What is bookkeeping?

Bookkeeping involves recording and organizing all your company’s financial transactions, typically using accounting software or manual records. This process provides insight into where your business spends money, how much revenue it generates, and which tax deductions may apply.

Why is bookkeeping important?

Here are five key reasons why bookkeeping is essential for your business:

1. Tax Preparation
   Accurate bookkeeping is crucial for calculating net profit, which you’ll need when filing taxes. It ensures you have a clear record of your income and expenses.

2. Tracking Finances
   By organizing your financial records, you get a clear view of your business’s financial health. This helps answer important questions like: Are sales improving? Are costs manageable? Do you have enough funds for payroll next month?

3. Maximizing Tax Deductions
   Well-maintained financial records make it easier to track deductible expenses, potentially increasing your tax return. Plus, it keeps you compliant with IRS rules, helping reduce stress if you face an audit.

4. Access to Loans
   To secure loans or investments, your business needs financial statements. Accurate books provide the data lenders and investors need, like revenue, cash flow, and asset details, which are found in balance sheets and income statements.

5. Error Detection
   Consistent bookkeeping helps you spot mistakes early, such as incorrect bank fees, rather than discovering them when it’s too late, especially at tax time. Regular updates ensure your financial records are always accurate.

The First Seven Steps in the Bookkeeping Process

While bookkeeping may seem straightforward in theory, when you’re deep in the details of tracking transactions, it can feel more challenging. But to simplify things, here are seven fundamental steps to help you get started with efficient bookkeeping.

1. Separate Personal and Business Finances
   The first step in managing your business finances is opening a separate business bank account. This keeps your personal and business expenses apart, protecting you from personal liability in case of business debts. It also ensures you don’t miss any deductible expenses or face unnecessary stress during tax season.

2. Select a Bookkeeping System
   There are two primary bookkeeping systems: single-entry and double-entry.

• Single-entry: Each transaction is recorded once, making it easier for small or hobbyist businesses.
• Double-entry: More comprehensive, this method records transactions as both debits and credits, giving a fuller picture of your financial health. Most accounting software uses double-entry.

3. Pick an Accounting Method: Cash or Accrual
   You’ll need to decide whether to use cash or accrual accounting.

• Cash accounting: Records transactions when money is received or spent, making it simpler and suitable for smaller businesses.
• Accrual accounting: Records transactions when they’re billed or incurred, providing a clearer long-term financial picture and is generally better for established businesses.

4. Select the Right Tools
   The tools you use for bookkeeping can vary, from software like QuickBooks or Xero to simple spreadsheets. Choosing the right tools depends on your needs and level of expertise. You can also consider outsourcing your bookkeeping to a service provider if you’re looking for a hands-off approach.

5. Categorize Transactions
   Each transaction must be properly categorized to ensure deductions are maximized and everything is accounted for. Defining categories that align with your business, such as revenue or expenses, helps keep your financial records clear and compliant.

6. Set Up Document Storage
   It’s crucial to maintain records like receipts and invoices for tax purposes. Using digital storage solutions like cloud-based systems (Dropbox, Google Drive) can ensure you always have access to your important documents, even when paper receipts fade.

7. Track and Organize Deductions
   For expenses to be deductible, they must be both ordinary and necessary for your business. While the IRS offers guidance, it’s important to stay organized to ensure you’re maximizing all eligible deductions.

Make Bookkeeping a Routine
One of the best ways to stay on top of your books is to make bookkeeping a regular habit. Set aside time each month to update your records, review statements, and stay organized, ensuring your finances are always in good shape.

DIY or Hire a Professional?
If you’re managing a small side project, DIY bookkeeping may work. However, as your business grows, you might consider hiring a professional to handle the complexity and save time.