Why Is Accounting Important for Small Businesses?

By Daniel Lewis
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Accounting is the method through which you ‘account’ for all of your financial activities throughout the fiscal year. There are Generally Accepted Accounting Principles (‘GAAP’) which govern how finances are to be reported to the authorities.

But at the same time, there is an incredible level of variance between industries and business types. There are many different ways to account for different expenses and income. This guide will demonstrate the importance of accounting for a small business.

Get it right, and you won’t have to worry about business inefficiencies or unwelcome fines from the authorities. 

An Introduction to Small Business Accounting

Small businesses do not need an in-house accountant. Given that most of the essential details can now be completed with high-caliber payroll software, this is not a requirement. Small businesses only need to use an accountant on an as-needed basis. For really small businesses, you don’t even have to do this.

Small businesses, however, often rely on thin profit margins. As such, it is important to file everything on time and to make sure that everything is accurately recorded. It is the indirect cost of poor accountancy that can kill a small business. If you get hit with a court case for liability but cannot find the record, it will result in no small amount of stress.

Not to mention the time you will save as opposed to manually filling in the information and sending it off yourself. Small business owners should look towards software and understand the following (non-exhaustive) list of terms:

  • The Balance Sheet – A balance sheet is an overview of a company’s financial status, including assets, liabilities, and equity. The accounting equation that you’ll want to keep in mind when it comes to your balance sheet is Assets = Equity + Liabilities. A typical balance sheet has three sections: assets, liabilities, and equity. GAAP calls for the balance sheet to always match. This is referred to as ‘Double Entry Accounting”.
  • Working Capital – Is the amount of money a company has to invest or spend on necessary items for the business. Essentially, it’s a measure of operating liquidity and can help business owners determine how much they can allocate toward operating expenses. If you combine working capital with fixed assets, like office buildings or equipment, you will have “operating capital.” Working capital is not the same as net worth. Net worth will include fixed assets like machinery and property.
  • Gross Profit Is the profit before you have deducted the Cost of Goods Sold. When you have deducted the Cost of Goods Sold, you will be left with the Net Profit. The net profit is the most relevant, as this is what investors and lenders will take into consideration.
  • Expenses – Expenses are the costs of acquiring something. You can expense everything from raw materials to services. There are typically four types of costs: fixed, variable, accrued, and operational. People can classify expenses differently depending on their accounting methodology. It is also one mechanism by which you can save on your total tax liability if you are clever enough.

What Is the Real Purpose of Accounting?

There are many reasons to take accounting seriously. Accounting is itself an indirect cost. You need it to run your business, but it has no impact on what you are providing (unless you are an accountant!).

But you need to do it right anyway. The following are just some of the reasons why accounting is necessary. Note that accounting and payroll are linked, and often come together in software packages. This means you hit two birds with one stone, so the employee hours are recorded, calculated, added to forms, and sent to the relevant authorities by the deadlines.

Compliance With IRS Deadlines

If you miss a deadline, you will get a fine. And there are many of these deadlines. Not only do you have to pay tax records on time, but you have more information to submit relating to employee information and other records. The accounting will save the relevant documentation for you. You can even get an accountancy software provider to automatically file the taxes for you. If you have ever tried to manually file taxes before, then you can see why this is a truly wonderful innovation for modern business owners.

Business Performance Analysis

Wouldn’t it be easy to have an online platform that showed you exactly where all of your money was going? How much you were spending on each department, employee, contractor, project, etc? Well, this is exactly what a good accounting system can do for you. This is slightly more relevant to large corporations as compared to smaller businesses, but only just. You can track where you are spending too much capital and see operational inefficiencies with smart accounting.

Budgeting and Performance

Linked to the above point, accounting is excellent for basic budgeting. How much capital do you have, can you afford to hire new staff, what are your debt obligations, etc. It is not fun when you misallocate resources and do now have enough capital to survive long term. Most US business owners barely have enough capital at hand to survive the month. Review your accounts to ensure that you have a backlog of capital and optimize it where you can.

