Small Business Accounting Basics

Accurate tracking of income and expenses is one of those underappreciated habits that quietly decides whether a small business survives, struggles, or scales. It affects everything: how much profit you actually make, whether you have enough cash to pay bills, how painful tax season feels, and how confident you are making growth decisions.

In this guide, we’ll walk through small business accounting basics in plain English. You’ll learn what to track, how to track it, and how to build a simple system you can actually stick to—even if you’re not a “numbers person.”

1. Why Accurate Tracking Matters So Much

Let’s start with the “why.” If you don’t care about this part, you’ll never keep up with the “how.”

1.1 Profitability: Are You Really Making Money?

Many owners look at their bank balance and assume “money in the bank = profit.” Not quite.

• Revenue is the money coming in.

• Expenses are the money going out.

• Profit is what’s left after all expenses.

Without proper tracking, it’s easy to under-estimate costs like software, taxes, or owner withdrawals and overestimate how much you’re truly making.

The IRS notes that good records help you monitor the progress of your business and prepare accurate financial statements such as income statements (profit and loss) and balance sheets. These statements are your scoreboard. Without them, you’re flying blind.

1.2 Cash Flow: Can You Actually Pay the Bills?

You can be profitable on paper and still run out of cash.

For example:

• You invoice a client for $10,000 today.

• They pay 60 days later.

• Meanwhile, you still owe rent, salaries, and suppliers.

Accounting for revenue and expenses—knowing what’s due in vs. what’s due out—is crucial to keeping your business running smoothly, as the U.S. Small Business Administration (SBA) emphasizes in its guidance on managing finances.

Accurate tracking lets you:

• Predict cash needs.

• Avoid late fees and bounced payments.

• Decide when you can safely invest in new hires, equipment, or marketing.

1.3 Tax Compliance: Avoid Audits and Penalties

For taxes, your numbers have to be more than “rough estimates.”

The IRS expects you to maintain records that clearly show your income and expenses and support items reported on your return (deductions, credits, etc.). If your return is ever examined, well-organized records are your best defense.

Good tracking helps you:

• Claim every legitimate deduction you’re entitled to.

• Avoid under-reporting income.

• Provide documentation quickly if the IRS asks questions.

1.4 Long-Term Growth: Better Decisions, Better Financing

Banks, investors, and lenders don’t care what you feel your business is doing. They care what your financial statements say.

Consistent, accurate bookkeeping helps you:

• Prove your income and profitability for loans or credit lines.

• Spot which products, services, or clients are most profitable.

• Decide when to expand, hire, or pivot.

Think of bookkeeping as the data layer of your business. The better the data, the smarter your decisions.

2. Core Accounting Concepts in Plain English

Before we touch tools and systems, let’s define a few key concepts.

2.1 Revenue vs. Profit

• Revenue (Sales/Income): The total amount of money your business earns from selling products or services.

• Expenses: The costs required to run your business (rent, payroll, software, utilities, etc.).

• Profit: Revenue minus expenses.

You can break profit into layers:

• Gross profit = Revenue – Cost of goods sold (COGS).

  • COGS: Direct costs of producing what you sell (materials, production labor, wholesale purchases).

• Operating profit = Gross profit – operating expenses (rent, utilities, salaries, marketing, etc.).

• Net profit (or net income) = What’s left after all expenses, including interest and taxes.

Many small-business resources define margin as the difference between revenue and profit, usually expressed as a percentage of revenue. For example, a 40% gross margin means you keep $40 of gross profit on every $100 of sales.

2.2 Gross vs. Net Income

• Gross income (for a business): Typically refers to revenue minus COGS.

• Net income: What’s left after subtracting all other operating expenses, interest, and taxes.

Think:

Gross = “Big picture before overhead.”
Net = “What actually lands in your pocket after everything.”

2.3 Fixed vs. Variable Expenses

This is crucial for understanding your cost structure.

• Fixed expenses: Stay relatively constant regardless of sales volume.

  • Examples: Office rent, salaried staff, insurance, most software subscriptions.

• Variable expenses: Increase or decrease with sales or production.

  • Examples: Inventory purchases, packaging, sales commissions, payment processing fees.

Knowing which costs are fixed vs. variable helps you:

• Calculate break-even (how much you need to sell to cover costs).

• Understand how scaling sales affects profit.

2.4 Cash vs. Accrual Accounting

This is one of the most important choices you’ll make early on.

