7 Steps to Setting up a Small Business Accounting System

While starting your small business may feel pretty daunting, setting up an accounting system, especially for those of us who barely scraped by the subject in college, can feel impossible.

Well, thankfully, I've done my homework and "earned my stars," so I'm ready to take you through 7 easy(ish) steps to setting up a small business accounting system.

Are you ready(ish)? Let's get started:

Step 1: Choose the right business structure

Yes Pam from The Office, it is. 

“But author-person (Joshua), how is this relevant to accounting systems at all?”

Just hold on a minute; I promise you it'll make sense. You see, small business accounting includes a lot of factors:

• Payroll
• Acquisition
• Inventory
• Taxes
• And much more

Because of this, it's crucial to determine where your money will be deposited first. And (you've probably guessed it) your business structure determines how you handle many of these variables.

In particular, the structure you opt for ultimately decides your tax management. So, you need to think carefully when deciding on the correct business entity. Here are the four main types:

• Sole proprietorships: When you think of a small business such as a local restaurant, convenience store, or bait and tackle shop, nine times out of ten, this will be a sole proprietorship. It's an easy-to-set-up entity type; business and personal assets aren't distinguished and can only be owned by one person (i.e., sole proprietorship).
• Partnerships: With partnerships, business ownership is shared amongst more than one person. However, like sole proprietorships, partnerships aren't considered separate entities, so business and personal assets aren't distinguished.
• Limited liability companies (also known as LLCs): These exist as separate entities, and owners aren't personally responsible for business liabilities or debts. These are more difficult to set up.
• Corporations: Like LLCs, corporations are harder to set up. These are typically composed of "shareholders," whereas ownership is shared among just one or two people in an LLC. Corporations also have greater legal protection.

While I could get into depth (and write an entirely different article), I won't. This is the necessary “just of it.”

But if you do want to go into greater detail about this, there are some great resources you can explore online.

Otherwise, note that sole proprietorships don't require a separate bank account, whereas the other three do. 

In addition, sole proprietors are subject to "pass-through taxation." This means that entrepreneurs can report their losses and income on their business on their personal tax return. The same can be said for partnerships.

However, because LLCs and corporations are separate entities, tax is also treated as a separate affair.

(I know this is a lot of information, but bear with me!)

Step 2: Setup your bank account for your business finances

Now that you've chosen your business structure (and presumably) registered your business, it's time to open a business bank account. 

And while you might be thinking that you're a sole proprietor and, therefore, can skip this section, I'd strongly urge you to reconsider.

Here's the thing: it just makes your life easier. This is especially true if you already have a full-time job with debit orders at different times of the month. 

It's easier to understand your business if you have business transactions in one account.

And if (and ideally when) you get a business credit card, you'll have some extra money to make those large purchases that can't wait till month's end.

... Such as the client who makes a large order, forcing you to contact the supplier who wants immediate payment for a discount. These things happen!

Step 3: Develop a record-keeping system

Don’t be this person, learn to keep record!

From the get-go, a small business owner must have a proper record-keeping system. And although (technically speaking) you don't have to provide receipts to the IRS that are under $75, it's still not a bad idea for your own records.

And this doesn't just mean keeping receipts for purchases. No, this could include:

• home office expenses
• business meetings
• travel
• and other business-related vehicle expenses

This could be done manually (i.e., pencil and paper) by using preformatted record books. You might also opt for ledger sheets.

Alternatively, if you'd like to reduce error, there's also computerized record keeping. You could opt to install a program such as Quicken to do this.

Step 4: Choose a bookkeeping method (this is why you're here)

Now, the fourth (and probably most daunting) step is creating a bookkeeping system.

As you probably know, this is so that you can (1) keep a record of your business transactions, (2) categorize them appropriately, and (3) ultimately reconcile them into your bank statements.

Now, there are a few ways you can approach this:

1. Using excel spreadsheets
2. Using accounting software
3. Or hiring a professional bookkeeper

While the former two (particularly accounting software) may seem like a more attractive option due to the cost savings, make sure you brush up on your accounting know-how, or you risk making (potentially costly) mistakes.

Miles Brook, Certified Public Accountant and Director of Tax Strategy at CoinLedger, had a particular bookkeeping software recommendation:

“QuickBooks Online: It is a cliché, but I recommend it as the best bookkeeping software for small businesses. Small businesses are often on a budget, and they might not hire top talent out there because of budgetary constraints.

 Still, QuickBooks has regular resources that the accountant can use and rely on to learn more about the software, increasing their skills and accuracy. I also recommend it for small businesses because it has affordable monthly subscription plans, which most small businesses can afford and continue to upgrade as the business continues to grow.”

And this brings me to my next step:

Step 5: Determining the suitable accounting method

Now, if you don't already know, there are two methods of accounting: the cash and the accrual method.

The cash basis involves recording expenses and revenue when cash is actually received or given. However, the accrual basis is when expenses and revenue are recorded before money is given or received.

Remember that, as a US business owner, if your business revenue is less than $5 million, you have to use the accrual accounting method.

Step 6: Setting up an employee payroll system

Okay, I know I've provided a lot of information. But stick with it; you're almost at the end.

And if you keep reading, I'll be providing additional resources to help you out.

So, while you may start without any employees, mainly if this is a family-run business or an online venture, eventually, you'll have to hire help.

By developing a payroll system, I mean that you need to ensure that you're withholding taxes correctly.

While I won't get into extensive detail about this, you can find more information online that will help guide you in the right direction.

It's important to understand:

• What tax brackets your employees fall into
• Tax obligations for international employees
• And how and when to make the tax payment

Step 7: Dealing with sales tax

Okay, so we're almost at the end of it.

Thank you for sticking with me on this journey! So, while I could get into a few more points, I think sales tax is the most relevant.

Consider how sales tax is pretty straightforward if you operate a traditional brick-and-mortar business. Online, however, is not so simple. In an e-commerce store, you'll need to determine whether:

(a) You're in an origin-based state

(b) Or you're in a destination-based state

As the name suggests, origin-based states have tax applied based on location. In contrast, origin-based states use the tax rate of the destination of the service or product.

However, remember that US-based businesses are exempt from tax for international purchases.

Additional resources (as promised)

Okay, so here are the resources that I personally find pretty useful and that also explore accounting terminologies:

• The Beginner's Guide to Reading & Understanding Financial Statements by Tim Stobierski, a contributing writer for Harvard Business School Online: https://online.hbs.edu/blog/post/how-to-read-financial-statements
• The IRS' guide on employment taxes: https://www.irs.gov/businesses/small-businesses-self-employed/understanding-employment-taxes
• Cash Flow Statement: What It Is and Examples by Chris B. Murphy, a financial writer for Investopedia: https://www.investopedia.com/investing/what-is-a-cash-flow-statement/
• Mini Course on Accounting Skills for Business Owners: https://www.udemy.com/course/accounting-for-business-owners/ 

I hope you've found this beneficial! Search our business section for more helpful articles.

(We made a video on this below, and yes, that’s my voice at the end!)