With the launch of your small business, you will need to excel in the accounting tasks that come with owning a store. Although accounting may not be the most exciting part of growing your business, it is critical to start on the right foot.
What is Small Business Accounting?
Small business accounting is a set of financial activities to process, measure, and communicate the financial matters of the business. These activities include taxes, management, payroll, acquisitions, and inventory.
1. Open a Small Business Bank Account
A separate business bank account protects personal assets in case of bankruptcy, lawsuits, or audits. If you wish to obtain funding in the future from creditors or investors, strong business financial records can increase the likelihood of approval.
Start by opening a checking account, then open any accounts that help organize cash flow and tax planning. For example, you might set up a savings account and store a percentage of every payment as you keep your income tax as a self-used return. A good rule is to set aside 25% of your income, although estimates for high-income individuals may be closer to a third.
Note that limited liability companies (see our US guide for LLCs in California, LLCs in Texas, and LLCs in Florida), partnerships, and corporations are required to have a separate business bank account. Sole proprietors are not legally required to have a separate account, but it is certainly advisable.
Next, as a new small business owner, you will want to consider a business credit card to start building credit. Credit is important for securing financing as well as funding large purchase orders in the future. Businesses and LLCs should use a separate credit card to avoid mixing personal and business assets.
Depending on the type of business transactions you will be making, different business credit cards offer various benefits. If you plan to spend a lot on travel, for example, a business credit card that offers miles may be the best option.
To open a business bank account, you will need a business name, and registration in your state or county may be required. Check with each bank to find out what documentation is needed.
2. Track Your Small Business Expenses
The foundational principle of good business accounting is effectively and accurately tracking expenses. It is a crucial step that allows you to monitor your business growth, build financial statements, track deductible expenses, prepare tax returns, and legislate your files.
From the start, establish an accounting system to organize receipts and other important records. This process can be a simple, old-school approach (using a Filofax) or you might use a service like Shoeboxed. For store owners in the United States, the Internal Revenue Service does not require you to retain receipts for expenses under $75, but it’s a good rule of thumb, anyway.
There are five types of receipts to pay special attention to: Meals and Entertainment. Holding a business meeting at a café or restaurant is a great option – just make sure to document it. On the back of the receipt, write down who attended and the purpose of the meal or outing. Travel out of town. The IRS and the Canadian agency are cautious of people who claim personal activities as business expenses. Luckily, your receipts provide a paper trail for your business activities while traveling. Vehicle Expenses. Record the where, when, and why you used the vehicle for business, then apply the percentage of use to your vehicle expenses. Gift Receipts. For gifts such as concert tickets, it matters whether the giver attends the event with the recipient. If they do, the expense will be classified as entertainment rather than a gift. Note these details on the receipt. Home Office Receipts. Similar to vehicle expenses, you need to calculate the percentage of your home used for business and then apply that percentage to home expenses.
Starting
Your home business is a great way to keep rental costs low. Additionally, you will be eligible for unique tax benefits. You can deduct a portion of your home used for business, along with home internet, mobile phone, and transportation to and from work and for business purposes.
Any expenses that are partially used for personal use and partially for business must reflect this mixed-use. For example, if you have one mobile phone, you can deduct the percentage that the device is used for business. Wi-Fi costs can fall into this category as well. Gas expenses are 100% recoverable, just make sure to keep all records and maintain a log of your business miles (where you go and the purpose of the trip).
3. Set Up an Accounting System
Accounting is the daily process of recording, classifying, and reconciling business transactions.
As a new entrepreneur, you’ll need to decide how you want to manage your books: follow the DIY method and use software like QuickBooks or Wave. Alternatively, you can use a simple Excel spreadsheet. Hire a local or cloud-based part-time accountant. If your business is large enough, consider hiring an in-house and/or accountant.
With many paid and free accounting software options available, you’re sure to find an accounting solution that fits your business needs.
Small business owners also need to determine whether they will use cash or accrual accounting methods. Let’s take a look at the difference between the two methods. Cash method: revenue and expenses are recognized when they are actually received or paid. Accrual method: revenue and expenses are recognized when the transaction occurs (even if the money isn’t in the bank yet). This requires tracking accounts receivable and payable.
In fact, Canadians must use the accrual method. To simplify things, you can use the cash method throughout the year and then make one adjustment entry at year-end to account for your accounts receivable and payable for tax purposes.
