10 Quick Tips to Level Up Your Accounting IQ
As a small business owner, you don’t have to be an expert in every part of running your company. However, you should have a baseline knowledge and understand the basics. Accounting and bookkeeping are an integral piece of any business. Whether you have no accounting background or are a former accounting pro interested in a refresher, read on for ten quick tips to take your accounting IQ to the next level.
Every Transaction Has Two Entries
In accounting, every transaction has two entries. This system of bookkeeping is known as double entry accounting or double entry bookkeeping. When a transaction takes place, one account is debited and a section account is credited.
For example, did you just sell a product for $10. In that case, you would debit (increase) cash by $10 and credit (decrease) inventory by $10. A similar logic takes place any time money or products are involved in any transaction.
Accounts Roll Up to Different Financial Statements
There are three primary financial statements for every business: income statement, balance sheet, and cash flow statement. In your accounting system is a chart of accounts, each account rolls up into one of these statements.
For example, cash in the bank rolls up to assets on your balance sheet. Sales roll up into revenue on your income statement. Salaries are an expense on the income statement. The statements give you a summary of all business activity, which you can use to make better informed business decisions.
Do Not Mix Personal and Business Funds
If you have a business, your business should have its own bank account. Every dollar you earn and every dollar you spend should ultimately pass through that account. Your business can also have its own credit cards to track and manage expenses, savings accounts to hold cash and earn interest, and any other type of account an individual can have.
Comingling personal and business funds can lead to an accounting nightmare, particularly during tax season. It can also break some legal protections that protects your personal assets in the event of a business lawsuit.
Actively Manage Accounts Receivable and Accounts Payable
Do you have clients that are perpetually late sending you payments? Do you regularly see clients go beyond 30, 60, or 90 days late? Late invoice payments represent both a business risk and cost, and actively working on collecting payments protects your business from unnecessary losses.
At the same time you work to get payments as quickly as possible, you should make sure you are not paying invoices early if you don’t have to. It may make your accounts payable process easier to pay right when you receive the request, but delaying keeps cash in your bank, which provides additional business security and additional interest earnings in some cases.
Use Detailed Income and Expense Tracking
When setting up your bookkeeping system, you can choose to be very granular and detailed with your account system or keep things at a higher level. The big benefit of keeping your accounts more general is time savings when dealing with bookkeeping tasks. However, there are even bigger benefits of being as detailed as possible.
Making a detailed system of accounts that roll-up to create higher level reports gives you the best information on your business. Knowing revenue at a high level is great, but being able to look at revenue by category, product, or whatever metric is most valuable to your business is the best way to get things setup. It is easier to set it up the right way from the start than make changes after your business has been running for a few years.
Understand Seasonal Cash Flow
If you earn most of your revenue during one particular time of the year, you have to manage your business finances around that. If you see seasonal peaks and troughs, you can forecast for it and ensure your business has the resources needed to always survive the slow seasons thanks to success during busy ones.
Know Your Core Account Rollups
We have discussed account rollups a couple of times already in this list. That is a testament to exactly how important they are in accounting. The most important rollups to understand are assets, liability, income, and expense.
Assets and liabilities make up two of the three primary sections of the balance sheet, the third being owner’s equity which is calculated by subtracting liabilities from assets.
The income statement is also made up of multiple sections. The primary sections are a total of revenue, represented by income, and a total of expense. Subtracting expenses from revenue gives you the net income, the primary metric used to represent business profitability.
Cash vs. Accrual Accounting
Among your many other business decisions, one that is incredibly impactful to your business taxes is your accounting method. There are two main methods to choose from: accrual basis accounting and cash basis accounting.
Cash accounting is the most basic accounting method. It requires recognizing revenue when the cash actually moves between parties. For example, if you provide a service in November and get paid in December, you recognize the revenue in December.
Accrual accounting requires recognizing revenue and expenses in the period in which the related service was performed. For example, if you provide a service in December and get paid in January, the revenue is recognized in December. Because the payment is in a different accounting year than the service, this means you recognize the revenue and pay taxes for the year including December even though you were paid the following year.
Constantly Challenge and Improve
As a business owner, you want to make as much money as possible. Why else would you be putting all of that hard work into your business? To do so, you should constantly be examining, challenging, and looking for areas to improve your business. That includes bookkeeping and accounting methods.
No business is perfect. No process is perfect. Always be on the lookout for opportunities to improve. If you hire out your bookkeeping or accounting, challenge and press your vendor to give you the best, most detailed information possible.
Do a Monthly Checkup
A lot can happen in business in 30 days. You make money, spend money, make sales, pay yourself, pay employees, transfer funds, pay taxes, and much more in a typical accounting month. Always review your financial performance at least once every month. Doing so will help you identify potential problems, focus on what’s working well, and take you and your business to greater success for many years to come.