Small Business Bookkeeping Basics: What to Track, What to Keep, and for How Long
Small business bookkeeping means keeping a system that clearly shows your business income and expenses, and keeping the paperwork that proves it. The basics are a separate business bank account, a chosen accounting method, a bookkeeping system, daily or regular entries, saved receipts, and a monthly bank reconciliation. This guide follows IRS guidance and is general information, not tax advice.
What is bookkeeping for a small business?
Bookkeeping is the day to day record of what your business earns and spends. It feeds your financial statements and your tax return.
The IRS lists several reasons to keep good records. They help you monitor how the business is doing, prepare financial statements, identify sources of income, track deductible expenses, and support what you report on a return. You are responsible for being able to prove the entries and deductions on your return.
Do I need special software or a special system?
No. The IRS says you may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records.
Electronic accounting software is acceptable. The IRS notes that the requirements for paper books also apply to electronic records. If you use QuickBooks Online, see my QuickBooks Online setup checklist for a small business.
Should I separate business and personal money?
Yes, and it is one of the first things the IRS says to do. IRS Publication 583 says one of the first things to do when you start a business is open a business checking account, and to keep it separate from your personal checking account.
The same section gives the basic habits:
- Deposit all daily receipts into the business account.
- Use the account for business purposes only.
- Note the source of each deposit, such as business income, personal funds, or a loan, and keep the deposit slips.
- Pay by check to document business expenses, as the publication advises.
- Avoid checks payable to cash. If you must write one, keep the receipt, or write an explanation at the time if there is no receipt.
For most small businesses, the business checking account is the main source for entries in the books.
What is the difference between cash and accrual accounting?
An accounting method decides which period an item of income or expense lands in.
| Cash method | Accrual method | |
|---|---|---|
| Income | Counted in the year you receive it | Generally counted in the year you earn it, even if paid later |
| Expenses | Usually deducted in the year you pay them | Deducted in the year you incur them, whether or not you pay that year |
2 rules from Publication 583 matter early. You must use the same method to figure taxable income and to keep your books, and once you set a method you generally need IRS approval to change it. If inventory is needed to account for your income, you generally must use an accrual method for purchases and sales, though the publication notes certain small business taxpayers can use the cash method and points to Publication 538 for details. Ask a tax professional which method fits your business.
What bookkeeping system should I use?
Publication 583 describes 2 kinds.
Single entry. This is the simple system, based on the income statement. You keep a daily summary of cash receipts and monthly summaries of receipts and disbursements. The publication calls it practical for a small start up.
Double entry. This uses journals and ledgers, and every transaction is a debit in one account and a credit in another. Total debits must equal total credits, so the books balance themselves. The publication's example: rent paid in October is a debit to Rent expense of 780.00 and a credit to Cash of 780.00.
Computerized systems are available and need little bookkeeping knowledge, according to the publication.
What records should a small business keep?
Books summarize your transactions, and supporting documents prove them. The IRS names sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks, and says to keep them organized, for example by year and type of income or expense.
| Record type | What to keep |
|---|---|
| Income | Documents showing amounts and sources: cash register tapes, deposit information, receipt books, invoices, Forms 1099 MISC |
| Purchases and expenses | Documents showing the payee, amount paid, proof of payment, date incurred, and what the expense was for: canceled checks or transfer proof, receipts, card statements, invoices |
| Assets | When and how you acquired it, purchase price, improvements, depreciation, how it was used, and when and how you disposed of it |
| Employment taxes | All records, for at least 4 years |
A combination of documents may be needed to prove 1 expense.
How long should a small business keep records?
The general rule is to keep records that support an item of income, deduction, or credit until the period of limitations for that return runs out. That period is the time in which you can amend the return to claim a credit or refund, or the IRS can assess more tax.
| Situation | How long |
|---|---|
| The general case | 3 years from filing |
| You file a claim for credit or refund after filing | 3 years from filing the original return or 2 years from paying the tax, whichever is later |
| You do not report income you should have, and it is more than 25% of the gross income on your return | 6 years |
| You file a claim for a loss from worthless securities or a bad debt deduction | 7 years |
| You do not file a return, or you file a fraudulent one | Indefinitely |
| Employment tax records | At least 4 years after the tax is due or paid, whichever is later |
Keep copies of your filed returns. Keep property records until the period of limitations ends for the year you dispose of the property. Before you discard anything, check whether insurers or creditors need records longer than the IRS does.
How to set up small business bookkeeping
This order is mine, built from the topics in IRS Publication 583. It is not an IRS sequence.
- Open a business checking account. Keep it separate from personal money and use it for business only.
- Choose an accounting method. Pick cash or accrual with a tax professional, because changing it later generally needs IRS approval.
- Choose a bookkeeping system. Single entry is practical for a small start up. Double entry or accounting software is the other approach the publication describes.
- Record transactions as they happen. Publication 583 says recording daily is generally best, and that you should record expenses when they occur and identify the source of receipts.
- Keep supporting documents. Save receipts, invoices, deposit slips, and statements, organized by year and type.
- Reconcile every month. Compare the bank statement, your checkbook, and your books. Publication 583 says to reconcile your checking account each month.
Why reconcile the bank account every month?
Reconciling means making sure the bank statement, the checkbook, and the books agree. Differences can come from bank charges you have not entered yet, and deposits or checks that had not cleared by the statement date.
Reconciling lets you verify how much is in the account, confirm the books show all bank charges and the correct balance, and correct errors. If you use QuickBooks Online, my guide to a small business month end close checklist walks through the steps.
FAQ
What is the first step in small business bookkeeping?
Open a business checking account and keep it separate from your personal account. IRS Publication 583 calls this one of the first things to do when you start a business.
Do I need accounting software to keep books?
No. The IRS says you may use any system that clearly shows your income and expenses. Accounting software is acceptable, and electronic records must meet the same requirements as paper books.
How long do I need to keep business records?
Generally 3 years from when you file the return. It is 6 years if you left out income of more than 25% of the gross income shown, 7 years for a bad debt or worthless securities claim, at least 4 years for employment tax records, and indefinitely if you never filed or filed a fraudulent return.
What is the difference between cash and accrual accounting?
Cash records income when you receive it and usually records expenses when you pay them. Accrual records income when you earn it and expenses when you incur them, whether or not money has moved.
How often should I reconcile my business bank account?
Every month. IRS Publication 583 says to reconcile your checking account each month.
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