How to Setup Accounting for Your Small Business

Accounting is challenging for most small business owners. At least once, you might dream of clawed numbers running toward you with a grinning smile. But wait, is it really rocket science? No.  Having a clear idea of where to start and how to build an accounting infrastructure for your business, you can make peace with the crunching numbers.

Starting a business is a demanding task, like a marathon but with hurdles. The first hurdle comes with brainstorming sessions of conducting market research to fund your business. Next comes scarcities of brand visibility, customers, and hunting for talents after launching your business. When you are about to sigh in relief, the next hurdle comes, which is accounting.

As a business owner, the last thing you might want to worry about is accounting. But failing to set up an accounting framework for business may lead to a financial crunch even when sales skyrocket. At that time, you might scratch your head, looking bewildered. Also, it may be too late to revert to the financial mistakes that led to the question of what went wrong with your business.

This article discusses the essential small business accounting elements you need to focus on to set up your accounting system and ramp up the required efforts.

Choosing a Business Structure

First things first. Selecting a business structure is as important as any other accounting element this article will cover. Accounting aids a small business in controlling finance and minimizing taxes. The business structure you choose for your business will heavily dictate your tax and tax management concerning accounting. So, serious consideration is required in deciding the business entity type, and also you can reach out to a tax specialist to know more about tax norms for following business structures. 

There are four business structures.

1. Sole Proprietorship – It is essentially what it states. You are the owner of the company. It is a simple and profound entity type used by small business owners and requires minimal setup to put in force. The drawback is that it makes you liable for anything the business owes. Meaning there is no legal differentiation between the business and you. 

2. Partnership - In which the business ownership will be shared between one or more people. Each partner's responsibility will be included in a partnership agreement.  

3. Limited Liability Company - It’s similar to the sole proprietorship; however, you are not responsible for any business liabilities.

4. Corporation - It’s a more complex business structure and separate entity from its owners and tax purposes. It’s expensive but has lower corporate taxes and added legal protection. 

Open a Business Account

Once you register your business, you must open a business account, as it is legally required. If you plan to use a personal account, there will be many legal and compliant complications. Let's assume you are using a personal account for business.  

You file a tax return and report your business expenses and income, and since you have been using the same bank account for both, it will be difficult to distinguish between personal and business transactions. For example, you might have inadvertently included personal expenses as business expenses, resulting in a lower tax bill.

Also, when the IRS flags a tax return for audit, they would conclude that you have claimed many business expenses compared to your income. Likely, your personal transaction might be considered as your income. So, there is a high chance of getting fined.

You should not commingle personal and business finances unless you want to get letters from the IRS stating that there are some discrepancies in tax return filing.

What do you need to open a business account?

1. In order to open a business account, you need to provide the business's legal name, address, and tax identification number. Basically, the details are available on the business structure registration document. 

2. You are required to provide an Employer Identification Number ( EIN ). Some banks allow small business owners to open accounts with Social Security Number ( SSN ). 

3. You need to submit your identification if you are the sole owner of your business. Suppose your small business has multiple owners submit their identities, such as driving licenses or passports.

4. You are required to provide a business license, operating permits of state or province, and business formation documents.

5. Some banks might ask for your business financial information.

Apart from this, there are other benefits when creating a business account.

1. When you use a business bank account, tracking your business expenses and income will be easier. It ensures that business transactions don't mix up with personal transactions.

2. With a business bank account, your bookkeeping will become easier. With all business transactions taken in one place, you can quickly identify expenses such as raw material costs, rent, and utilities. It can generate the monthly statement without much ado. You can connect the bank account with accounting software like QuickBooks to import your transactions easily.

3. A dedicated business account adds a level of professionalism to your business and cultivates trust in vendors, customers, and lenders like banks or investors.
   Using the bank debit card, you can use the business name on checks, invoices, and payments for suppliers and others. Accepting credit card payments through your business account develops customers' trust.
   It shows you are serious about your business, thus motivating the banks and investors to lend you a loan or invest in your small business. Most importantly, It gives confidence that you can repay them a loan or credit line.

4.  It simplifies the process of paying quarterly business taxes. As you can connect accounting software like QuickBooks with the business account, you can easily calculate the tax with a click.

