How to Prepare a Profit and Loss Statement

Your goal as a business owner is to keep your business financially solvent, and to do that, you absolutely must know how much you're making and how much you're losing. A profit and loss (P&L) statement, otherwise called an income statement, breaks down your profit and loss line by line so you can determine your net income and make wise decisions about business opportunities. 

Since an income statement gives you a close look at your total profits, liabilities, and expenses, it's one of the most important financial documents in your roster. Because P&L statements are so important, even the most basic accounting software programs generate them for you at the click of a button. 

But if you want to draw up your own P&L statements (or if you want to understand exactly what goes into generating income statements), Here are a few pointers on the subject...

What is an income statement?

 Let's talk a bit more about why understanding profit and loss is essential to running a successful business.

Profit obviously refers to the amount of money your business is making—and yes, it's critical to know what your income is at any given moment. But revenue alone doesn't accurately represent your business's profits. After all, expenses like rent, employee paychecks, damaged inventory, bank fees, and a host of other expenses and liabilities come out of your bottom line.

To accurately understand your business's fiscal position, then, you need to calculate both profit and loss to find your total net income. And that's exactly what the profit and loss sheet does for you: lists your total revenue, total expenses, and total equity line by line to show how much cash your business is really bringing in.

P&L statements are also important for banks, lenders, and other investors. Lenders will almost always look at your income statement before deciding if your business is profitable enough to invest in. P&L sheets also demonstrate your own financial know-how—if you as a business owner don't have a good understanding of how to effectively manage profit and loss, lenders will be less likely to trust that your business can give them a good return on investment.

Again, you don’t have to prepare a P&L statement on your own. Plenty of accounting software will do it for you. And if you want more information on how to create an income statement specific to your business, we always recommend talking to your financial advisor. Virtual accountants and bookkeepers can help, as can business bankers, CPAs, or other trusted financial professionals.

1. Choose an income statement format

If you're creating an income statement by hand, using a spreadsheet program like Excel or Google Sheets will help you keep the process simple. Depending on the product you use, you can find an easy template instead of building a document from the ground up. For instance, Microsoft Office offers a series of Excel templates for P&L statements.

The U.S. Small Business Association also offers a simple income statement template you can easily download, print, and fill out. Your accountant can also show you how they draw up a profit and loss statement. And, again, most accounting or bookkeeping software can automatically create a P&L statement for you or provide you with a template for you to fill in.

2. Decide on a time period to calculate net income

Most businesses calculate their profits and losses on a monthly, quarterly, or annual basis. If a lender or investor asks you for a P&L statement, they should specify the time period they need to see. Otherwise, just make sure to choose a time frame that shows you a general trend without overwhelming you with too much data; less than a month is probably too little time to reveal trends, while more than a year is probably too much.

3. List your revenue

For most product-based small businesses, revenue equals sales, or the amount goods sold—such as the amount of hair products sold by your salon, the number of baked goods sold by your cafe, or the number of printouts sold by your copy shop. But depending on the business, revenue could also include things like rent money, tax returns, or licensing agreements.

List each revenue source as its own line on your profit and loss statement. Then, once you’ve listed each source, total the amount to find your gross revenue.

4. Calculate your direct costs

After adding up your revenue, it's time to add up your direct costs, or costs related directly to producing the products or services you sell. If you sell a physical product, direct costs can also be called COGS, or cost of goods sold. Not sure what expenses count as COGS? Let’s say you sell holiday-themed oven mitts on Etsy. To make your goods, you have to buy fabric, thread, a sewing machine, scissors, pins, patterns, and a host of other materials. The money you spend purchasing those items is your direct cost.

What if your business provides a service instead of goods? Since you don’t sell a physical product, you don’t have COGS, but you do still have direct costs. For instance, if you’re a psychologist, your office space is essential to the service you provide: without an office, you can’t offer services. So in this case, the money you pay for the office would be one of your primary direct costs.

Direct costs can also include the costs of the labor that goes directly into your product or service. Let’s imagine you’re the owner of a small lawn mowing company. Purchasing a lawn mower isn’t your only direct cost—the amount of money you pay an employee to push the lawn mower is also a direct cost.

5. Calculate your gross profit

So now you know what your direct costs are. But do they outweigh what you charge customers for your products or services? Let’s find out: subtract your direct costs from your total revenue to get your gross profit. Hopefully, you’re left with a positive number that shows how much your business is making.

Once you've calculated your gross profit, you can also calculate your gross margin, which represents your gross profit as a percentage. Just subtract your direct costs from your gross revenue, and then divide that number by the gross revenue. Then simply multiply that number by 100.

6. Calculate your operating and non-operating expenses

Operating expenses (OPEX) are any expenses necessary to your business that aren’t direct costs. In other words, these expenses refer to any money that doesn’t go directly into creating goods or supplying services, which is why you'll also see operating expenses referred to as indirect expenses.

