How to do bookkeeping for small businesses: A step-by-step guide

As procrastination-worthy as it may seem, bookkeeping is a necessary part of successfully running your business. 

Bookkeeping is important because it gives you insight into where your money is going and how your business is performing, helping you make smart business decisions. It also keeps you organized for tax time and helps you find tax deductions and shows your credibility to investors and lenders so you can get funding. 

We know, we know—that doesn’t make bookkeeping any less boring and painful. That’s where we come in. 

In this blog, we’ll break bookkeeping down into five easy steps and, hopefully, help bookkeeping suck a little less. We’ll cover how to: 

1. Gather your financial documents 
2. Categorize your business transactions 
3. Reconcile your business transactions
4. Prepare your business's financial statements
5. Review your financial statements
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By the end of this post, bookkeeping won’t seem so overwhelming (...and that new Netflix show won’t seem so bingeable). Let’s do this! 

Bookkeeping for small businesses: Five easy steps

Let’s back up a little. Before you start bookkeeping, you need to determine the right bookkeeping method and corresponding accounting method for your business. 

There are two bookkeeping methods you could go with depending on the complexity of your business: the single-entry method or the double-entry method. 

Single-entry bookkeeping is simpler, and is usually used by businesses with few or no employees, minimal plans to scale, and no need for in-depth financial reporting.

The double-entry bookkeeping method, on the other hand, is usually used by businesses that want to expand or do need more nuanced reporting. 

Now, let’s go over the two accounting methods: the cash-based method (also called “cash basis accounting”) or the accrual-based method (also called “accrual accounting”). 

The cash-based accounting method is the simplest method, and makes it easier to track your cash flow in real time. You record transactions when the money actually enters or leaves your business, even if they were earned or billed earlier.  

The accrual-based accounting method works better with double-entry bookkeeping, so it’s best for more complex business structures or businesses that keep inventory or sell goods. You record transactions as soon as they’re invoiced or billed, even if the money isn’t in your metaphorical pockets yet. 

Still with us? Nice. Let’s get into what you came here for: the five bookkeeping steps.

Step 1: Gather your financial documents

The first step is to gather your business’s “source financial documents.”

A “source financial document” is the first documentation of a business transaction. Think: invoices and receipts. 

They need to contain information about the: 

• Date of the transaction
• Buyer and seller
• Amount of the transaction
• Product or service provided

You need to keep track of every sale and purchase you make, along with payroll records and tax returns, since you’ll use the information from these documents for the next steps of the bookkeeping process. That’s why recording is so important. Psst—to stay organized and make recording easier, remember to keep your personal finances and your business finances separate. 

Recording can be pretty time-consuming (especially if you’ve been putting it off), which is where accounting software like Wave’s can help. You can connect our accounting software to your business bank account and import your transactions, reducing the amount of manual work you have to do and lowering the risk of making human mistakes. 

Step 2: Categorize your business transactions

This step is an important one—it's the heart of the bookkeeping process! 

Once you’ve gathered your business’s source documents, you’ll need to sort them into a specific category: assets, liabilities, equity, revenue, or expenses. 

Let’s go over the definitions of each category and explain them in more detail.

Assets

Assets refer to anything physical and non-physical that your company owns. This means assets like cash, equipment, and inventory (physical), along with intellectual property or patents (nonphysical).

If you’ll get long-term benefit from something—like investing in a new computer or equipment for your business—it goes under “assets.”

Liabilities 

Liabilities refer to money you owe that will leave your business and get paid to another party at a future date. 

For example, a loan would go under liabilities since you'll have to pay it back later. Amounts owing on credit cards, funds that need to be paid to vendors, or payment terms on a vehicle or item of equipment you purchased also count.

Equity 

Any money or investments (like equipment and property) coming in from the owner of the business (so, probably you!) goes under equity. 

For example, you’d be putting “equity” into your business by investing your personal money into your business. It works the other way around as well: if you pull money out of your business to invest it somewhere else, equity gets affected.

Revenue

The money you make from selling goods or services goes under revenue. Nice and simple! 

Expenses 

Any purchases you make or money you spend on the operation of your business (toward things like supplies, utilities, or advertising) goes under expenses. 

Transfers 

Bonus section!

“Transfers” are a unique situation. This happens when you transfer money from one of your business accounts to another one or to a business credit card.

Moving money from one account to another is like moving a five dollar bill from one pocket to another. You're not actually making or losing any money—it’s just in a new place. 

But you still need to note that the money exited one account and entered another so you don’t accidentally duplicate any of your income or expenses.

Step 3: Reconcile your business transactions

Next up, it’s time to reconcile your business transactions, which means comparing your business books and/or your bookkeeping software to your bank statements to make sure the information matches, and that every transaction is accounted for or hasn’t been counted twice.

