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How to do accounting for small businesses

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Accounting may seem like a tedious aspect of running a small business but it is essential for monitoring income and expenses, as well as assessing the current state of the business. Besides keeping you up to date about business’ past and present financial results, accounting also helps with invoicing and cash management. Having detailed information about the financial situation, business owners can make more informed short-term and long-term decisions about further business development.

While accounting is a fairly massive topic, for small businesses it often boils down to three main aspects: bookkeeping, financial reporting, and filing tax returns. But before accounting, it is necessary to create conditions for a basic accounting cycle.

How to set up an accounting system?

When you start your business, you need to open a bank account for the company, where your business finances are separate from your personal funds. This will allow you to make accounting more accurate and avoid confusion between personal and business-related transactions.

Then choose the accounting method of recording income and expenses. Basically, there are two methods of accounting for financial transactions — accrual and cash-basis. The accrual method means that you record income and expenses on the day of the transaction, regardless of whether they were paid. In the case of a cash-basis method, income and expenses are recognized on the date they are paid and received. While the cash method is easier for small businesses because it does not require tracking of accounts payable and receivable, the accrual method provides opportunities for more accurate asset recognition, measurement, and management.

Besides, you need to decide who will keep the accounting and where. Sometimes small business owners record transactions on their own and manually. But as the business grows, the business owner will have to pay more attention to strategic issues, so it is worth considering hiring a professional accountant and keeping records in specialized accounting software.

How to do bookkeeping?

The bookkeeping process begins with the analysis of financial transactions and their definition. For this, source documents are prepared. They serve as the basis for recording transactions. Transactions are recorded in the so-called general journal using the double-entry bookkeeping system (debit and credit). The transactions in the journal are listed in chronological order, indicating the amount, date, and explanation of the transaction.

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Then the operations from the general journal are added to the ledger. It is a collection of classified accounts that displays changes based on previous transactions and balances for each account. Depending on the nature of the transaction, the amount on this account may increase or decrease. For example, let’s say we received payment from a customer for our services to a bank account, and then purchased materials. The first operation says that the amount in our bank account should increase (debit), and the second — decrease (credit).

Based on various transactions and their amount, the accountant indicates the current state of the account and its change over a certain period.

Creating financial reports and paying taxes

Checking the status of various accounts and their changes allows you to create a trial balance. It is used to check that the total amount of debits is equal to credits. If the amounts are not equal, then the trial balance contains errors. In this case, it is necessary to double-check that all transactions and their amounts have been taken into account and are correct.

Once errors are discovered, the trial balance can be corrected using adjusting entries. Remember that sometimes errors can exist even when debits match credits. For example, if you made a double posting or did not take into account the transactions/entries. Also, some adjusting entries may be made at the end of the reporting period, such as asset depreciation or revaluation.

After making adjusting entries and checking that the debit corresponds to the credit, you can proceed to generate financial statements. Financial statements can include an income statement, statement of cash flows,  statement of changes in equity that are the final products of accounting. Based on financial statements, a business can determine the amount of taxes required to pay, as well as how successful the reporting period was.

Working with other currencies and crypto

If you have a small business, this does not mean that your business will operate only locally. For example, an online business is often faced with payments in other currencies but records transactions in its national/reporting currency. In addition, cryptocurrencies are gaining more and more popularity for international transactions and investments. So if cryptocurrency appears on your business balance, then it must also be taken into account in a relevant way.

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Foreign currency transactions are initially recorded in the reporting currency by converting foreign currency using the exchange rate at the transaction date. In many countries, the central bank rate is used as the exchange rate standard. When working with foreign currency, you also need to take into account the exchange rate difference that may arise in the case of debts and other transactions.

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The situation with accounting for crypto is much more complicated. IFRS, International Financial Reporting Standards, still does not have a single generally accepted accounting system for various types of digital assets. Cryptocurrency accounting may differ depending on the regulator’s position, laws, and business model. Existing guidelines in the IFRS indicate that cryptocurrencies may be defined as currency, cash equivalent, financial asset, inventory, property, and intangible asset. Therefore, before recording operations with cryptocurrencies in your country, you need to consult with an expert.

However, most companies classify cryptocurrencies as intangible assets. It means they most often use the reevaluation method when accounting for cryptocurrencies. The intangible asset is reevaluated at the end of the reporting period, and then it is defined as the company’s profit or loss.

Like with foreign currency transactions, companies record the crypto price at the transaction date. Some companies, especially in the United States, do not log their gains until they sell the asset if its price rises. But if the price drops, then they register a loss in any case. For instance, Microstrategy and Square use this principle.

Another important aspect of accounting for cryptocurrencies is the price source. There is no price standard or central bank that regulates prices in the crypto world, so businesses need to determine it on their own. As a guideline, you can use services that use the average estimated price or volume-weighted average. Also, you can use prices on a cryptocurrency exchange such as CEX.IO. This option may be even more convenient if you convert cryptocurrency on the same exchange. One way or another, when choosing a price source, it is recommended to use it for all further operations with cryptocurrency.

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Christopher Stern
Christopher Stern is a Washington-based reporter. Chris spent many years covering tech policy as a business reporter for renowned publications. He has extensive experience covering Congress, the Federal Communications Commission, the Federal Trade Commission, and other federal agencies. He is a graduate of Middlebury College. Email:[email protected]

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