Depending on the type of business you run, these could include monthly utilities, business internet and phone plans, hardware and equipment, marketing costs, office supplies, building maintenance, and equipment repairs and maintenance. Basically, anything that impacts your day-to-day business operations should be listed as an operating expense on your income statement.

Since there are so many types of operating expenses, most income statements break down your OPEX by category. Here are a few of the most common.

• Administrative expenses

Administrative expenses, also called general expenses, are any expenses you incur in the general administration of your business. You can also think of administrative expenses as costs you'd pay even if you weren't producing goods or selling services—for instance, even on a day you don't sell a single product, you're still paying for inventory storage space.

• Overhead expenses

Overheads can refer to the fixed costs of running a business that don’t vary from month to month (in contrast with operating costs, which can fluctuate). If you pay the same monthly fee for your accounting software, that would count as a fixed cost, or overhead.

Depending on your business and type of income statement, overhead costs can also encompass all indirect labor and production costs. This contrasts with operating costs, which can mean the costs of actually running a business. Your accountant can help you understand more about what overheads look like at your unique business.

• Additional operating costs

A few other main OPEX categories include payroll expenses, marketing costs, and sales costs. Once again, we recommend asking an accountant for personalized recommendations about how to break down your operating expenses on an income statement.

• SG&A

SG&A stands for selling, general, and administrative expense, and it's yet another term you might see used as a synonym for OPEX.  Basically, the term encompasses everything except for COGS, direct costs, research and development expenses, and interest on business loans.

• Non-operating expenses

Non-operating expenses are (hopefully) one-time expenses like legal fees, tax penalties, or interest on a business loan. Once you've calculated your operating expenses, make sure to include your non-operating expenses on your P&L statement as well. 

7. Determine your net income

It’s time for the moment of truth: is your business profitable or not? Steel yourself, take a deep breath, and subtract your total expenses from your gross profit to get your net profit.

Is your net profit positive? Nice! You’re on track for financial health. Is it low, zero, or in the negatives? It’s time to reevaluate some business practices. That could mean cutting down your OPEX (operating expenses), downsizing departments, or switching raw materials manufacturers to reduce your COGS (cost of goods sold). Source

What Is a Balance Sheet?

A balance sheet is a straightforward (but crucial!) financial document that balances your assets against your liabilities and equity. Luckily for the busy business owner, they’re pretty easy to create and read: one half of the sheet lists what your business owns while the other half lists how much you owe, along with how much of the company you or your shareholders own. The information on a balance sheet gives you, your lenders, and your investors a quick overview of your business’s current financial health. In other words, when you need to take your business’s temperature, a balance sheet is your thermometer.

And along with a profit and loss statement (also called an income statement) and a cash flow statement, a balance sheet is one of your business’s most essential financial documents. You’ll be drawing up a lot of balance sheets, and if you want your business to stay in the black, you need to know how balance sheets work, how you read them, and how you can create your own.

What information is on a balance sheet?

Balance sheets draw on a simple equation, which is also one of the most basic accounting principles: assets = liabilities + equity. Of course, when we say “simple,” what we really mean is “less complicated than taxes,” but then again, what isn’t? So let’s look closer at what each term means:

• Assets refer to your current cash balance plus the dollar amount of anything your company owns, which includes property, equipment, inventory, accounts receivable, and anything else you could liquidate for cash.
• Liabilities refer to any money owed by your company. Typically, this category includes income tax, rent on office buildings, utility payments, wages paid to employees, and loans from banks and investors.
• Equity is also called “net worth” or “net assets,” and it’s the amount you or other shareholders would walk away with after debts to non-shareholders get paid off. If you’re the sole owner of your business, you call this owner’s equity. If external stakeholders own parts of your business, you call this shareholders’ equity.

Wondering why your assets need to equal both your liabilities and your equity, especially since “net assets” is another term for equity? Honestly, it’s kind of confusing, but try thinking of it like this: the only reason you have assets is because you took out a loan from a bank, accepted money from shareholders, or invested your own money in your business. Since your assets stem from a combination of liabilities and equity, the two halves of the equation need to balance.

So once you have all this information, it’s time to make sure the numbers all balance—or rather, the balance sheet makes sure they balance. Basically, the assets on one half of the sheet should equal the liabilities and equity on the other side of the sheet. Say you take out a $10,000 loan. That means you have a $10,000 liability—but it also means you have $10,000 in assets. See? Balanced.

That’s obviously the easiest, most simplistic example; alas, creating your first balance sheet won’t be that easy. But that example gets at the basic principle of the thing, which is to make sure your assets, liabilities, and equity are all balanced.

How can you draw up a balance sheet by hand?

If you’re set on doing your first balance sheet with pen and paper, open up your spreadsheet program or pick up your graphing paper and calculator and let’s get started;

1. List your assets

On the left half of your sheet, list your assets, starting with the most liquid assets and moving to least. Liquid assets are assets you can easily convert to cash, so you’ll want to start with your cash balance, then list the easiest items to cash out on, then the hardest items to cash out.

