The Importance of Accounting for Small Businesses
Bookkeeping is necessary in any business. As a small business owner, it's important to recognize that the best practices used by Fortune 500 companies also apply to you. Following basic accounting principles is essential for success in any size business; savvy record-keeping and financial analysis is key to not only monitoring your expenses, but to discovering new avenues of growth. In addition, it ensures you stay responsible for tax obligations to the government and to your employees.Read Our Guide to Basic Accounting Terms
Accounting entails more than just managing credits and debits, and it comes into play more often in everyday business decisions than you may realize. A few examples include:
- Closely monitoring your accounts receivable to illustrate trends or behaviors in your customer base. It can also cut down on the costs you incur by pursuing late payers.
- Establishing a detailed budget to help discover inefficiencies within your operations.
- Sudden changes in vendor costs or sales revenues can alert you to important industry changes.
- Understanding your financial position in order to spot problem areas that could interfere with loans earmarked for expansion.
As you consider your accounting strategy, review your company's financial goals. Whether you are a solo entrepreneur or you employ a staff, your survival hinges on clearly stated financial objectives. You may be in business to reap as much profit as you can, or you may be interested in sharing a product or service that you believe in. Either way, experts agree that one of the most common reasons small business fail is because cash flow runs dry. To prevent this disaster, your business should implement policies for efficient record-keeping and a sound financial strategy.
Taxes are unavoidable. Depending where you operate and the nature of your business, the IRS has very specific requirements about the documentation you're required to file. Submitting improper or inaccurate documentation can get you into trouble, and it can be extremely costly in terms of fees and penalties. Preparing the required tax documentation has its benefits though, and it can give you vital information about the health of your business. Monthly or quarterly financial statements, cash flow statements, and asset and income statements can provide a clearer picture of your business than your bank balance. Understanding IRS requirements and how you can make them work for you can give you a deeper understanding of your company's financial health.
What information should I be tracking?
If you haven't had formal training in accounting or are more interested in other aspects of your business, keeping meticulous records of financial data can be a chore. Furthermore, understanding precisely what information you should be tracking can be overwhelming and confusing. Most small businesses should track the following categories of data:[categories-of-data]
How should I track these metrics?
Though it's quite common for small business owners to have a spouse or family friend “do the books,” effectively managing your small business's finances goes beyond bookkeeping. Properly strategizing for your company's future, as well as meeting your legal requirements, is best achieved with professional accounting methods. This is particularly true if you're too busy or too uninterested in the nitty-gritty details to analyze the numbers. At this stage, successful small businesses consider either outsourcing their accounting needs or investing in accounting software. Each option has its pros and cons.
For many startup companies, funds are tight and it may be tempting to pursue the cheapest method. Because your legal requirements are only due once per year, you may choose to ignore it all until tax time every spring. Remember, if you choose this option, you're essentially opting out of receiving crucial data that can encourage success. The short-term solution may not be the best one, and it pays to do your due diligence when making this critical decision.
Tech-savvy business owners or those familiar with accounting principles may be drawn to accounting software. From a time management standpoint, digital bookkeeping is a vast improvement over manual calculations. These applications automatically crunch numbers, perform data entry, track performance metrics and produce business reports. Once your data is entered into an application correctly, the accuracy of the software's calculations is virtually guaranteed; this can be a comfort in the event of IRS scrutiny.
More advanced versions integrate with other office management programs, display data trends, pay accounts receivables, remit invoices or ensure that you're meeting tax requirements. Extensive data storage within an application like this also increases your company's efficiency, allowing access to details like payment history with a few keystrokes.
|Software Pros||Software Cons|
|Data entry saves redundancy||
Security is riskier within
|Pre-calculated sales taxes||
Often packaged as subscription
services that charge for annual updates
Cloud-based storage eliminates
the need for costly desktop
technology in the office
Dependent on tech support from
Costs can be high, especially for
a desktop-based installation
Some software programs are targeted toward small business accounting professionals or bookkeepers; others are designed for business owners who are unfamiliar with accounting but willing to learn. For companies with little or no inventory and few employees, minimalist accounting software is available for free or at low cost. These basic solutions are affordable and easy to implement, though they do leave you at risk of spending considerably more for an IRS audit triggered by inaccurate reporting.
Below, we've aggregated a list of the 10 most popular accounting software programs for small businesses.[accounting-software]
Hiring an Accountant
In some cases, small business owners may be more comfortable hiring a sole practitioner or accounting services firm, perhaps one that specializes in small businesses. Other businesses may hire temporary accounting staff at certain times during the year, or hire part-time bookkeeping staff with advanced training. In each of these cases, business owners transfer the company's financial management to another individual. For a business owner who lacks accounting skills or detests crunching numbers, outsourcing the company's financials can be an attractive choice.
Many business owners find an accountant's expertise and tax knowledge to be the biggest draw towards outsourcing. A qualified accountant can assist in numerous ways outside of managing day-to-day finances. For example:
- Advising on how best to structure a company before it's formed
- Consulting on the financial details of your business plan
- Identifying potential cost savings in operations
- Managing payroll
- Developing a financial safety net in case of catastrophic events or struggling growth
- Liaising with the IRS in the event of an audit
Though many small businesses start out with the owner as the sole employee, there comes a point during their growth when it's wisest to hand over accounting functions to a professional. In this situation, businesses may choose to hire an inside accountant or an outside accountant in an accounting firm. For younger, growing businesses, using an accounting firm offers some flexibility. Keeping a firm on retainer for consultation can be particularly useful for the business that only needs their expertise a few times per year, for example. This is a cheaper option that still delivers high-level knowledge. Accounting firms generally charge by the hour, though some analytic functions will be priced higher than others. If you're unsure, weigh the cost against what such a firm can save your company over time.
|Accountant Pros||Accountant Cons|
|CPAs are trustworthy||Hourly rates are costly|
|Tax law knowledge is crucial||
Most of your company's financial
knowledge lies with one person, which is risky
|IRS audit assistance||Lack of control over daily transactions|
|Development of business growth strategy||Outside of the office|
Choosing an accounting services provider can be just as daunting as keep your own books. Most small business owners are familiar with the Big Four names in accounting:
- Deloitte Touche Tohmatsu
- Ernst & Young
These firms are easily accessible and well-staffed with qualified CPAs. However, their size leads some small business owners to prefer a smaller firm that won't lose them among their top-dollar clients or pass them off to junior staff. Smaller firms are generally much less expensive, and can provide face-to-face service.
For established businesses, the hourly rates of an accounting firm can become exorbitant as the complexity of transactions increases. In this case, it may make more sense to hire an in-house accountant. Once the right individual is on the payroll, he or she can manage a wealth of processes that ultimately justify the salary.
It's no secret that small business owners have a lot to do. As we've explored here, the financial implications of business ownership are extensive, yet critical to a company's success. Having a dependable, efficient accounting system can free up your time to focus on the things you love about your business. As you explore accounting solutions for your company, consider the following questions:
- What is the size of my company? Small businesses generally have fewer than 20 employees.
- What technology is available to me and my employees?
- Is my understanding of basic accounting up to the task?
- Does my cash flow allow for accounting expenditures on a monthly or annual basis?
- How comfortable am I handing over sensitive business data to an individual or accounting service?
- Is daily data entry something that I or one of my staff can reasonably accomplish?
- Does my company operate in a complex tax environment that may be subject to audit?
- Do my competitors in the industry find a particular method to be most useful?
- Are there compatibility factors to consider with other technological processes that regularly occur, like payroll?
The answers you determine will help you decide which options make the most sense for you and your business. Then, you can get back to doing what you love with confidence in your financial future.