Business owners in the United States can use cash accounting if their revenue is less than $5 million; otherwise, they must use the accrual method.
4. Set Up a Small Business Payroll System
Many online stores start as a sole proprietorship. But as a small business owner, there comes a time when it makes sense to hire outside help. To do this, you need to determine whether this person is an employee or an independent contractor.
For employees, you’ll need to set up a payroll system and ensure you’re withholding the correct taxes. There are many services that can help with this, and many accounting software options offer payroll as a feature.
For independent contractors, be sure to track the amount you pay to each individual. Small business owners in the United States may be required to issue 1099 forms to each contractor at the end of the year (you’ll also need to keep their names and addresses for this purpose).
5. Explore Import Taxes
Depending on your business model, you may plan to purchase and import goods from other countries to sell in your store. When importing products, you’re likely to be subject to taxes and duties, which is worth paying attention to if you run a dropshipping business.
If you are importing goods, a duty calculator can help you estimate the costs in your business and plan for expenses. For more information on import taxes, visit the International Trade Administration (for U.S. businesses) or the Canada Border Services Agency.
6.
Determining How to Get Your Money
As sales begin to increase, you’ll need a way to accept payments. If you’re a store owner in North America using Shopify, you can use Shopify Payments to accept debit or credit card payment requests. This saves you time and effort in setting up a merchant account or third-party payment gateway.
If you use a third-party payment processor, the fees vary. Some companies charge a rate plus a flat fee per transaction, while others charge a monthly fee for an unlimited number of financial transactions. You can refer to this list to help you find a payment gateway that works in your location.
7. Setting Up Sales Tax Procedures
Making sales to customers outside your state or even country is easier than ever in the business world. While this is a great opportunity for brands with growth goals, it creates confusing sales tax regulations that can cause headaches in the future.
When a customer enters a physical retail store, they pay sales tax in whatever state or county they are purchasing in, regardless of whether they live in that city or are visiting from anywhere in the world. However, when selling online, customers may be located in different cities, states, counties, or even countries.
Canadian store owners only need to start collecting VAT/Sales Tax when they have revenues of $30,000 or more in a 12-month period. You can remit the VAT/Sales Tax you collect in installments. If you wish, you can collect VAT/Sales Tax even if you haven’t reached that revenue threshold and use it to obtain a tax credit.
Selling to international customers can be easier than local sales. Canadian business owners do not need to charge VAT/Sales Tax to customers who are outside Canada.
For small business owners in the United States, sales tax becomes more complex. You’ll need to determine whether you are operating in a source-based state or a destination-based state. In the former, you must charge sales tax based on the state where you operate your business. The latter requires applying sales tax based on the buyer’s location.
International purchases are not subject to tax for businesses located in the United States. All of this can become somewhat complicated, so check with your accountant for detailed information on your specific state’s regulations regarding international sales tax.
8. Determining Your Tax Obligations
Tax obligations vary depending on your business structure. If you operate as a sole proprietor (sole proprietorship, LLC, partnership), you will report business income on your personal tax return. Corporations, on the other hand, are separate tax entities and are taxed independently of their owners. Income from the corporation is taxed as employee income.
If you’re confused about potential tax obligations, it’s wise to speak with a tax professional. While there may be a cost, it can save you a lot of time and money in the long run.
9. Calculating Gross Margin
Improving your store’s gross margin is the first step toward earning more income overall. To calculate gross margin, you need to know the costs incurred to produce your product. To understand this better, let’s quickly go over both Cost of Goods Sold (COGS) and gross margin. Cost of Goods Sold (COGS). These are the direct costs incurred by the company in producing the products it sells. This includes both material costs and direct labor costs. Gross margin. This figure represents the total sales revenue retained after the company incurs all direct costs to produce the product or service.
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How to Calculate Gross Margin:
Gross Margin (%) = (Revenue – COGS) / Revenue
You can also use a free profit margin calculator to input your numbers for a quick calculation.
The difference between the selling price of the product and the amount the business takes at the end of the day really determines your ability to keep the doors open.
10. Apply for Small Business Funding
You may experience an unexpected downturn in sales due to circumstances beyond your control, or perhaps you need a financial boost during slow periods of seasonal business. Brand owners with big ambitions often need funding to invest in new product development, inventory, retail locations, hiring, and more.
