When your business is still young, it might make sense to handle your own accounting until you have more cash flow coming in.

We know—this can sound really intimidating if you’re unfamiliar with how to manage your own books. But it’s not too hard once you understand the foundations and have the right tools in your toolbox.

That’s exactly what we’ll dive into here. We’re going to cover the accounting basics for small businesses, as well as the best small business accounting software to help you with the process.

Accounting basics for small businesses

1. Open a business bank account

After you’ve legally incorporated your business, you’ll need a bank account to stash your cash. Opening a separate business bank account will prevent your personal and business finances from becoming muddled.

It also helps keep your personal assets safe in case of lawsuits, audits, and bankruptcy. And if you need additional funding from investors or creditors, strong financial records can improve the chances of approval.

Start by opening a business checking account, followed by a separate savings account, to help you plan for taxes and organize funds. For example, open a savings account and put aside at least 25% of your income for paying your self-employed withholding tax. Note that high earners have to put aside a bigger percentage of their income, as they fall into brackets with higher rates.

Once you have your business bank account, you can also get a credit card to start building credit. Don’t forget to shop around for the best banking deals. Business accounts often come with monthly fees, and some have better benefits than others, like free airline miles or special services.

small business accounting basics: open a bank account

2. Establish your bookkeeping system

Bookkeeping is the accounting process of recording business transactions, organizing them, and reconciling bank statements. You can choose to take the DIY route and manage your books in a simple Excel spreadsheet. Alternatively, you can use a part-time or outsourced bookkeeper who’s either cloud-based or local.

Based in the US? You’ll also need to determine whether you’ll use the accrual or cash accounting method. Here’s how each method works:

  • Cash method: Recognizes income and expenses at the moment they’re received or paid.
  • Accrual method: Recognizes income and expenses when the transaction occurs (even if there’s no cash movement in your bank yet) and requires tracking payables and receivables.

If you want to keep things simple, use the cash method throughout the accounting period and then make a single adjusting entry at year end to account for outstanding payables and receivables. However, Canadians must use the accrual method, as they’re required to report income in the fiscal period they earn it.

3. Track your expenses

Expense tracking is a crucial step that lets you build financial statements, prepare tax returns, and monitor the growth of your business. You can keep receipts and other important records in a file or use a service like Shoeboxed to store them digitally.

shoeboxed expense tracking

Some of the most common expenses you’ll need to account for are:

  • Business travel. Keep receipts for any expenses you incur while traveling for business, including accommodations and airline, bus, or train costs.
  • Meals and entertainment. It’s possible to count business meals as “expenses,” but everything must be well-documented, with details on who attended the meeting.
  • Vehicle expenses. Vehicle-related expenses like fuel and maintenance are sometimes classified as business expenses when recorded correctly.
  • Receipts for gifts. Gifts to clients can be categorized as a business expense. However, if the gift-giver party enjoys the rewards with the recipient (such as taking them to a concert), this would be classified as “entertainment” rather than a gift.
  • Home office receipts. Costs for using your home as an office can also be considered when sending your tax returns, but you’ll only be able to claim tax relief on a portion of the bills, based on what you use for your company.

Running your business from home is a great way to reduce overhead costs, plus it makes you eligible for some tax breaks. For instance, you can deduct your home internet, cellphone, and any other service you use for business.

4. Create a payroll system

Though your business might start off with just you on the payroll, it can quickly evolve to include several important team players. When you hire outside help, you’ll need to determine whether that person is an independent contractor or an employee.

With contractors, you’ll need to track how much you’re paying each person. US business owners are sometimes required to file 1099 forms for each contractor at the end of the tax year. Plus, you’ll need to keep the name and address of each contractor on file for this purpose.

With employees, you’ll need to set up a payroll schedule and ensure you’re withholding taxes correctly. Accounting solutions can help you with this, as many of them offer payroll as a feature.

5. Determine your tax obligations

The legal structure of your business will determine the amount of tax you’re required to pay.

If you’re self-employed (partnership, sole proprietorship, or LLC), you’ll claim business income on your personal tax return. Also, you’ll need to withhold taxes from your income and remit them to the government based on the withholding that a company would normally deduct.

Corporations, in contrast, are taxed independently from owners. With a corporation, you’re taxed as an employee on the income you make from the business.

6. Find out sales tax and import duties

When exploring your tax obligations, make sure you consider additional expenses, like sales tax and income duties. If you’re running a dropshipping business, for instance, you may be importing items from overseas, which requires you to pay specific duties.

Sales tax can be a tricky concept too. You’ll need to figure out whether you operate your company in a destination-based or origin-based state. In an origin-based state, you charge tax based on the state where you run your business. If you’re selling in a destination-based state, the sales tax will be applied based on the customer’s location.

International purchases are exempt from tax for US-based companies. If it all seems complicated, check with your accountant for relevant information regarding international sales tax regulations in your specific state.

small business accounting tip: determine sales tax

7. Determine how you’ll get paid

Your business can only begin making money when you have a method of accepting payments. Small business owners can use various payment processing tools, such as PayPal, Stripe, and Google Pay.

