Keeping a tight grip on your finances is critical for the success of your business.

For small business owners—busy juggling multiple other things—managing accounting can be a bit of a daunting task. That said, maintaining a proper book of accounts will help you stay on top of money matters, unlock new avenues of growth, and avoid unexpected realizations about account balances and expenses.

We’ve put together this guide to help you understand the basics of small business accounting. To stay organized and up-to-date with financial reports, we’re also sharing reviews of the popular small and medium-sized business (SMB) accounting tools on the market.

What is small business accounting?

Small business accounting involves maintaining a complete record of expenses and incomes and classifying, reporting, and analyzing a company’s financial transactions.

Accounting helps small businesses monitor their finances closely and better understand their profitability. By accounting for and documenting the purchases, sales, expenses, taxes, payroll, and inventory—small business owners can track the money that flows in and out of business accounts. 

Accounting for small businesses: Basics and best practices

Whether you opt to manage it all by yourself or with the help of an accountant, getting down to the basics of accounting will help you make informed decisions about pricing, investments, and growth. 

From opening a small business bank account to understanding and adhering to tax laws to reevaluating your accounting practices—we’re covering the fundamentals and adding tips to ensure that you’re following sound accounting procedures.

1. Create a small business bank account

First up, it’s important to have a separate bank account for your business. This way, any payments or revenue will go directly to your business checking account, and you can also increase your chances of getting credit approvals by maintaining a strong set of business financial records. 

Splitting up your business and personal funds will also make it easier for you to manage your business finances. Moreover, it safeguards your assets, like your home or retirement savings, in the unfortunate event of a lawsuit or bankruptcy.

Before you set out to open a business bank account, check with the bank for the documents you need to keep handy and ensure you have registered your business with your state.

Which bank account should you opt for?

While there are multiple types of business bank accounts that you can consider based on your needs and stage of growth, the ideal choice for a small business (in its early stages) is a business checking account. It’s also important to review features of your bank account, like fees, interest rates, and transaction limits, before you take a final call. 

While the business checking account will be the hub to manage your day-to-day transactions, it’s also recommended to open an additional savings account dedicated to setting aside a portion of your earnings (about 25%) to better manage cash flow. If you accept debit and credit card payments, you may also want to consider opening a merchant services account. 

Do you need a small business credit card?

Numerous small business credit cards offer an intro 0% annual percentage rate (APR), which is a great option for new businesses, as they let you pay purchases off with no interest. They can also help you earn rewards on daily spending and build a business credit history to secure funding in the future.

2. Set up a small business bookkeeping system

Every business needs an effective bookkeeping system to record financial transactions, categorize them, and finally reconcile them with their bank statements. The approach you follow will depend on your unique revenue model and the size of your business.

Here’s a quick checklist of what to do when setting up your bookkeeping:

• Establish definite financial goals that are in line with your business’s overarching objectives.
• Then begin by analyzing your financial transactions and logging the ones pertaining to the business entity into the accounting system.
• Your business transactions are entered in a journal in chronological order using the double-entry bookkeeping system. This includes two accounts—debit and credit.
• You can then classify transactions recorded in a journal using a general ledger, the principal book of accounts.
• The accounts should be reconciled with the bank statements regularly.

Pro tip: All of the above steps are automated for you in DayZero

What accounting method is best for small businesses?

As a small business owner, you can choose between a cash-based or accrual accounting method based on your business type and how and when your business will record transactions. 

Cash method: Under this method, revenue and expenses are recognized when money is received and payments are made.

Accrual method: This method records revenue when it's earned and expenses when they are incurred. This involves tracking accounts receivable and payables, as revenue and expenses are recognized regardless of whether the money flows in or out of your bank accounts. 

As per the Internal Revenue Code Section 448(a), C corporations (including partnerships with a C corporation partner and tax shelters) are required to use an accrual method of accounting. 

Businesses that generate income through purchasing, manufacturing, or selling merchandise generally follow the accrual method of accounting for inventory transactions. They may, however, opt to use the cash method for non-inventory-related transactions if they do not wish to apply accrual accounting universally.

3. Manage your small business expenses

For a small business, an expense could include anything from variable expenses like marketing costs or fixed expenses like office rent. It’s important to track and document these expenses accurately to assess your profitability, optimize cash flow, and ensure compliance with tax regulations.

Pro tip: Often, small business owners miss out on budgeting for irregular or annual expenses like insurance premiums. Be sure to set aside money to cover these costs when they arise and record them on time.

4. Establish a small business payroll system

Regardless of the size of your business, when you hire employees—you will have to set up a payroll system and ensure the right taxes are being withheld.

For this, it is important to have a good understanding of the relevant state and local laws. In the U.S., different regulations apply, such as the employment tax rates, minimum wage laws, and the Family and Medical Leave Act. 

