Finance 101 for eWorkers: Bookkeeping

Kristin Kane writes for www.ework.com – a Ms.Money partner.

Accurate accounting is essential to every business. It provides the basis for all budgeting decisions. It keeps you on the right side of the IRS. But for those who are just starting out as independents, the process can seem confusing. With some diligence, however, you will find that good accounting can be an easy and enjoyable part of your business.

Getting Started

First, start a ledger. The most critical accounting tool, a ledger is essentially a chronological database of all your revenues and expenses. Traditionally, accountants have kept these records in bound books of ledger paper, from which we get the terms, the books and bookkeeping. Today, most accountants and small business owners use an accounting software package, such as Quicken.

Next, gather your receipts. Each entry into your ledger should be backed up by a receipt or other appropriate documentation. In my own practice, I keep a numerical database of the invoices I send out. This database includes information such as the invoice date, billing amount, project description, and payment status. I also recommend keeping a file of paid supplier invoices. Come tax time, you’ll be glad that both your income and expense records are in good order.

Cash vs. Accrual Accounting

There are two methods of accounting: cash, and accrual. While the IRS allows most independent professionals to use either method, they do require you to choose one, and apply it uniformly.

The difference between the two methods lies in the timing of entries into your ledger. Under the accrual method of accounting, transactions are recorded when they occur, regardless of when payment is made. In the cash method, transactions are recorded when money changes hands. For example, suppose you buy a laptop on credit in December 2000, but you don’t pay for it until July 2001. Using the cash method, you would record the transaction in July 2001; using the accrual method, you would record it in December 2000. Similarly, the accrual method records income as projects are completed, while the cash method records income when payment is received.

Which method is right for you? Each has distinct advantages and disadvantages. The accrual method provides the best monitor of your business’s profitability, although it cannot tell you how much money you have in the bank at any given time. The cash method, on the other hand, relates the accounting directly to bank transactions. This method has the advantage of simplicity, plus it is an excellent index of cash flow. However, advocates of accrual accounting argue that, because the cash method is so dependent on cash flow and not on the actual timing of transactions, it can be a misleading indicator of the profitability of a business.

Your choice of method could also have important tax ramifications, as a given transaction might be reported in one fiscal year or another. In my own business, I try to achieve a balanced method of accounting, by using the cash method in combination with an invoice database that closely monitors the month-to-month profitability of my enterprise.

Financial Reports

Once you have recorded a body of information in your ledger, you will be able to generate financial reports. Reports such as Profit and Loss Statements or Cash Flow Statements provide summaries of important financial information about your business. Not only are these reports helpful when filing your taxes, they are essential if you ever want to apply for a small business loan. Fortunately, most accounting software packages can generate a variety of reports, pulling the information directly from your ledger. But remember the golden rule of computing, “garbage in, garbage out.” Your reports will only be as accurate as the records you keep.

For more information on establishing an effective accounting system for your business, contact a professional accountant.