Small business accounting is a lot of work.
Learning the basics of accounting is important when running a small business, even if you're already working with a professional accountant. — sturti/Getty Images

When you first start your small business, you'll likely have to take on many day-to-day administrative tasks yourself, including accounting. Knowing how to track and project your business income and expenses are important skills for business success, so it's important to familiarize yourself with the fundamentals of accounting.

Even if you're ready to outsource your accounting and bookkeeping needs right away, it's still good to have a grasp on the basics so you can understand your financial professional's reports and accurately gauge your business's financial health.

Below, we break down everything you need to know about small business accounting, including how to track and analyze your company's key financial metrics.

Accounting 101: The basics of business bookkeeping

On its most basic level, accounting is how a business keeps track of how much money is coming in and going out. Having this information handy and organized is important not only for you as the business owner, but for any external stakeholders who may need to investigate your financial records.

There are several different types of accounting, but they can typically be divided into general accounting and financial accounting. The former generally focuses on accurate recordkeeping, while the latter is done to help a business look ahead and plan key expenses and investments accordingly.

As Logan Allec, CPA and owner of Money Done Right, said in an interview with CO—, "your accounting department will tell you what happened financially at your company, while your finance department will perform an analysis … [and] make recommendations and forecasts on where the company will be in the future."

Key accounting terms to know

Some common accounting terms that every small business owner should know include:

  • Generally Accepted Accounting Principles (GAAP): GAAP is a set of standard rules that most American companies are expected to follow in their accounting practices. These principles provide guidelines for how to track, measure and report on your company's finances for outside parties.
  • Cash basis accounting: One of the two most common accounting methods, cash basis accounting means you record income and expenses as they are, respectively, received and paid. This is often preferred by small businesses because of its simplicity, even though it may give a misleading picture of your cash flow (e.g., if you receive payment for a bill the month after you issued it).
  • Accrual basis accounting: Businesses that earn more than $25 million in revenue are required to follow accrual basis accounting. Instead of recording income when it is received, you must log it when you bill it⸺which means you may be paying taxes on money you haven't received yet. However, it does provide a more accurate long-term view of your finances than cash basis accounting.
  • Accounts payable: Any outstanding bills you owe vendors for goods and services are considered part of your accounts payable. These liabilities must be considered against your business assets and income to accurately project cash flow.
  • Accounts receivable: Your accounts receivable is all the money owed to your business by its customers or clients. These accounts are typically tracked via invoices, which specify payment terms (e.g., within a specific number of days after receipt) so you will know when to expect incoming cash.

Knowing how to track and project your business income and expenses are important skills for business success.

Common accounting reports

There are a few key financial reports that every business must understand how to prepare as part of their financial accounting processes. These statements are designed to document your business's income and expenses for outside parties, including investors, lenders and creditors.

  • A profit and loss (P&L) statement is most commonly requested by accountants and tax preparers when it comes time to file your business taxes with the IRS, but you may also need to share it with lenders if you apply for funding. Your P&L statement gives an overview of your company's profitability by listing your revenue, expenses, cost of goods sold, gross margin, profit and other key metrics during a specific time period (e.g., monthly, quarterly, annually).
  • A balance sheet offers a "snapshot" of your business's financial standing at a given point in time. It lists your company's assets, liabilities and capital, all of which can be used to understand how much your business is worth.
  • A cash flow statement helps you monitor your company's financial activity by tracking and categorizing each individual expense and earning, line by line. Nearly every item on your cash flow statement will be classified as an operating activity, investment activity or financing activity.

If your business has shareholders or investors with equity in the company, you will also be responsible for creating a stockholders' equity statement. This statement is part of your balance sheet and breaks down any changes in value of your stockholders' ownership interest over a period of time, typically the beginning to the end of the year.

[Read: How to Open a Business Bank Account]

Accounting tools and systems

Good accounting requires the right tools and systems for the job. Some very small businesses still rely on pen-and-paper ledger books or simple Excel spreadsheets to track their income and expenses, but as your business grows, you may wish to look into accounting software to automate your bookkeeping processes.

Modern accounting tools are typically available in the form of downloadable desktop software or as an online, cloud-based tool. While both types offer similar functionalities, such as invoicing, report generation and bank account syncing, businesses that want "anywhere, anytime" access to their accounting software often opt for online tools so they can check their finances on-the-go from any device.

If you're looking to purchase accounting software, check out CO—'s buyer's guide, which outlines the different types of software available and the criteria you should consider when selecting the right solution for your business.

[Read: 3 Things You Need to Know About Accounting Software in 2019]

Outsourcing your accounting needs

One of the most frequently asked questions about accounting is whether your small business truly needs to hire an accountant.

The short answer is "yes." As a business grows, its finances typically become more complex. At this point, you will likely need to hire an accounting firm or independent CPA to help you manage your books. This will become especially important when you start hiring full-time or part-time W-2 employees, as the tax payment and reporting requirements for these workers are more involved than 1099 contractors.

Not only can outsourcing your core accounting tasks ensure that these requirements are met and completed accurately, but it can free up valuable time that you can reinvest back into your business.

When searching for the right accounting firm for your business, be sure to consider the following:

  • Location (local versus remote).
  • Certifications.
  • Relevant experience.
  • Money-saving strategies and expertise.
  • Knowledge of your preferred software.

Get more tips and recommendations in our guide to finding a business accountant.

Accounting tips for small businesses

No matter what stage your company is in, follow these three tips to help you improve your business's accounting strategy and overall financial health:

Use the right tools. A reputable, user-friendly accounting software can help you streamline and simplify your accounting tasks and keep better track of your money.

Get your key staff involved in accounting. Regardless of their specific departments, all key executive and managerial staff should have a basic idea of where your company stands financially, and how they can contribute to accurate recordkeeping and forecasting.

Develop the right internal processes. The proper internal accounting controls can keep everyone on staff accountable for financial success, reduce the incidence of fraud and accidental loss/risk and keep your financial information safe from the wrong hands.

[Read: Common Accounting Mistakes and How to Avoid Them]

CO— does not review or recommend products or services. For more information on choosing the best accounting software, visit our friends at business.com.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published January 15, 2020