Furthermore, in addition to the actual salary—your payroll structure will also include cost-to-company (CTC) components. These are any form of allowance, insurance, provident fund, or other benefits that you plan to offer. 

You must also determine your payroll schedule by choosing if you want to pay employees weekly, biweekly, or monthly. If you have contractors on your payroll, the IRS requires business owners to report payments to contractors on Form 1099-NEC.

5. Determine the import tax

You also need to be aware of the taxes and import duties that may apply if your business model includes purchasing and importing products from other countries. This is especially important for those running a dropshipping operation. 

Additionally, understanding the logistics, such as shipping timelines and potential customs delays, is crucial to managing your supply chain effectively.

6. Decide how you want to get paid

How do you plan to accept payments for your business? Or ensure that you get paid on time? Every business is subject to late-paying clients. Offering your clients multiple payment options, such as credit cards, digital wallets, and bank transfers, will accommodate client preferences and make it easy for them to pay you.

Further, offering flexible payment terms, like installments or subscription models, can also attract more clients. 

7. Understand and establish sales tax procedures

Sales tax is often complex for most small business owners to tackle. Depending on your location, the sale tax can vary. It applies to any tangible goods that are sold within a state. In some cases, sales tax can also cover a few services, such as professional or repair and installation services.

Small business owners are required to charge and collect sales tax from customers. But when and how much to charge is the most confusing aspect. 

In the U.S., 45 states and the District of Columbia collect statewide sales taxes. You need to be mindful of the various exemptions that every state or locality offers depending on factors including the type of product, point of sale, and more.

‍

If you operate from an origin-based state, you need to charge sales tax based on the state where you run your business, whereas operating from a destination-based state would mean that you need to take sales tax based on where the customer is located.

While collecting sales tax from a customer who walks into your brick-and-mortar retail store will depend on the state or province they purchase in, charging sales tax to a customer buying online is a lot more complicated. 

Here’s how to go about it: Let’s say your business has a physical presence in a state where the sales tax rule applies. In this case, you will have to charge sales tax for online purchases made by individuals who reside in that same state. You don’t have to worry about sales taxes at all if you operate an online store registered in a tax-free state.

8. Assess your tax obligations

As per the U.S. tax codes, businesses need to file taxes at the federal, state, and local levels. The IRS publishes all the taxation information for business owners.

Your business’s tax obligations will differ based on its legal structure, the number of employees, and its annual income. In the U.S., the majority of small businesses pay taxes at the owner’s individual income tax rate, except for C corporations. 

C corporations are taxed at the corporate level, and any distributed profits may be subject to additional personal income tax.‍

9. Secure small business funding

For small businesses that operate with tight cash flows, you never know when you might need additional funding. There may be economic downturns or pressure from your competitors. Maybe you are looking to expand your operations or ramp up hiring. In all these instances, securing timely financing becomes inevitable.

Traditionally, most banks require you to submit financial statements like the balance sheet and the income statement. You are also required to have a strong credit history to improve your chances of getting approved for a loan. 

Pro tip: DayZero gives you all the financial information you need to apply for small business funding

10. Revisit your accounting methods

Most small businesses end up spending hours scouring through spreadsheets to manage their books. As your business scales up, financial statements are only going to get more complex. This makes it important to regularly review your accounting methods and find ways to improve them.

Leveraging accounting software could be a game changer for your business, helping you make informed financial decisions. 

Accounting software will help you stay on top of your expenses, automate processes such as billing and invoicing, create reports, and keep business financial data secure. 

The five best tools for SMB accounting

Essential financial management is imperative for businesses to thrive. There are a range of accounting software out there that are designed to help businesses keep tabs on their finances and prepare for tax season.

Before we take a look at our top accounting software picks, here are five of the many reasons why you need to consider leveraging an SMB accounting tool:

1. Automate repetitive tasks: An SMB accounting software automates routine tasks like expense categorization and tracking, in turn removing the manual hassles of managing accounting. 
2. Simplifies workflow: By leveraging an accounting tool, you can streamline your workflows and consolidate the different aspects of your business’s financial management, including invoicing and payments, into one cohesive system.
3. Get real-time financial insights: These accounting tools come loaded with features like a unified dashboard, automated reporting capabilities, and KPI tracking. All of which will empower you to make well-informed financial decisions.
4. Take the stress out of the tax season: The tax season can be a grueling time, especially for small business owners. Accounting software helps maintain proper financial records all year round, enabling businesses to be well-prepared for the tax season.
5. Scale up with ease: Using spreadsheets to maintain financial records may be feasible for a business in its early stages, but once you start growing your business, Excel sheets can soon become a pipework of frustrating bottlenecks. Opt for accounting software that will help you scale up with ease and adapt to increasing volumes and complexity.
   

We’ve narrowed in on the best SMB accounting tools out there and the key benefits that set them apart. We’ve got DayZero, QuickBooks, Xero, Bench Accounting, and EcomBalance.