Another way to think about liquidity is in terms of time. Current assets include everything you can turn into cash within a year or less—such as inventory, like unsold bags from your boutique, or equipment, like your industrial bread maker. Long-term assets are things you couldn’t easily liquidate within a year, including long-term investments and intangible assets like copyrighted logos.

To keep things organized, you’ll want to split up your list of assets by category, or current vs. long term. At the end of each category, list the total; then at the very bottom of the assets column, list the sum total of all the assets.

2. List your liabilities

On the right half of your sheet, list your liabilities, starting with the most current debt owed (i.e., accounts payable, biweekly wages, or utility payments) to the longest-term debt (i.e., a five-year bank loan). Follow the same organization as the assets column, totaling each type of liability and then the sum total liability.

3. List your owner’s equity or shareholders’ equity

On the right half of your sheet—beneath the liabilities section and with its own heading—list your equity. Depending on your small business’s ownership structure, equity could include:

• Stock options, including common stock, treasury stock, and preferred stock
• Retained earnings, or money earned by the owners that they then reinvest in the business
• Paid-in capital, or additional money invested in the company that is not common stock
• As with the other categories, total each type of equity, then list the sum total equity.

4. Check the balance

Does your assets section equal your liabilities and equity section? If so, great news: you’re in the clear! But if your liability and equity outweigh your assets, you’ll need to put in a few extra hours as you figure out how to restore the balance. Source

Outsourcing vs Insourcing: Which is Right for You?

For business owners, one of the most critical decisions that can shape the trajectory of a company is choosing between insourcing and outsourcing. According to recent industry reports, a staggering 70% of businesses have embraced outsourcing as a strategic tool to optimize their operations and stay ahead of the competition. But is outsourcing always the answer? That's where understanding the nuances and benefits of insourcing and outsourcing becomes paramount. As the renowned management guru Peter Drucker once said, "Efficiency is doing things right, but effectiveness is doing the right things."

What is Insourcing?

Insourcing can be defined as the practice of keeping specific tasks or operations within a company's internal resources, utilizing its own personnel and infrastructure to fulfill those functions. Instead of seeking external assistance, insourcing involves relying on in-house capabilities to handle various aspects of business operations.

Examples of Insourcing in Business:

• IT Services: Many companies maintain an in-house IT department to handle network maintenance, software development, and technical support tasks. However, even IT is outsourced these days. It is predicted that by 2025, the IT outsourcing market will be worth $397.6 billion.
• Customer Service: Businesses may establish their own customer service department and implement IT help desk software to handle customer inquiries, feedback, and support directly.
• Manufacturing: Some organizations opt to have their own manufacturing facilities, employing their own workforce and equipment to produce goods, often utilizing MRP software to streamline and optimize their production processes.

What is Outsourcing?

Outsourcing refers to delegating specific tasks, processes, or operations to external third-party providers. Instead of relying solely on internal resources, businesses choose to leverage external expertise and resources to handle certain functions.

Examples of Outsourcing in Business:

• Accounting and Bookkeeping: Many businesses outsource their accounting and bookkeeping tasks to professional firms.
• Human Resources: Outsourcing HR functions, such as payroll processing, recruitment, and employee benefits administration, is a common practice for businesses.
• Call Center Services: Companies often outsource their customer support and call center operations to specialized service providers.
• Administrative Services: From solopreneurs to executives, people outsource their administrative tasks to virtual assistants.

Outsourcing vs Insourcing: Pros and Cons

Pros of Insourcing

Let’s delve into the pros and cons of insourcing first. There are several advantages of insourcing for businesses that choose to keep operations in-house:

• Control and Oversight: With insourcing, you have direct control and oversight over the tasks and processes. This enables you to maintain quality standards, ensure alignment with your company's vision, and have immediate access to information and resources.
• Confidentiality and Security: By keeping sensitive operations within your organization, you can maintain greater confidentiality and control over proprietary information, trade secrets, and customer data.
• Enhanced Collaboration: Insourcing promotes stronger collaboration among internal teams, fostering knowledge sharing, innovation, and a sense of unity within the organization.

Cons of Insourcing

Despite its benefits, there are also some disadvantages of insourcing:

• Increased Costs: Insourcing often requires significant investments in infrastructure, equipment, training, and hiring specialized personnel. These costs can be substantial and may impact your bottom line.
• Limited Expertise: Depending solely on internal resources may limit access to specialized skills or knowledge that external experts or service providers can offer.
• Lack of Scalability: Insourcing may pose challenges in scaling operations quickly during periods of growth or in response to fluctuating demands.

Pros of Outsourcing

Outsourcing presents its own set of advantages:

• Cost Savings: Outsourcing allows businesses to access specialized expertise without significant upfront investments. Service providers often operate cost-effectively, helping you reduce expenses and improve profitability. According to SiaPartners, in 2018, a majority of companies, 62%, saved between 10% to 25% by outsourcing, while the remaining 38% achieved savings of up to 40%.

