Bookkeeping basics for small business owners

What is bookkeeping?

Bookkeeping is the day-to-day recording of a business's financial transactions: every sale, every expense, every loan and every transfer between the owner and the business. Accounting then uses those records to produce reports and tax returns. See bookkeeper vs accountant vs tax preparer. If the bookkeeping is right, year-end and tax filing are quick. If it is not, they are slow and expensive.

Why start with a separate bank account?

Because your bank statements become the backbone of the books. When every transaction in the account belongs to the business, bookkeeping is mostly a matter of categorizing what the bank already recorded. When personal and business money are mixed, every line has to be questioned. See why mixing accounts costs you. See how to open a business bank account for your LLC.

Cash or accrual: which method should you use?

Most small businesses may use the cash method for tax. Businesses that sell products and hold inventory need to track the cost of goods sold properly whichever method they use. Choose a method and use it consistently. See cash vs accrual accounting.

What is a chart of accounts?

It is the list of categories every transaction is sorted into. Keep it short and matched to your tax return, so that year-end totals drop straight onto the forms. A simple one for a small business:

• Income: sales or fees, and other income.
• Cost of sales: goods bought for resale, freight in, platform fulfillment fees.
• Expenses: advertising, software, professional fees, rent, utilities, insurance, travel, meals, bank and payment fees, contractors, wages.
• Assets: bank accounts, money owed to you, inventory, equipment.
• Liabilities: credit cards, loans, sales tax collected and not yet paid.
• Equity: owner contributions and owner's draws or distributions.

For which expense categories are deductible, see deductible business expenses.

How do you record transactions?

Connect the business bank and card accounts to accounting software so transactions flow in automatically, then assign each one a category. See how to categorize business expenses. Record a few things with extra care:

• Money you put in or take out is equity, not income or expense. Marketplace sellers should see bookkeeping for Amazon sellers. See how to pay yourself from an LLC.
• Loan repayments split between interest, which is an expense, and principal, which reduces the loan.
• Sales tax you collect is a liability you owe the state, not income.
• Equipment purchases are assets, even if the tax deduction comes in the first year.

What does reconciling mean, and why monthly?

Reconciling means checking that the balance in your books matches the bank or card statement at the end of each month, and explaining any difference. It catches missing transactions, duplicates, bank errors and fraud while they are still easy to fix. A month is short enough that you remember what each transaction was.

Which reports should you look at?

• Profit and loss statement: income minus expenses for a period. It shows whether the business made money.
• Balance sheet: what the business owns and owes on a date. It shows its financial position.
• Cash flow statement: where cash came from and went. It explains why profit and bank balance differ.

See reading a P&L and reading a balance sheet.

What does a monthly routine look like?

1. Categorize every transaction

   Weekly if you have many, monthly if you have few.

2. Attach or file the receipts

   Especially for meals, travel and anything over a small amount.

3. Reconcile every account

   Bank, cards, payment platforms and loans.

4. Review the profit and loss

   Compare it with last month and look for anything that seems wrong.

5. Set aside tax

   Move money for income tax and any sales tax collected into a separate account. See estimated quarterly taxes.

How long should you keep records?

The IRS says to keep records for as long as they may be needed for a tax return: generally 3 years after filing, 4 years for employment tax records, 7 years if you claim a loss from worthless securities or bad debt, and indefinitely if you do not file a return. Keep records for assets until the period for the year you dispose of them has passed. See how long to keep business records.

Spreadsheet or software?

A spreadsheet works for a handful of transactions a month. Once you have regular sales, several accounts or inventory, accounting software pays for itself through bank feeds, reconciliation tools and ready-made reports. If you would rather hand it over, see how much bookkeeping costs.

Sellers can follow channel-specific routines: Shopify, eBay and Amazon.

The main options are compared in QuickBooks vs Xero vs Wave.

If you are still on a spreadsheet, see when Excel stops being enough.

Are there bookkeeping guides for specific industries?

Yes: construction contractors, restaurants, rental property owners, agencies and consultancies, and online sellers on Amazon, Shopify and eBay. Before you start, check the bookkeeping mistakes that cause tax problems.

This guide is general information. It is not tax or legal advice for your situation.