Decision Making

You cannot run a business without making good decisions. And you cannot make good decisions if you do not know everything about your organization in-depth, right down to the last expense. Many businesses go under due to poor management of resources. They thought they were in a better position than they were, and they ended up blindsided. Review your accounts to understand where you should take your business in the future. And always have capital reserves at hand, just in case.

Liquidity

If you do not know where the money is going, then you are unlikely to have a lot of it. Like all resources, money has to be managed. And you need to make sure that you have an adequate amount at hand. You can never really know when a disaster is going to strike. Which is an apt sentence, given we are currently going through the COVID pandemic which shut down a lot of businesses.

Loan Acquisition

All banks are going to want to review your accounts. The last 3 years are the most relevant to them, but they will want to see as much as possible to make the correct decisions. Take your cue from this. The banks want to look over your finances in detail – surely you should want to look at your business documents in far greater depth to spot trends?

Online loan providers will also want to see business documents. Many will require you to hook up an accounting system for easy transfer of accounting records. Some online providers only require this before you can take out a loan. This is how relevant accounting software is.

Business Sale and/or Audits

If you are getting an audit, then it is best to have all of your records in order. You do not have to have done anything actively criminal, simply by failing to keep adequate records you are violating the law. In the context of a business sale, you will also need to have a good accounting system in place for easy retrieval. Potential business owners will want to see all of your accounts before they even consider making a purchase. Different documents for the sale of the business and audit qualification will be relevant, depending on your industry, state, and size of business.

How to Stay on Top of Small Business Accounting

In the past, the only way to stay on top of accounting was through a dedicated accountant. It was tough work, not to mention expensive! Thankfully, we are now in the digital age where you can avail of these benefits at a low cost. The most direct way to stay on top of small business accounting is with high-quality accounting software providers. We have made a detailed list of the advantages and disadvantages of each. In shorter formats, the 3 top providers we tested are:

  • FreshBooks – Freshbooks is an all-time favorite. It is accountancy software of choice for a majority of online review sites, and with good reason. While it started as a simple invoicing solution (an area where it still excels), it now provides a massive range of payment processing and accounting functionality. A perfect design interface with a Lite plan that starts at only $6 a month. The downside is that this only allows 6 clients and you will soon have to upgrade. It is better at the payroll side of things in comparison to accounting, but it will be suitable for the accounting purposes of the majority of business owners. It is especially useful for creative business models looking for fancy invoicing.
  • Sage – Sage is an industry-standard that is perfect for small businesses looking for a powerful accountancy system. For pure accounting, Sage is one of the best and most long-standing accounting software providers. The reason is that it is simple to use and provides a huge range of functionality. It might lose out a little in comparison to some of the fancy designs on other platforms, but serious business owners will not care. It is particularly useful for professional services such as law, finance, and business consultancy.
  • Zoho BooksZoho Books is a direct competitor to FreshBooks and they tend to have a lot in common. Both are aimed at small business owners and are quite affordable, versatile, and with a slick design interface. The basic package starts at $8 a month. It offers Bank Reconciliation, Custom Invoices, Expense Tracking, Projects and Timesheets, Recurring Transactions, Sales Approval, Budgeting, and Zoho Sign Integration. Zoho Books can integrate with the massive Zoho suite of products to complete all of the most common business-related tasks. And all of them are superbly intuitive and fun to use, at a good price.

The level of functionality offered with each platform differs depending on what kind of package you subscribe to. Ideally, look for an accounting solution that also offers payroll. Some will even offer Human Resource management on top, which can be ideal for larger businesses. The most important item to look for is automatic tax filing and the ability to issue the relevant forms to contractors and employees. Most small business owners will only need basic accounting functionality unless they are specialized.