Master Accounting Terminologies

Believe it or not- Getting accustomed to accounting terminologies will help you master them over time. Without knowing the basics, if you look into a simple income statement, the terms used in the report might overwhelm you. Also, you might need to run into your accountant repeatedly to make sense of the report.

Because you have a business to focus on, you wouldn't want to spend too much time on the report when you analyze your profit or cash flow statement. You shouldn't simply rely on the gut feeling to run the business. Simply begin with understanding the terms like revenue, expenses, depreciation, and ROI. Also, you must understand important statements such as profit and loss, balance sheets, and cash flow statements to learn about your business health.

For example,

Understanding overhead costs enables you to optimize expenses.

Overhead costs are the indirect operating and maintenance expenses that help you run the business. Like, as rent payment, employee salary, insurance, and equipment maintenance cost.

Usually, a small business owner runs a business with limited cash, and this expense can be challenging. Once you understand the overhead cost, you can minimize the expenses while improving the business operations and profit.

You can invest in technology to improve efficiency and productivity. When you use accounting automation tools like PayTraQer or SaasAnt Transactions, your accountant can complete hours-long work within a few minutes with minimal manual intervention.

Also, you can invest in a point-of-sale system that can track sales and inventory, allowing you to optimize the ordering and restocking process. This way, you can efficiently manage the inventory without over-ordering the stock or running out of items.

So, it's better to start learning accounting terminologies as soon as possible. You can learn them here.

Cash Vs. Accrual - Choose a Bookkeeping Method for your Small Business

The next crucial thing you need to do is select an appropriate accounting method for your business.

There are two accounting methods.

1. Cash Method

2. Accrual Method

Cash Accounting Method - In which expenses and income are recorded only when cash is received or paid out. For example, if you receive a payment for a product or service in March, the income will be recorded in March with the received date in March. Similarly, if you pay for the supplies in March, it'll be recorded.

With reference to the above table, your income was $1000 in February, which means that your company earned $1000 in February, and the expense you spent in March is $500.

Accrual Accounting Method – The transactions will be recorded when the income or expenses are incurred. For example, if your business provides service in February but doesn't receive the payment but receives it in March and the income will still be recorded in February month. Similarly, if your business receives a bill of supplies in February, and you will pay it in March, it will still be recorded in February.

In this example, accrual accounting records an income of $1000 in February for the services provided even though the cash is received in March. Similarly, a bill of supply is recorded in February even if you pay the bills in March.

You need to choose an accounting method by understanding the nature of your business and the industry your business belongs to. Each accounting method has its own advantages and disadvantages.

You can learn more about it by reading Bookkeeping.

When your business involves cash transactions, you can opt for this method. Examples: coffee shops, retail shops, and individual freelancing services.

You can choose the accrual method when your business involves construction, manufacturing, and wholesale business.

Use Accounting Software

Using accounting software for your small business can be a game changer when managing your finances. As a small business owner, you might need to use the Excel sheet to keep track of the transactions. But manually tracking your finances would drive you nuts at some point. But, using accounting software requires a small amount of energy and saves you a lot of time. You can easily generate invoices, track payments, and send the remainder to a customer about payment rather than running behind them. Also, it provides you with many insights with just a few clicks.  

When choosing accounting software for your small business, here are some things to think about:

Look for accounting software with features that meet the needs of your business. Some important features are billing, keeping track of expenses, managing inventory, and giving financial reports. Find out which features are most important for your business and choose software with those features.

Cost- Accounting software can cost a lot of different amounts. Some software has a one-time fee to buy it, while others charge a monthly or yearly fee to use it. When making your choice, be sure to consider how much the software costs and how much it will cost to keep it running.

User-friendliness- Choose software that is simple and straightforward to use. Accounting software can be hard to use, so choosing software with clear instructions and an easy-to-use interface is important.

Integration- Look for software that works well with your business's other tools and software, such as payment processors, bank accounts, and e-commerce platforms. By automating data entry and reconciliations, integration can save time and cut down on mistakes.

Security- Accounting software stores sensitive financial information, so choosing software with robust security features is important. Look for software that will protect your data with encryption and other security measures.

QuickBooks and Xero are used by most small business owners, and you can integrate tools like PayTraQer and SaasAnt Transactions to simplify your data management processes. 

You can read more about selecting accounting software for your small business here.