1. DayZero

‍

DayZero is a modern, hands-free general ledger bookkeeping system built to streamline financial management for SMBs. It is easy to use and offers a comprehensive suite of tools to manage your finances, from invoicing and inventory management to financial reporting. 

The best part? Apart from automating routine accounting tasks, the tool updates your numbers automatically, 24/7, and has a personalized AI bookkeeper, Emily, that generates custom reports for you. 

You can even upgrade to full-service, human-in-the-loop support within the platform, to answer any of your accounting questions. 

Key benefits include

• Fast setup: Getting started is easy and businesses can receive fully reconciled financials in under 10 minutes.
• Intuitive Interface: DayZero is well known for its intuitive interface.
• Automated chart of accounts: DayZero automates your chart of accounts and takes care of all the double-entry accounting for you, leaving you hands-free.
• Automated categorization: DayZero categorizes your incoming transactions, automatically.
• Ecom-focused features: Enable Shopify sync for automated journal entries, reconciliation, and tracking of the product catalog and COGS.
• Real-time numbers: Your financials update automatically, every day, so there’s never any catchup bookkeeping.
• Customizable dashboards: Access intuitive dashboards and get real-time insights about your business’s financial health delivered to your inbox.
• Working capital financing: Unlock flexible working capital financing options in just a few clicks.
• Human support: Opt for DIY bookkeeping or upgrade for professional support within the platform.

2. QuickBooks Online

This small business accounting software by Intuit is known for its robust functionality. It has a myriad of features that help businesses manage income, expenses, payroll, and taxes.

Key benefits include

• Invoicing and payments: Create professional invoices, accept payments, and track sales.
• Expense tracking: Import and categorize expenses from your bank account.
• Tax preparation: Simplifies tax filing by organizing your finances and generating tax reports.

3. Xero

Xero is a cloud-based accounting software that offers a powerful set of tools tailored for SMBs, with an emphasis on collaboration and accessibility from any device. 

Key benefits include

• Invoicing: Create and send custom invoices, and follow up with automated reminders.
• Collaboration: Invite your accountant or team members to collaborate directly within the platform.

4. Bench Accounting

Bench Accounting is a bookkeeping service combined with simple, intuitive software. It pairs you with a dedicated bookkeeper who handles your monthly bookkeeping, so you can focus on running your business. 

Key benefits include

• Personalized bookkeeping: Simplify accounting with the help of their dedicated bookkeepers, who take care of all your bookkeeping needs.
• Financial reporting: Access easy-to-understand financial reports that give you a clear picture of your business’s performance.
• Human support: Reach out to a team of experts who can answer your questions and help with your finances.

5. EcomBalance

EcomBalance is an accounting service specifically designed for ecommerce businesses. It specializes in understanding the unique challenges of ecommerce, offering tailored solutions to better manage their bookkeeping and finances. 

Key benefits include

• Transaction reconciliation: Automatically reconcile your sales, expenses, and fees from multiple platforms.
• Monthly financials: Receive accurate monthly financial statements, including profit and loss, balance sheets, and cash flow statements.
• Sales tax compliance: Ensure that your business stays compliant with sales tax regulations across different states.

Managing your accounting doesn’t have to be stressful

A good understanding of basic accounting principles can help you take better control of your business finances. Adopting practices like monitoring your expenses regularly, selecting the right accounting method, and following applicable tax laws can enhance your financial oversight. 

Additionally, leveraging an SMB accounting tool like DayZero will help you ace business accounting and make it extremely easy for you to stay organized and compliant.

Frequently Asked Questions (FAQs)

We thought we should highlight some of the most common questions DayZero customers ask regularly.

Can I do my business accounting?

Yes, you can do your business accounting, especially if you have a small business with straightforward financial transactions. 

However, it’s essential to have a good understanding of basic accounting principles. Using accounting software like DayZero can help simplify the process and ensure greater accuracy.

What is single-entry bookkeeping for small businesses?

Single-entry bookkeeping is a simplified accounting method where each financial transaction is recorded only once, either as an income or an expense. 

This method is typically used by small businesses with fewer transactions, providing a clear overview of cash flow. It’s easier to maintain, but less comprehensive than double-entry bookkeeping.

How to maintain accounts for a small business?

To maintain accounts for a small business, follow these steps:

• Choose an ideal accounting method for your business.
• Record transactions regularly using accounting software or a manual ledger.
• Reconcile accounts monthly to ensure accuracy and catch any discrepancies.
• Prepare financial statements periodically to assess business performance.

Which accounting method is frequently preferred by small businesses?

The most commonly used accounting method by small businesses is the cash basis method. This approach logs income and expenses at the time they are received or paid.

However, some businesses may opt for the accrual basis method, which records transactions when they are incurred, regardless of cash flow.

How many accountants should a small business have?

The number of accountants a small business should have depends on its size and complexity. A small business might operate effectively with just one accountant or even manage the bookkeeping themselves.