• Focus on Core Competencies: Outsourcing non-core functions can redirect your resources and energy towards core business activities, increasing efficiency and productivity.

• Access to Global Talent: Outsourcing opens doors to a global talent pool, enabling you to tap into specialized skills and experience that may not be readily available internally.

Cons of Outsourcing

Outsourcing also comes with potential downsides:

• Communication and Control: Distance and time zone differences can sometimes pose challenges in effective communication and maintaining direct control over outsourced tasks or projects.
• Dependency on Third-Party Providers: Relying on external service providers means placing the success of certain operations in their hands. This can introduce risks if the provider fails to deliver as expected.

• Potential Quality Concerns: Outsourcing may lead to concerns regarding quality control, especially if the service provider's standards do not align with yours. Source

11 Strategies to Help Generate Positive Cash Flow

To help you generate a positive cash flow, we asked business professionals and leaders for their best insights. From bootstrapping the business to raising your rates, there are several strategies to generate a positive cash flow.

Here are eleven strategies to help generate a positive cash flow:

• Bootstrap the Business

The easiest way to be cash flow positive is to bootstrap the business. That way, if you don't have enough cash, you'll go out of business. The fear of going out of business is a good motivator to focus on what will get a business to be cash flow positive, such as increasing revenue or reducing expenses. Cut the safety net of raising more funds or taking out loans, and a small business will have no other choice than to make money.

• Talk With Vendors to Negotiate Terms

Talk with your vendors and see if you can negotiate more advantageous terms with them. For instance, you can ink a longer-term contract with them in exchange for you paying lower prices. Reducing your costs in this area can help generate a positive cash flow. Stabilizing and increasing the longevity of your business arrangements can also help you stay focused and increase positive cash flow over time.

• Save on Production Cost with Technology

Using technology is one very effective way to generate a positive cash flow. Depending on your industry, technology can help you save on production costs or even automate certain aspects of your customer service. Embrace the latest technology, use it to reduce costs and you’ll see a more positive cash flow.

• Delay Expenses

One thing you can depend on is that not all customers are dependable. Some clients make promises to pay on time, and then simply can’t. When you face such situations, it’s tempting to conduct business as usual. However, if your income is delayed, it only makes sense to also delay any expenses you can. By doing so, you can keep tabs on your cash flow and ensure that everything balances out.

• Start a Partner Referral Program

Consider starting a partner referral program to drive traffic and increase conversions. If you leverage your relationships with other businesses, you can mutually recommend your services or products to each other’s customers, growing both your customer base and sales. With a referral program in place, your cash flow will surely grow.

• Have Operating Assets

One strategy to help generate a positive cash flow in a business would be to have operating assets. Operating assets are used in the course of producing goods or services. If a business has enough operating assets, it may be able to wait on the payment for its invoices until it gets paid, which can help produce a more stable cash flow. You can also periodically and systematically look for ways in which the company can save money. Examples of such money-saving measures might be switching cell phone carriers, negotiating with suppliers for better prices, and renegotiating long-term leases.

• Send Invoices Early

If you’re providing products or services to others, and get paid by the invoice, don’t wait to send those invoices out. It’s understandable to want to stick to a predetermined schedule, perhaps sending out invoices all at once each month. This can lead to money crunches, though, and can get in the way of goals or budgets. Keep it all organized, but don’t delay when it comes to sending out invoices to have a more steady, positive cash flow.

• Check Your Inventory

Check your inventory for items that are not selling well. These products tie up your cash flow. Sell those at a discount or bundle them up with another product. You may also decide against manufacturing or buying the same item/s, moving forward. The same goes for unused equipment. You can either sell it for cash or lease it to another company. The proceeds from the sale can help add funds to your business.

• Leverage Relationships

We create long-term relationships based on trust and mutual benefits during our business dealings. One way to generate positive cash flows is to leverage those relationships to negotiate deals based on the needs of your business. Over 80% of businesses that fail state cash flow as the main reason for their decline. Purchasing goods from vendors and suppliers often accounts for over 60% of daily business costs, which means the timing of receiving and pricing goods is critical.

It is important to remember that vendors have a vested interest in your success as it impacts their bottom line. Working with them to renegotiate credit lines, prices, and quantities can dramatically impact generating a positive cash flow. By utilizing the trust you have built to keep your business running at its most efficient level, you can maintain positive cash flows and increase profits.

• Improve Productivity

Improving productivity can be a somewhat overlooked method of generating positive cash flow. By eliminating redundant tasks and automating processes, you open up opportunities for your employees to do more productive work. You can also discover which of your current methods are cash drains by conducting an audit of them. You can then eliminate these processes to ensure maximum cost-effectiveness and savings. The more redundant processes and outdated procedures you eliminate, the more time and resources your staff will have to devote to productive work, ensuring that goals and targets are met.

