you're in a growth phase and don't have enough staff to separate roles, consider outsourcing your bookkeeping.
Getting started Ready to take bookkeeping seriously at your business? Getting started can be hard, which is why our team at Edeal Inc. is here to help. Contact us today to schedule your free consultation.