Features of a High-Quality Accounting Software Provider

Accounting software can do a lot to enhance a business. Below is a list of some of the items that an accounting software package can provide:

  • Vendor Records Payable – Know your vendors with vendors’ records management to keep track of who you are dealing with. You can also take advantage of vendor management to see the top vendors, what they are charging, who is the best, how long you have been with them, etc.
  • Check Printing – While not as popular as it once was, check printing is still used by many businesses. Certain accounting systems can excel at check creation.
  • 1099 Forms – Form 1099 is used to pay contractors. In the modern era, most businesses are going to be using a lot of freelance and third parties. Some payroll/accounting systems do not allow 1099 forms until above the basic tier.
  • Customer Accounts Management – Similar to vendor management, except this is to know your end customers. This might also contain advanced functionality, easy customer creation, records cloning, etc.
  • Invoice Creation – Practically all accounting systems will allow for fancy-invoice creation. It is not an area that can be overlooked, as it is important for branding purposes. You can even create personalized invoices for long-standing customers if you wish.
  • Cost of Goods Sold Reporting – Cost of Goods Sold is a unique metric that is especially relevant for manufacturing businesses. It is tied to gross profit and has tax implications. So it is very important for tax purposes and for increasing the operational efficiency of businesses. It is also related to shipping and handling for businesses that ship goods.
  • Sales Tax Calculation – Sales tax calculation tools are very important, especially since they are different state to state. Some states (Alaska, Delaware, Montana, New Hampshire,  Oregon) do not even have a sales tax.
  • Sales Forecast – This is a blend of both art and science. But it’s best to lean on the science/data side of things! Crunch the figures of all of your income/expense streams to figure out what kinds of sales to expect based on the market phenomenon, prior orders, and other data points.
  • Actual Variance Reporting – Correlate your prior projections to what happened. What is the variance between your budget and what happens on a year to year basis? This will help you to budget more accurately in the future. This can also improve your sales forecasting.
  • Bank Reconciliation – This is a critical accounting feature. You need the capability to improve bank records in real-time. But you want to go further with this to sync your bank and accounting records smoothly. The best software will handle split payments, which can be a difficult item to deal with for many providers.
  • Purchase Orders – Maintain product order histories, avoid duplicate purchases, satisfy supplier requirements, and create a check and balance for outgoing payments by using purchase orders.
  • Federal W2, 940, 941, 944 Forms (Payroll) – All of these forms are essential to running a business. You need to file these taxes with the relevant authorities, mainly the IRS. Most accounting software will cater to these forms, though some do not, as they are more related to payroll than accounting.
  • Fund Accounting – This is more relevant to nonprofit organizations as well as government branches. It is useful when working with grants and allocations. Small businesses will often not be involved in large funds.
  • Tax Withholding Calculation (Payroll) – This automatically totes up the amount you have to withhold for your employees. Primarily this will be FUTA taxes, which is Social Security and Medicare. You will have to withhold about 7.6% for these taxes on behalf of your employee and also contribute an identical amount.
  • Benefits Deduction (Payroll) – Along with FUTA tax deduction, you will also have to deduct benefits from your employees, depending on what benefits are on offer. The ability to properly deduct for 401k, insurance, or other employer-provided benefits is a critical component of any complete accounting/payroll hybrid.
  • Employee Self Service (Payroll) – This is essentially employee self-onboarding. The employees are automatically given the correct forms to fill out and upload to the system. No HR or manual entry requirements.

On top of this, the typical accounting functions will be provided by all platforms. This includes double-entry accounting, balance sheet, profit, and loss, etc. Other providers may cater to specific industries. Some businesses might have a real need for inventory management functionality and job costing, or other benefits.

There are many, many, many other features we could enumerate upon. These include Envelopes, Receipts, Reminders, Credit Notes, Pack Slips, Estimating, Quoting, RMA Support, Customer Credit Management, Versioning And Approvals, Variance Reporting, Flexible Accounting Periods, Lifo, Fifo, Average Cost Option, Multi-Currency Support, and more.

At Finimpact, we love all things related to accounting! But we have given you the most relevant ones above. The bottom line is that a good accounting and payroll system can do much to improve your business. It should also serve to help you to understand the business in-depth.