Setting Up Payroll

Each business with employees must have a payroll system to ensure accurate and timely payment of wages and compensation. In addition, it facilitates compliance with tax and other legal obligations, such as the calculation and withholding of payroll taxes. Let's have a look here to understand the legal requirements below.

Paying wages and salaries need to be paid on time. Using a payroll system helps businesses follow the law regarding paying frequency, minimum wage, and overtime. For example, a payroll system can automatically calculate overtime pay based on the number of hours worked and the employee's pay rate. This makes sure that employees are paid correctly for any overtime they work. In the same way, a payroll system can make sure that employees get at least the legal minimum wage and are paid on time and according to their pay schedule.

Your business needs to be in compliance with tax rules: A payroll system calculates and deducts the right amount of federal, state, Social Security, Medicare, and Medicaid, as well as any other payroll taxes. This helps businesses follow tax rules and avoid fines or legal problems resulting from incorrectly withholding taxes. A payroll system can also help a business keep up with changing tax laws and regulations, ensuring that the business stays in line with tax laws.

It requires keeping accurate and well-organized records. A payroll system helps businesses keep accurate and well-organized records about taxes and employee pay. This is important for tax and legal compliance because businesses need to show proof of employee pay and taxes in case legal entities audit your business or there is a legal dispute. A payroll system can make pay stubs, tax forms, and other employee pay and taxes paperwork. This makes it easier for businesses to keep accurate records and follow laws and tax rules.

For small businesses, setting up a payroll system may seem difficult. Still, it can be easy if you follow these steps:

1. Determining your paycheck schedule - Choose if you will pay your staff weekly, biweekly, or monthly. Ensure that you comply with state and federal pay frequency standards.

2. Gather employee details - Collect all required employee data, including Social Security numbers, tax withholding allowances, and pay rate.

3. Choose a payroll system- Choose a dependable and user-friendly payroll system that meets the demands of your organization. There are several different solutions, including cloud-based and desktop software. Mostly, accounting software comes with a payroll system.

4.  Once you have selected your payroll software, configure the system by adding employee information, pay rates, and the payment schedule.

5. Calculate payroll taxes: The payroll software should calculate the right payroll taxes, including federal and state income tax, Social Security, and Medicare taxes. 

6. Process payroll- Enter the employee hours worked or salary information into the payroll software, and it will calculate the gross pay, deductions, and net pay for each employee.

7. Pay taxes and employees- Send the net pay amount to employees' bank accounts or print checks. Additionally, ensure that payroll taxes are paid to the appropriate tax authorities.

8. Maintaining accurate records of all payroll activities, including pay stubs, employee data, and payroll tax payments, is essential. A well-organized system will make it easier to present required paperwork in the case of an audit.

Look at Harry’s case, the owner of a small firm with ten workers. Using cloud-based payroll software, he establishes a payroll system. He selects a bi-weekly payment plan and collects employee data, including Social Security numbers and tax withholding allowances. He configures the system by entering employee information, pay rates, and a payroll schedule into a payroll system with all the capabilities required for his firm.

The payroll software automatically calculates employees' payroll taxes, gross pay, deductions, and net pay. Harry enters employees' worked hours or compensation information into the software and pays them via direct deposit.

Harry checks all payroll transactions at the end of the year and ensures that all required tax forms are filed with the appropriate tax authorities. He can promptly offer precise and structured payroll records in the case of an audit.

Setting Up Payment System

A payment system is an integral aspect of any business, whether big or small or what it does. It makes it possible for your customers to pay you for the goods or services you offer.

Imagine you just started a small business where you sell handmade items online. You've made a beautiful website, added your products, and started promoting your business on social media. Your business is growing, and people from all over the country are ordering from you. Now is the time to set up a payment system that will make it easier and more convenient for your customers to pay you.

Usually, a payment system has three main parts: a payment gateway, a merchant account, and a payment processor.

Payment Gateway - A payment gateway is software that safely sends your customers' payment information to the payment processor. This information includes the customer's name, billing address, credit card number, and other relevant details. Stripe, PayPal, and Authorize.Net are all popular payment gateways.

Merchant Account - A merchant account is a type of bank account that lets you accept payments from customers using credit and debit cards. Most of the time, this account is set up with a bank or a payment processor. The money from your customer's payment is held in the merchant account until it can be moved to your business bank account.

