Small business accounting: What is it and how to start

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Learning how to do accounting for small businesses is an often overlooked but essential step in managing your new venture. Whether your company operates primarily online or in person, you’ll need to understand all the accounting responsibilities that come with owning a business. We’ll cover the importance of small business bookkeeping, top online accounting software and when to engage in small business accounting services.

What is small business accounting?

Small business accounting tracks all the money that moves through your business. It includes all financial activities within your company, such as sales, expenses, payroll, tax preparation and more.⁽¹⁾ Effectively managing your business’ accounting can make it easier to attract investors and funding and avoid tax penalties and fees.

Small business accounting can also help you make informed decisions about the direction of your business, such as when you can afford new equipment or need to cut back on spending. Spotting trends is another benefit of strong accounting records, like which products are your best-sellers or what seasons make you the most money.

While pencil and paper were once popular, many businesses now use online accounting software to streamline their expenses and access their records from anywhere.

3 types of financial reporting

As part of your basic accounting, you’ll need to keep track of financial statements, including these three crucial reports:

1. A balance sheet indicates what a company owns in assets and owes in debt at a specific time. It helps business owners understand immediate and near-future budgetary needs.⁽²⁾
2. An income statement shows generated revenue over a specific time, like a month, quarter or year. It also includes costs and expenses and represents the company’s profit or loss.⁽³⁾
3. A cash flow statement details the inflows and outflows of cash. While an income statement represents total revenue, a cash flow statement documents when the cash was collected.⁽⁴⁾

Small business accounting vs. bookkeeping

Small business bookkeeping focuses on recording daily transactions and includes tracking expenses, sales and payments.⁽⁵⁾ It is essential for maintaining financial records, which lay the groundwork for accounting. That’s why bookkeeping software focuses on documenting customer and vendor transactions, like recording sales and paying bills.

Small business accounting includes bookkeeping as well as all other financial aspects of a company, such as payroll, marketing budgets, real estate expenses and more. Accounting software for small businesses encompasses a wide range of features, like financial analysis and tax preparation.

So, while small business bookkeeping sets the foundation by recording daily transactions, small business accounting includes all financial aspects of a company and builds on this information to offer insights and strategies for the business.

6 steps to set up your business accounting system

How you set up your business accounting system depends on your type of business, the products or services you sell and if you operate wholly online or in person. Here’s what the process might look like.

1. Choose your accepted payment methods

How will your clients pay for your goods or services? Consider your customer base and type of store. While in-person businesses may accept cash, online services will be fully electronic. Selecting your accepted payment methods impacts how you’ll manage transactions, and a smooth transaction process is essential for accurate bookkeeping.⁽⁶⁾

2. Set up business bank accounts

Opening a dedicated business bank account helps separate business transactions from personal finances. Many top business checking accounts can also integrate with accounting software to help streamline your expense tracking, tax saving and invoice management. For example, Novo's Small Business Checking account connects with Quickbooks, Xero, and more. While, Grasshopper gives access to Autobooks, a free accounting and bookkeeping service available to all account holders.

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3. Organize bookkeeping, accounting software and payroll systems

Evaluate whether you’ll track records manually or need accounting software, which can help with inventory management, invoicing and tax prep. Research and compare accounting software that offers the features you need for your small business. Opt for platforms that offer trial periods to test their functionality and ensure they meet your business’ needs.

4. Determine tax obligations

Start by familiarizing yourself with the local, state and federal tax requirements relevant to your business type and industry. Heavily regulated industries, like selling cannabis products, will have different legal and tax obligations than a freelance writer or graphic designer, for example. Consult with a tax professional annually about the specific requirements of your business to reduce your risk of errors and penalties.

5. Develop invoicing and payment procedures

If you’re selling goods or services with established milestones, such as a construction project, you’ll need to establish clear payment terms and deadlines. Develop invoicing that shows when payments are due and implement a system to track the payments, due dates and unpaid or overdue invoices to maintain consistent revenue. Have a plan of action in place if a client refuses to pay and understand your legal recourse if you run into trouble.

6. Conduct financial reviews

Reviewing your accounting regularly is essential for maintaining good records and identifying growth opportunities or areas needing attention. If your business accounting is straightforward, you may be able to do this yourself. However, a financial expert or accounting software may better assess your financial statements and provide insights into your business’ financial health.

Should I DIY or use an accounting software?

Deciding between doing it yourself or using accounting software depends on various factors. Here are some things to consider:

1. Complexity. Businesses with limited transactions, inventory and expenses may get by doing it themselves. However, those with large sales volume, international transactions or in heavily regulated industries will probably need bookkeeping software.
2. Budget. Doing it yourself is usually cheaper upfront. However, purchasing accounting software may save you more in the long run with accuracy and automation.
3. Time. Learning how to use accounting software for small businesses takes time, but can be more efficient than doing it yourself, especially as your business grows.
4. Legal obligations. Most accounting software comes with tax preparation and legal compliance for small businesses. Failing to understand these complex laws yourself may result in fees, penalties or legal action against your company.
5. Strategic financial advice. Accounting software can offer insights into your business’ financial health and help with budgeting, forecasting and decision-making. If you need this type of insight, accounting software can help.

As your business evolves, your accounting needs may change. While doing it yourself may work for some years, if your finances become complex or tax laws change, using accounting software may become beneficial. Consult a financial expert to understand more about your business’ specific needs.

5 popular online accounting software

Choosing the best online accounting software depends on your business’ specific needs, such as your budget and feature requirements, like third-party software integration. Here are five top small business accounting software to compare.

1. Quickbooks. One of the most popular accounting software on the market, Quickbooks users say it’s easy to learn and integrates smoothly with third-party apps. However, it lacks industry-specific features, like lot tracking and QR code scanning.
2. Xero. Cloud-based software is the key advantage of using Xero for your accounting, as you can access your data from anywhere. However, it comes with a steeper learning curve than most competitor products and may overwhelm some users.
3. Zoho Books. If you need a cost-effective solution, Zoho Books offers a free plan, plus a range of paid plans to fit your budget. But while it offers a wide range of features, its third-party integrations are somewhat limited.
4. Freshbooks. If you always have your phone on hand, Freshbooks allows you to view and send invoices, answer customer questions and more through its mobile app. However, its highest-tier plan only comes with access for two employees, and it charges a fee to add more.
5. Wave Accounting. Unlimited users, unlimited invoicing and custom templates — all for free — make Wave Accounting appear hard to beat. But there’s no live support unless you pay for an additional service, like Wave Payroll. And it doesn’t allow any third-party integrations.

Bottom line

Understanding and maintaining the financial health of your business is crucial. By keeping your books up-to-date and accurate, you gain insights to make informed decisions about marketing, expansion and more. To help manage your finances, consider the best free business checking accounts that integrate with accounting software.