• Raise Your Rates

Many entrepreneurs launch their businesses with rates that are too low. Lack of experience is no reason to charge less than what it costs to produce your products.  The simplest, and most overlooked strategy to produce positive cash flow is to simply raise your rates. Don’t sell yourself short. If you’re good at what you do, and you’ve gotten great feedback on your work, don’t be afraid to charge your worth. One of the most common reasons why entrepreneurs find themselves getting sales but not producing positive cash flow is because they’re not charging enough. Source

Schedule Bookkeeping Activities Into Your Regular Day

Bookkeeping isn’t a once-a-month or once-a-week activity. Schedule your bookkeeping tasks and activities into smaller tasks and complete them over the course of the week.

Decide how much work you can do yourself and how much you should outsource. Here are a few examples of essential bookkeeping tasks and how often you should handle them:

• Issuing invoices to customers – once a week
• Recording customer payments – once a week
• Depositing customer payments in the bank – once a week
• Recording vendor invoices you received – once a week
• Recording changes in credit cards – once a week
• Issuing checks to pay vendors – once a week
• Reconciling credit card and bank account transactions into statements – once a month
• Producing financial statements – once a month
• Closing books to keep further entries – once a month

The weekly tasks you can assign to employees or complete yourself. Paying bills and invoicing happen daily, so they can be complicated to outsource. But complex projects like reconciling your accounts and closing the books should be done by a professional. Source

5 Ways a Bookkeeper Can Save You Money

As a small business owner, you’re likely a fan of the do-it-yourself lifestyle and used to juggling an ever-increasing number of tasks. While managing finances may not be your favorite, putting it off has real repercussions.

You may feel confident with payroll and bookkeeping software, or think that can’t afford to hire a bookkeeper, but they can be incredibly helpful in ensuring things are done well and alleviate some of your stress. Here are five ways a bookkeeper can save you money and help you run your business more efficiently:

1. Makes Managing Your Profit Margin Possible

As a small business owner, you’re probably used to working with razor-thin profit margins. A professional bookkeeper can help you keep track of these margins and offer insight on how to leverage them for greater returns on operating expenses.

A bookkeeper can also manage your monthly transactions, handle payroll, take care of government remittances, and ensure that bills are paid on time, freeing you up to concentrate on growing your business.

2. Lets You Take a Load Off

Running a small business is no easy task. The first few years are often the most difficult, as many small business owners struggle to make ends meet. Being forced to juggle multiple roles at once can translate into neglecting aspects of your business, like administration. Fortunately, this is a task that bookkeepers can help with.

3. Alleviates the Stress of Taxes

The collective panic business owners face during tax season is no laughing matter. While it’s something we all like to avoid, taxes are an essential part of business. 

Employing a bookkeeper, even temporarily, means the accurate and timely reporting of your expenses, write-offs, salaries, and budgets. This makes tax season less stressful for you and ensures things are done properly.

4. It’s Only Temporary

Unless your business employs over 30 employees or your revenue exceeds one million dollars annually, it’s unlikely you’ll have enough work to employ a bookkeeper full-time. 

Most small business owners can get away with outsourcing their bookkeeping, allowing them to save money. Calling in the help of a bookkeeper for tax season can be a beneficial and temporary solution, while your business grows.

5. Peace of Mind

Beyond the tangible benefits to your business, bookkeepers can also provide you with peace of mind. 

Jacquie Johnston, VP of the Canadian Bookkeepers Association, recalls receiving countless end-of-fiscal-year phone calls from frantic small business owners. On the benefits of hiring an external bookkeeper, she says, “Flexible scheduling and hourly rates allow you to pay for only what you need—nothing more, nothing less.”

While employing a bookkeeper may be a difficult decision for your small business, the benefits often outweigh the costs, as you’ll save time, money, and reduce some of the stress associated with running your business. Source

The Importance of Business Owners Understanding Contracts

Contracts are legally binding and critical to business operations, but many business owners overlook their complexity, leading to potential legal and financial risks. 

Here are key reasons why understanding contracts is essential:

1.) Legal Binding: Once signed, contracts obligate both parties to fulfill the terms. Non-compliance can lead to lawsuits or financial penalties.

2.) Hidden Clauses: Legal language can obscure unfavorable terms like automatic renewals or harsh penalties. Careful review is necessary to avoid surprises.

3.) Clear Obligations: Misunderstanding responsibilities such as delivery timelines or payment schedules can result in breaches of contract.

4.) Negotiation: Reviewing contracts enables business owners to negotiate better terms, such as payment conditions or less restrictive clauses.

5.) Legal Counsel: Hiring an attorney can ensure you understand the full implications of complex agreements and avoid costly mistakes.

6.) Dispute Resolution: It's important to clarify how disputes will be handled and understand exit strategies before signing.

7.) Intellectual Property: Contracts involving IP must be reviewed to avoid inadvertently losing ownership or control over valuable assets.

8.) Flexibility: Consider how contracts might limit your future business decisions, including long-term commitments or exclusivity agreements.

In short, contracts can greatly impact a business’s success, and it’s vital for business owners to review them thoroughly, negotiate wisely, and consult legal professionals when needed to protect their interests.