Payment Processor - A payment processor is a third-party company that processes credit and debit card payments on behalf of your business. The payment processor checks the information about the payment, takes out the transaction fees, and sends the money to your merchant account. Square, PayPal, and Stripe are examples of payment processors.

Let's talk about how to set up a payment system for your business. Here are the steps you need to take:

1.  Research to find the best payment gateway for your business. Think about transaction fees, security, customer service, and how well it will work with your e-commerce platform.

2. Apply for a merchant account with a payment processor or a bank. You will have to give information about your business, like its legal name, business type, and how much money it makes.

3. Integrate your chosen payment gateway with your e-commerce platform or website. This will enable your customers to make payments directly on your website.

4. Make sure your payment system works correctly by doing a few test transactions. Check that your customer's payment information is being sent securely and that the money is sent to your merchant account.

5. Monitor your payment system regularly to ensure that it is functioning properly. Keep track of your transactions, fees, and chargebacks.

Understanding the Financial Reports

Financial reports are a group of documents that show how a business is doing financially. These reports include a variety of financial statements, such as balance sheets, income statements, and cash flow statements, which present financial data in a structured and organized way.

Any business owner needs to be able to read and understand financial reports to see how their business is doing financially. By looking at these reports, business owners can find their shortcomings and opportunities, compare their financial performance to industry standards, and make decisions about the future of their business based on reliable information.

Let's use Joe as an example. He wants to start a small business. As John sets up the accounting for his business, he needs to know how important financial reports are.

1.  Joe needs to know about the different kinds of financial statements and each report's different insights.
   For example, the balance sheet shows the business's finances at a particular time. The income statement, however, shows how profitable the business was over a certain period. And the cash flow statement shows how money comes into and leaves the business.

2. Joe should also learn how to read and understand financial reports. To do this, you need to know the terms used in financial reports and look at the numbers to find trends and patterns.
   For example, Joe can look at his income statement to see how much money his business is making and then compare that to his expenses to see if he is making a profit.

3. Joe should use the information from analyzing financial reports to make smart business decisions.
   For example, if Joe's income statement shows that his business is not making enough money, he can look for ways to boost sales or cut costs. Also, if his balance sheet shows that he has too much debt, he can look for ways to reduce his liabilities.

Know Your Tax Obligations

As you start this exciting business journey, it's important to know the different tax obligations that come with owning a business in the United States.

Tax obligations are important because not meeting them can lead to fines, penalties, or even jail time. It's important to know the different types of taxes that may apply to your business and ensure you're meeting all your obligations.

Sales tax is one kind of tax you will have to consider. It's a tax that state and local governments charge on selling goods and services. Sales tax laws can be hard to understand, and knowing your state's rules is important.

For example, let's say your online store is based in California, but you plan to sell your products to people in California, Arizona, and Texas. If a business makes more than $500 in sales in California in a given year, it must register for a sales tax permit. Arizona and Texas have similar rules that say businesses must register for a sales tax permit if they make a certain amount of money or have a physical presence in the state.

Your accountant can help you determine if you need a sales tax permit and explain the tax rules in each state where you plan to do business. They can also help you determine how much sales tax to charge for each sale and ensure you send the right sales tax amount to each state.

By getting help from an accountant to figure out the complicated world of sales tax, you can ensure your business follows all tax laws and avoid penalties or fines for not doing so.

Import taxes are another type of tax that you might have to pay. When you import materials, you may be subject to various taxes and duties, such as customs duties, excise taxes, and value-added taxes (VAT). These taxes can differ depending on which country you are importing from, what you are importing, and how much you are importing.

An accountant can help you determine how these taxes affect you and how to pay them. They can look up the tax laws and rules in the countries you're importing from and help you figure out how much you'll need to pay in taxes and duties.

Once you understand the taxes and duties, you can consider them while determining the price. For example, if the taxes and duties are high, you might need to raise your prices to cover those costs. If taxes and duties are low, on the other hand, you might be able to keep your prices low and get more customers.

By working with an accountant, you can ensure you're keeping track of all the costs of importing materials and making smart pricing decisions to help your business grow.

Having read all the necessary topics, you can have a head start in setting up small business accounting - from choosing your business structure to knowing your tax obligations. Also, you can streamline your turbulent accounting chores by opting for automation integrations like PayTraQer or SaasAnt Transactions.