The Consequences of a Poor Accounting System

As can be seen from the list above, the benefits of a high-quality accounting system are vast. And we haven’t even scratched the surface. On the other hand, a poor accounting system is next to useless. You need accounting software to complete the tasks pertinent to your business model. Records need to be kept, forms need to be filed, and you need the ability to crunch numbers and see the correct, real-time information.  

The worst-case scenario is when an accounting provider updates their software and leaves you in the dark due to a lack of backward compatibility. It can be a literal nightmare when you have customers to invoice and suppliers to pay. Reconciling bank accounts and records en masse with a new provider is a massive pain. 

And there are direct financial costs. If you fail to submit a form on time, you will get a fine. If you fail to keep proper records, you could get a fine or lose a court case due to it. In a more general sense, you will suffer from a lack of time and efficiency due to a poor interface. You will not be able to view all of the details of your company from a financial perspective. Ultimately, your business will suffer, as there will be a mismatch between your suppliers and vendors. A smooth system of financial transfer is needed.

The Bottom Line

Accounting is not an area that you can skimp out on. Free trials are available, and the basic packages typically only cost about $10 a month for those that have less than 10 employees. You can scale as you see fit, once satisfied with the design and functionality.

There can be something of a learning curve despite the intuitive nature of such platforms. But all in all, accounting has been made easy for small business owners. It can serve to enhance your business and your business knowledge if you take the time to get familiar with it.

There is no excuse for maintaining sloppy records or trying to save $5 a month on such a vital business component. Let automation resolve the accountancy and payroll side of your business while you focus on profit generation.

FAQ

What is Cash Basis Accounting?

The cash basis is excellent at monitoring the actual cash available. Expenses and revenues aren’t carefully matched on a month-to-month basis. Expenses aren’t recognized until the money is paid out, even if the expenses are incurred in previous months, and revenues earned in previous months aren’t recognized until the cash is received.

What is Accrual Accounting?

With this common method of accounting, expenses and revenue are matched, providing a company with a better idea of how much it’s spending to operate each month and how much profit it’s making. Expenses are accrued in the present month, even if the cash isn’t paid out until the month after this one. Revenues are recorded in the month the project is complete or the product is shipped, even if the company hasn’t yet received the cash from the customer.

What Is Cost Accounting?

Cost Accounting is most relevant for manufacturing businesses. It is a method of internal accounting that does not have to adhere to the Generally Accepted Accounting Principles. It is used so that management can determine how to make better decisions. Due to this, there are many different kinds of cost accounting, depending on what kind of industry the business is in. Cost accounting is more relevant to businesses in manufacturing, producing physical items. Yet other businesses may have their version of cost accounting.

Should I Hire a Dedicated Accountant?

Unless you have more than 100 employees, then you do not have to need for an in-house accountant. What you can do is work with a good accountancy firm on an as-needed basis. It can be useful to work with a good accountant, especially if you are taking in significant revenues. It’s just that you do not have to hire a full-time accountant anymore. Just get high-quality software providers and consult an accountant a couple of times a year, or when it is time to file.

How Do I Select the Right Accounting Software?

Before you select any software, you should make a list of what exact features you are looking for and how many clients/vendors you are working with. It might be a good idea to look for an accounting/payroll hybrid system. In this manner, you can seamlessly complete two formerly separate tasks. The payroll will allow employee self onboarding, time tracking, employee withholding, and benefits deductions, as well as automatic tax filing. The accounting system will allow vendor and inventory management, budgeting, sales forecasting, balance sheet analysis, and more. Price should not be much of a consideration. Most of the accounting software providers are similarly priced, with various tiers to cater to what you are looking for. Lastly, always look to social proofs to determine whether a provider is reliable or not. Accounting errors can be costly if you cannot talk to an agent fast.

Daniel Lewis
Daniel Lewis
Daniel Lewis is an MBA accredited investment professional who wants to assist small business owners to gain access to finance. After going through many channels for funding, Lewis has found that getting the first loan right is vitally important for future success.