In other words, you’re double-checking your work.

So, how do you reconcile? Start by ensuring that the beginning balance (the amount of money your business has at the beginning of an accounting period) shown in your business

books and your bank statements are the same. 

Then check each transaction one by one. Be sure to make note of anything that doesn't match up, and find out the reasons why, so you can correct it.

The more often you reconcile, the faster you’ll catch any overlooked transactions. We suggest turning reconciliation into a habit and doing it at least monthly to prevent the work from piling up and becoming overwhelming.  

BTW, you can also hire a bookkeeping pro to help you out with reconciliation.

Step 4: Prepare your business's financial statements

This is another major step, get excited.  

Now that your books are nice and balanced, you can use this information to prepare important financial documents that’ll provide you with important insights into how your business is performing, including:

• A balance sheet
• A profit and loss statement (also known as an income statement)
• A cash flow statement

If you use Wave’s accounting software, these forms will be automatically generated for you. As long as you've done all the previous steps correctly, your reports will be accurate!

Balance sheet

The balance sheet contains information about your assets, liabilities, and equity for a given period, providing you a snapshot of your business’s health based on what it owns and owes.

Your assets are listed on the left side of the document. Cash is always listed first, followed by the rest of your assets, based on how quickly each asset can be converted into cash.

Income statement

You’ll want to pay extra attention to your income statement (also known as a profit and loss statement). It helps you better understand what types of expenses and income are impacting your bottom line (aka your net income), and will be needed at tax time. 

To prepare a profit and loss statement, first include all the revenue your business made during that period. Then, add up all the expenses from that period. Finally, subtract your total expenses from your total revenue to get your bottom line.

Cash flow statement

Your cash flow statement shows how money moved into and out of your business in a given period. It lets you know if your business is making money at a healthy pace, or if you might be struggling to stay afloat soon.

There are three parts of a cash flow statement:

• Cash from operations: cash entering or leaving your business during its daily operations, like selling a product or paying a contractor
• Cash from financing: cash you’ve gained or lost from financing your business through things like investors or loans
• Cash from investments: cash your business has earned (or lost) by investing in long-term assets (like equipment, for example) 

Step 5: Review your financial statements

Now, it’s time for the juicy part. You’ll analyze your financial documents to get key insights into your business’s health, which will help you make smart business decisions going forward. 

Quick note—every business is unique, so before you get started, it’s always best to speak with a professional who can help you decide what’s best for your business.

Balance sheet 

The assets section of your balance sheet tells you how much value your business has, while the liabilities section tells you how much money you owe.

The equity section gives you the net worth of your business, which is the value of all your physical and non-physical assets.

You can further analyze your balance sheet and get insight into your business using financial ratios.

For example, the Current Ratio is a formula used to determine if you’ll be able to meet your financial obligations within the next year, and is calculated by taking Current Assets and dividing by Current Liabilities. 

If your ratio is less than 1:1, that indicates you don’t have enough assets (or money) to cover your liabilities (or bills) for this period.

Income statement 

Your income statement shows you how much your business is earning and spending and, ultimately, what your bottom line is.

You can also use financial ratios here to dive deeper into your profit and loss statement.

An example of a popular ratio is the gross profit margin, which is (Total Revenue subtracted from Cost of Goods Sold) divided by Total Revenue.

It shows the income your business has remaining after paying off the cost of goods sold. What

qualifies as a “good gross profit margin” is subjective, but generally anything over 25% is good news.

Cash flow statement 

Your cash flow statement helps you understand how money moves into and out of your business.

Financial ratio time! Let’s use the cash flow coverage ratio as an example, which will tell you if you have enough cash to pay off debts in the short term and the long term. To calculate the Cash Flow Coverage Ratio, divide Net Cash Flow from Operations by Total Debt. A good ratio is above 1.0. 

How software can help with bookkeeping for small businesses

Congratulations on making it to the end of a blog about bookkeeping! To recap, we covered: 

• How to categorize your business transactions, and make sure they’re accurate 
• How to create and read financial statements 
• How to use the data to make smart money decisions
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Super pumped up about bookkeeping now and looking for something to get started on right away? A great next step is to get yourself some accounting software. 

Remember, Wave’s accounting software is perfect for beginners and helps with most of the bookkeeping work, including categorization and generating financial reports, so you can spend more time on the actual fun parts of running your business. 

You can also hire Wave’s in-house bookkeeping experts to help you out with categorization, reconciliation, and bookkeeping in general—or have them do it for you in your Wave account. 

With this blog and some trusty accounting software on hand, you’ll be all set to kick some serious bookkeeping butt. 😎