Contact us today with any questions; 

Susan Powers- 916-302-9153 or visit our website here

The Importance of Separating Personal and Business Finances

One fundamental financial practice that often gets overlooked, yet holds immense importance, is the separation of personal and business finances. By maintaining distinct bank accounts and credit cards for business transactions, small business owners can streamline bookkeeping processes, ensure accurate expense tracking, and foster clarity in financial management. 

Importance of Separating Personal and Business Finances: 

The intertwining of personal and business finances can lead to a myriad of complications, from blurred financial visibility to tax compliance issues. By segregating personal and business funds, entrepreneurs create a clear delineation between their personal assets and those belonging to the business. This clear separation simplifies financial record-keeping and also protects personal assets in the event of business-related liabilities or legal disputes. 

Clarity in Expense Tracking and Budgeting: 

When personal and business finances commingle, tracking expenses and creating accurate budgets become arduous tasks. By maintaining separate accounts, business owners can easily categorize transactions, identify deductible business expenses, and track cash flow with precision. This clarity in expense tracking enables informed decision-making, facilitates accurate financial reporting, and ensures compliance with tax regulations. 

Simplifying Bookkeeping Processes: 

Effective bookkeeping is essential for maintaining financial health and facilitating business growth. Separating personal and business finances streamlines bookkeeping processes by eliminating the need to sift through mixed transactions. With distinct bank accounts and credit cards for business transactions, entrepreneurs can reconcile accounts efficiently, generate accurate financial statements, and gain valuable insights into their business’s financial performance. 

Enhanced Financial Reporting and Analysis: 

Accurate financial reporting is crucial for assessing business performance, identifying trends, and making informed strategic decisions. By separating personal and business finances, entrepreneurs can generate comprehensive financial reports that reflect the true financial standing of their business. This transparency fosters stakeholder confidence and empowers business owners to analyze key metrics and pinpoint areas for improvement. 

Mitigating Tax Compliance Risks: 

Mixing personal and business finances can complicate tax reporting and increase the risk of tax compliance issues. By maintaining separate accounts, entrepreneurs can easily distinguish between personal and business expenses, facilitating the preparation of accurate tax returns. This separation also reduces the likelihood of triggering IRS audits and ensures compliance with tax regulations, ultimately minimizing the risk of penalties and fines. 

Protecting Personal Assets: 

Incorporating a business provides limited liability protection, shielding personal assets from business-related liabilities. However, this protection can be compromised if personal and business finances are intermingled. By keeping personal and business finances separate, entrepreneurs safeguard their personal assets from potential legal claims or creditors seeking recourse against the business. 

Building Credibility and Professionalism: 

Maintaining separate bank accounts and credit cards for business transactions signals professionalism and financial discipline. It instills confidence in clients, suppliers, and financial institutions, reinforcing the credibility of the business. Additionally, distinct business finances facilitate accurate financial projections and secure financing opportunities, further bolstering the business’s reputation and growth prospects. 

By separating personal and business finances, small business owners can streamline bookkeeping processes, track expenses accurately, and maintain clarity in financial management. This practice not only enhances decision-making and financial reporting but also mitigates tax compliance risks and protects personal assets. As businesses navigate the complexities of financial management, the importance of keeping personal and business finances separate remains a cornerstone of sound financial stewardship.  Source

The First Seven Steps Of A Bookkeeping Process

Step 1: Separate your business and personal expenses

The first step to mastering your business finances is pretty simple: get a business bank account and separate your business and personal expenses.

Why? Liability is one big reason. If you’re running a corporation or an LLC and there isn’t sufficient distance between your personal and business finances, there’s a chance that you could be held personally liable for any debts incurred by your business.

Mixing together personal and business expenses in the same account can also result in unnecessary stress when you need to file taxes or do your bookkeeping. It could mean a business expense gets lost in your personal account and you miss out on an important deduction. Or it could mean your CPA spends more time doing your taxes. Either way, you end up losing money.

Step 2: Choose a bookkeeping system

There are two main bookkeeping methods: single-entry and double-entry bookkeeping.

Under single-entry, journal entries are recorded once, as either an expense or income. Assets and liabilities (like inventory, equipment and loans) are tracked separately. If you’re just starting out, are doing your books on your own and are still in the hobby stage, single-entry is probably right for you. It’s simple, fast and good for really basic bookkeeping. Double-entry is more complex, but also more robust, and more suitable for established businesses that are past the hobby stage.

Under double-entry bookkeeping, all transactions are entered into a journal, and then each item is entered into the general ledger twice, as both a debit and a credit. Most accounting software today is based on double-entry accounting, and if you ever hire a bookkeeper or accountant to help you with your books, double-entry is what they’ll use.

Step 3: Choose an accounting method: Cash or Accrual

You have another important decision to make when setting up your bookkeeping: whether to make your accounting process cash or accrual based.