Remember, to obtain a small business loan, you will likely need to present financial statements – a balance sheet and an income statement at the very least, and possibly a cash flow statement as well. Shopify Capital makes it simple for Shopify merchants to obtain funding. Loans and advances are calculated based on the store’s past sales and are paid back through future sales of the store.
Before you agree to any debt, it’s important to calculate the return on investment (ROI) for the loan. Gather all expenses that need the loan to cover, the expected new revenue you will gain from the loan, and the total interest cost. You can use our business loan calculator to determine the overall cost.
11. Find High-Quality Accounting Partners
As a small business owner, you will want to understand Generally Accepted Accounting Principles (GAAP). It’s not a rule, but it helps you measure and understand your company’s finances.
If you need additional help or guidance with financial planning, many small business accountants and financial professionals can assist you in gaining more control over your finances. Here are a few people you may want to consider hiring:
- Certified Public Accountant (CPA). In case of an audit, the CPA is the only person who can prepare legally audited financial statements.
- Accountant. The accountant manages daily records, reconciles accounts regularly, categorizes expenses, and manages accounts receivable/payable.
- Tax Preparer. The tax preparer fills out necessary forms and may file them on your behalf during tax season. They may also prepare your estimated tax payments.
- Tax Planner. These professionals help optimize your taxes before submission, assisting you in finding ways to reduce your tax burden.
12. Regularly Reassess Your Methods
When you are starting out, you may choose to use a simple spreadsheet to manage your books, but as you develop, you will want to look at more advanced methods like QuickBooks or Bench. Business financials naturally become more complex with growth.
It is important to continuously evaluate how much time you spend on your books and how much that time costs your business. This is why learning the basics of accounting is crucial, even if you don’t intend to do the accounting yourself all the time.
The right accounting solution means you can invest more time in working without accounting weighing you down and save money for the company. Win-win!
Best Accounting Software for Small Businesses
Every good business owner needs good accounting software to avoid wasting time on manual data entry. Small business accounting software is something you use to access financial information quickly and easily. It allows you to check bank balances, understand revenue and expenses, forecast profitability, and anticipate tax liabilities, among other things.
Once you link your business bank accounts and credit cards to the software, financial transactions show up in a queue and are categorized. You can find all this information in your account statement. Once you approve the categories, transactions are automatically reconciled in your financial statements.
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The features to look for in your accounting software include:
- Platform integration. You want your accounting software to integrate with your e-commerce platform, as well as support integration with third-party applications for contract management tools and more.
- Extensive reporting. Most accounting software provides basic reports. You will need one that offers advanced reporting, such as inventory and expenses, so you can quickly monitor the health of your financial business.
- Sales tax configuration. Knowing if you are required to collect sales tax and how much can be confusing. The best accounting software makes it easy to calculate sales tax.
- Excellent support. Check reviews and support ratings to see how good customer support is from the software company. Aim for 24/7 support and self-service centers.
There are many easy-to-use accounting software options for small businesses, ranging from free to paid models. You can also browse the Shopify App Store to find accounting software that integrates seamlessly with your e-commerce store.
Check out the following accounting software you can use to manage your books:
- Xero: A cloud-based accounting system designed for small and startup businesses. You can connect with a trusted advisor and gain insight into the health of your financials. Accessible from any device. Plus, with Xero’s advanced accounting features, you can view cash flow, transactions, and other financial information from anywhere.
- QuickBooks Online: A small business accounting software managed by Intuit. You can use it to capture and store expense receipts, track income and expenses, and more.
- Wave: A web-based accounting solution designed for small businesses. With the bank reconciliation feature, you can link your bank accounts, PayPal accounts, and other data sources to see business transactions in real-time. You can also generate reports like accounts receivable, balances, sales tax reports, and accounts payable.
- FreshBooks: A cloud-based accounting and invoicing software for small businesses. It provides expense management and basic accounting along with everything you need to take care of your core accounts.
While there is no shortage of accounting and tax tools to choose from, you want to use a tool that you feel comfortable using and intend to use for the long term. You can always switch tools, of course, but that can be a time-consuming process you want to avoid as much as possible.
Know Your Numbers to Grow Your Business
Starting a business can be overwhelming. By doing your homework regarding banking, transaction management, funding collection, and other accounting topics, you will have your new store’s finances in order from the start. From opening the right type of business credit card to determining how much revenue you will generate per product, all of these tasks contribute to your business’s success, both now and as it grows.
Are you ready to create your first business? Start your free trial of Shopify – no credit card required.
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