If you’re a North American Shopify store owner, you can use Shopify Payments to accept credit or debit card payments. This saves you the hassle of creating a third-party merchant account. Those who use a third-party payment processor need to pay an interchange fee plus rate (around 2.9% + $0.30 per transaction).

If you’re accepting payments offline, you’ll need a point-of-sale system to handle the transactions for you. The costs of payment processing can vary, depending on the system you use.

8. Calculate your gross margin

Gross margin is one of the most important metrics you’ll need to keep track of as a business owner. Your gross margin is the total sales revenue remaining after your business incurs all costs to make the product or service.

To calculate gross margin, you’ll need to know the expenses involved in creating your products. The cost of goods sold, or COGS, is the direct cost incurred when producing your products, including materials and labor. The formula for gross margin is:

Gross Margin (as a percentage) = (Revenue (all the money from transactions) – COGS) / Revenue

You can also use Shopify’s free profit margin calculator for a quick calculation.

free profit margin calculator

9. Find high-quality accounting professionals

While it’s possible to manage your books alone, working with financial professionals reduces your risk of accounting errors. There are various kinds of accounting professionals you can hire, including:

  1. Tax planner: A professional who helps you organize your taxes before filing them and shows you ways to reduce your tax burden.
  2. Tax preparer: A person who fills out the necessary forms you need to submit during tax season. Some of these experts also set up estimated tax payments.
  3. Bookkeeper: A professional responsible for managing daily records, account reconciliation, expense categorization, and accounts receivable.
  4. Certified public accountant (CPA): An individual who can legally prepare audited financial statements, should you face an audit.
  5. Accountant: An adviser and expert who can help with your business structure, creating financial statements, obtaining permits and licenses, and writing business plans.

10. Apply for a loan

Many small businesses face scenarios where they need to seek external business financing to maintain their operations. For instance, you might want to raise capital to invest in new inventory, hiring, product developments, and more.

To get a small business loan, you’ll likely need to provide financial statements, including a balance sheet tracking your expenses, and an income statement showing your profitability. Some lenders also require cash flow statements.

Remember to shop around for the best deal on your loan before signing on the dotted line. Add up the expenses you need to cover, your expected ongoing revenue from the loan, and the total interest to ensure the debt makes sense for your business.

Don’t wait for someone else to do it. Hire yourself and start calling the shots.

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Best small business accounting software

There are plenty of great tools to help with small business accounting. You can also visit the Shopify App Store for accounting apps that seamlessly integrate with your online store. The right app for you should be easy to use, accurate, and equipped with the features required for your business.

Some of the best options on the market include:

1. Xero

best small business accounting software: Xero

Xero is a cloud-based accounting system aimed at small and growing businesses. You can sync it across multiple devices and gain visibility into your financial health from anywhere. Xero features a clean, intuitive interface and can handle everything from billing and invoicing to payroll and cash flows.

Key features:

  • Inventory and stock management
  • Bank reconciliation
  • Contact segmentation and database
  • Customizable reports
  • Sales tax calculation
  • Mobile app

2. QuickBooks

Created by Intuit specifically for small businesses, QuickBooks is an easy-to-use accounting software for organizing receipts and other important records. You can use it to track your income and expenses, evaluate all kinds of maintenance and inventory costs, and record sales your business makes over a period.

Key features:

  • Cloud based
  • Inventory tracking and mileage tracking
  • Contractor management
  • Accountant access
  • Mobile app

3. FreshBooks

FreshBooks is another cloud-based invoice management and accounting software for small businesses. It comes with core accounting, expense management, and everything else you need to do basic bookkeeping.

Key features:

  • Easy to use backend
  • Customizable invoices
  • Invoice tracking
  • Detailed self-service support
  • Simple pricing

Small business accounting is easier than you think

By now, you have a good idea of what it takes to manage your own books while your business grows.

All you need is an understanding of the fundamentals and good software to help fill in the gaps.

Then, once your company is more established, you’ll be able to hire a professional to take your finances to the next level.

Small business accounting FAQs

How do I create accounting records for my small business?

You can set up basic accounting records in a spreadsheet, though this is more prone to error than a small business accounting software. Ideally, you’ll want to use a cloud-based platform so you can track income and expenses quickly and accurately.

What does an accountant do for a small business?

A small business accountant performs various duties, including the following:

  • Form your company
  • Audit your cash flow
  • Manage debt
  • Advise on business strategy
  • Find cost-saving opportunities
  • Follow up with defaulters
  • Plan budgets
  • Help set up accounting software
  • Prevent audits
  • Recommend business tools

How much does an accountant cost for a small business?

Small business accountants typically charge between $100 and $500+ per hour—depending on the type of work and the level of services provided. Bookkeepers charge around $18 per hour, according to PayScale.

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