Under cash accounting, you record transactions only once money has exchanged hands. If you bill a customer today, those dollars don’t enter your ledger until the money hits your bank account. Many small businesses opt for the cash basis of accounting because it’s easy to maintain, doesn’t require you to track receivables or payables, and tells you exactly how much cash you have on hand at any given point in time.

Using the accrual accounting method, you record income when you bill your customers, in the form of accounts receivable (even if they don’t pay you for a few months). Same goes for expenses, which you record when you’re billed in the form of accounts payable.

Generally speaking, accrual accounting is better for larger, more established businesses. It gives you a more realistic idea of your business’ income and expenses during a period of time and provides a long-term view of the business that cash accounting can’t provide.

Step 4: Choose the right tools

Every transaction you make needs to be categorized when it’s entered in your books. This helps your bookkeeper catch more deductions, and will make your life easier if you get audited.

The way you categorize transactions will depend on your business and industry. Generally speaking, your transactions fall into five account types—assets, liabilities, equity, revenue, and expenses. Individual line items are then broken down into subcategories called accounts. In our ice cream shop example, some accounts in your ledger might be “revenue-ice cream sales”, “expenses-ice cream ingredients”, etc.

These days, you’ve got three options when it comes to bookkeeping tools.

You could go with one of dozens of popular cloud accounting solutions, like QuickBooks, Xero or Wave. These tools can be powerful if you know what you’re doing. However, if you don’t have a lot of bookkeeping experience (or don’t have time to learn), they could stress you out more than they help you. Especially if your accountant ends up telling you you’ve been using them incorrectly for the past year.

Step 5: Make sure your transactions are categorized

Every transaction you make needs to be categorized and entered into your books. This helps your bookkeeper catch more deductions, and will make your life easier if you get audited.

Remember: an unmarked receipt for lunch at a restaurant might not mean much to you six months later. Was it a client lunch? Did you treat your employees after a successful quarter? Properly categorizing and recording your transactions can help you avoid doing all of this extra investigative work later.

If you’re going to be doing your own bookkeeping, it’s worth talking to a pro when you set up your system to make sure the accounts you create align with your industry standards and CPA expectations.

Step 6: Choose a system for storing your documents

At tax time, the burden is on you to show the validity of all of your expenses, so keeping supporting documents for your financial data like receipts and records is crucial.

Diamonds may be forever, but the ink on your expense receipts is not. Since the IRS accepts digital records, it’s smart to use a cloud-based system like Dropbox, Evernote, or Google Drive so you never have to deal with smudged receipts. You can also use apps like Shoeboxed, which are specifically made for receipt tracking.

Step 7: Organize your deductions

The IRS’ golden rule on deductions is that they must be both ordinary (a common expense in your field) and necessary to your business. For example, pens would be an ordinary expense for a writer, but a $900 pen might not fall into the category of “necessary.”

But even if an expense is ordinary and necessary, you may still not be able to deduct all of it on your taxes. Just because you do most of your work from your dining room table doesn’t mean that you can deduct your entire monthly rent. Luckily, the IRS has put together a comprehensive guide on business deductions that you can consult if you’re ever unsure about a deduction.

Source

Why is Bookkeeping Important for Businesses?

Bookkeeping is not just a legal requirement; it’s the lifeblood of a business’s financial health. Below are some critical reasons why bookkeeping is important for businesses;

Make Accurate Budgeting possible

Bookkeeping is vital for budget creation as it provides an organized view of income and expenses, which helps businesses in making informed financial decisions. A well-planned budget acts as a roadmap for controlling costs and allocating resources in an efficient manner.

Accurate Bookkeeping Keeps You Prepared for Taxes

By regularly updating financial records, bookkeeping helps businesses stay prepared for tax season. Having all the financial information easily accessible keeps the tax authorities satisfied and prevents any last-minute headache during tax filings.

Maintains Organized Records

Regular bookkeeping ensures well-maintained and organized records. This helps in easily retrieving crucial financial information and saves businesses from the stress of searching for documents during deadlines.

Enables Proper Reporting to Investors

Investors own a share in a company and are in a position to make effective decisions. They are mainly concerned about whether their money has been used properly or not. They certainly want to know if the company is making money or not. They also want to know what potential the business has. These aspects can be easily managed with bookkeeping. The profit and loss statement, which is prepared regularly, shows the profits and also determines the potential based on the revenue. The performance charts and various information can be easily prepared and documented. Thus, bookkeeping helps to avoid the hassles associated with reporting to investors.

Aids in Setting and Monitoring Business Goals

By keeping a close eye on financial records, businesses can set realistic goals and track their progress. This, in turn, fosters better decision-making and faster business growth.

Ensures Compliance with Government Regulations

Government regulations often require businesses to maintain financial records. Regular bookkeeping ensures that businesses stay compliant and avoid any penalties or legal issues.

Offers Learning Opportunities

Whether you are new to bookkeeping or an experienced entrepreneur, engaging in bookkeeping practices helps in learning and understanding your business’s finances, thus making smarter business decisions. Source

Six Reasons to Keep Your Bookkeeping Up-to-date

Just like your car needs regular maintenance to run well, your bookkeeping needs regular updates to keep your business purring. Falling behind on your bookkeeping means you constantly have to be ready for a breakdown. Here are six useful things you can do with up-to-date books;

1. You can manage expenses

Every time you incur a business expense, it needs to be accounted for. Maybe the expense is paperclips for your office. Maybe it’s a tank full of diesel for the tractor on your organic farm. Big or small, it needs to be entered in your books.

Typically, expenses are recorded in the general ledger. When they’re not—due to bookkeeping that’s lagging behind—you can run into trouble.

Take the tractor example. Let’s say you spend $80 on fuel on Friday. On Saturday, at the farmer’s market, you sell $300 worth of fresh kale.

The $300 goes into your bank account, and you figure you’re up $300 for the week. That’s fine—until you go to pull out $300 for a tractor payment, and find you only have $220.

Up-to-date bookkeeping means knowing how much you’ve spent, and how much you’ve earned. That’s important information for the day-to-day operations of your business.

2. You can stick to a business budget

Staying on top of your expenses is great. Making a plan for every dollar you earn next year is even better.

But you can’t make a budget without having a realistic idea of what you spent last year. That’s your baseline. Then, you plot out what you *hope *to spend this year.

Here’s where most budgets fail: they don’t get updated each month with real spending numbers. When you do regular bookkeeping, you can see where you’re tracking against your budget plan, and you can make changes on-the-fly as you need.

Say you planned to cut back on Facebook advertising to only $300/month, so you could start saving $150/month towards an expensive industrial screen printer. But you realize you have some inventory you need to get rid of ASAP, so you put $450 into your next Facebook promo.

Now, with updated books (and an updated budget) you can see the printer will have to wait another month. But at least you know exactly where every dollar is going, and how that affects your business.

3. You can forecast revenue (this is useful, we promise)

Forecasting revenue is one of things that feels like an academic exercise. But there are certain times when you absolutely need an accurate forecast, and the best way to get an accurate forecast is by looking at your past financial statements.

For instance, if you’re making quarterly estimated tax payments, you’ll need to forecast revenue for the year, so you can estimate how much tax to pay.

Forecasting is also important month-to-month. Maybe it’s tourist season, and business is booming at your hamburger stand. It’s so busy, in fact, that you need to hire another high school kid to tend the grill.

How will you know you can afford to cover your another wage, unless you can anticipate the amount of money you’ll have coming into your business during the rest of the summer? Looking back over your books for the past few summers, you’ll be able to do the math, and add another spatula to your fleet.

4. You can skip the tax-season stress

When your books are up to date, you can glide into tax season—and the new year—with an easy mind.

Having all your business transactions recorded up to December 31 means you’ve got everything you need so an accountant can prepare your tax return for you. Come New Years’ Eve, you can worry about popping champagne, not prepping your taxes.

Reach the end of the year with out-of-date books, though, and you could find yourself scrambling. Getting a bookkeeper or accountant to do catch-up bookkeeping for you—or even hunkering down and doing it for yourself—costs money and time. Come New Year’s Eve, you could end up counting pennies instead of counting down til midnight.

Even if paying for a bookkeeping solution costs you money over the course of the year, that expense is at least partially offset by what you save in catch-up costs.

5. You can get a loan (or take on investors)

Let’s say your burger stand does really well during the summer tourist season, but you want to keep business moving during the rainy part of the year. A covered patio area could do the trick, encouraging people to come in out of the rain and get a bite. You need money to hire a builder. But before the bank is willing to extend your line of credit, they want proof that your business is making money. (After all, they’d like it if you eventually paid off the money they’re letting you borrow.) For that, you’ll need to present up-to-date financial statements.

The three key financial statements are the income statement, the balance sheet, and the cash flow statement. These three statements let you know, respectively, how much money you’re earning, how your expenses affect your revenue, and how money is moving throughout parts of your business.

An accountant can generate reliable financial records for you—so long as you provide them with up-to-date books. Then, a lender can use your financial statements to figure out whether or not your business is healthy, and whether they should lend you money.

6. You can prepare for emergencies

When you run your own business, it’s smart to expected the unexpected. But sometimes, Murphy’s Law gets the upper hand.

A swarm of aphids takes out your kale crop, or a burger grill suddenly decides to give up the ghost. When you’re facing a sudden spike in expenses—or a decline in revenue—you need to be able to make up the difference. That could mean drawing on backup reserves.

An emergency fund can help absorb the impact of unforeseen costs. Just by putting away a fraction of your business income every month, you may be surprised to see how quickly your savings add up. But it’s nearly impossible to save for emergencies when your bookkeeping is out of date.

Current books tell you how much you’ve saved. They’ll also let you know when you can start withholding more from your income, or when you need to divert some of that emergency fund savings to cover more immediate costs. Source