Cash basis accounting

• You record income when cash hits your bank, and expenses at the time you settle the bill.

• Simple and intuitive.

• Often allowed for very small service businesses and sole proprietors (depending on local tax rules).

Accrual basis accounting

• You log income at the time you complete the work or deliver the product, regardless of when the cash is received.

• Expenses are recorded at the time they are incurred, even if payment hasn’t been made yet.

• Gives a more accurate picture of profitability and financial performance over time.

Xero and other accounting platforms describe the key difference as timing: cash accounting waits for money to move, while accrual accounting recognizes income and expenses when the underlying economic activity happens.

Which should you use?

• Very simple, cash-based businesses often start with cash accounting.

• If you manage inventory, send invoices with payment terms, or plan to seek investors/loans, accrual accounting is usually better and sometimes required.

Talk to a tax professional to confirm which method you can or should use for your jurisdiction and entity type.

3. Laying the Groundwork: Separating and Organizing

Before you open a spreadsheet or sign up for software, set up the foundations.

3.1 Separate Business and Personal Finances

This is non-negotiable.

• Open a separate business bank account.

• Use a separate credit card for business expenses.

• Pay yourself through owner draws or payroll, not by mixing personal bills in the business account.

Benefits:

• Cleaner bookkeeping (no sorting out groceries from client lunches).

• Clear audit trail for tax authorities.

• Better legal separation if you operate as an LLC or corporation.

3.2 Choose an Accounting Method (Cash or Accrual)

Decide this before you start booking transactions:

• Ask your accountant what’s allowed and recommended for your business.

• Once chosen, stick with it—switching later often requires a formal process with tax authorities.

3.3 Decide on a Bookkeeping System

You have three main options:

1. Manual paper ledger

   • Very rare now, but still technically allowed as long as it clearly shows income and expenses.

   • Not recommended unless your transactions are extremely few and simple.

2. Spreadsheets (Excel, Google Sheets)

   • Good for very early-stage businesses.

   • Flexible and low-cost.

   • Easy to break as the business grows—high risk of data entry errors, missed transactions, and formula mistakes.

3. Accounting software (QuickBooks, Xero, others)

   • Automatically tracks assets, liabilities, equity, income, and expenses.

   • Syncs bank transactions, handles invoices and bills, and generates financial statements.

   • The small-business accounting software market is already worth over $11.38 billion and growing rapidly, highlighting how essential these tools have become.

For most serious small businesses, cloud-based accounting software strikes the best balance between control, accuracy, and time-savings.

4. Setting Up a Basic Chart of Accounts

Your chart of accounts (COA) is the complete framework that organizes how you classify transactions, including expenses, income, assets, equity, and liabilities.

4.1 What Is a Chart of Accounts?

Think of it as the table of contents for your financial records. Each account:

• Has a name (e.g., “Office Rent,” “Software Subscriptions”).

• Often has a number (e.g., 6100 for Rent).

• Belongs to a category (Asset, Liability, Income, Expense, Equity).

QuickBooks notes that a chart of accounts typically organizes accounts into major types like assets, liabilities, income, and expenses, often using distinct number ranges (e.g., 1000s for assets, 2000s for liabilities, 4000s for income, 6000s–7000s for expenses). Many accounting systems (QuickBooks, Xero) auto-create a basic COA that you can customize.

4.2 Core Categories to Include

At minimum, you’ll want:

Assets

• Checking account

• Savings account

• Accounts receivable (if accrual)

• Inventory

• Equipment

Liabilities

• Credit card(s)

• Business loans

• Taxes payable

Equity

• Owner’s equity / Capital

• Owner’s draws (for sole proprietors)

• Retained earnings

Income

• Product sales

• Service income

• Other income (interest, refunds, etc.)

Cost of Goods Sold (COGS) (if applicable)

• Inventory purchases

• Direct materials

• Direct labor

Expenses

• Rent / lease

• Utilities

• Payroll / wages

• Contractor payments

• Software subscriptions

• Marketing & advertising

• Travel & meals

• Insurance

• Professional fees (legal, accounting)

• Bank & payment processing fees

4.3 Example: Simple Service Business COA

For a freelance designer or consultant:

• 1000 – Business Checking

• 1200 – Accounts Receivable

• 2000 – Credit Card Payable

• 3000 – Owner’s Equity

• 3100 – Owner’s Draw

• 4000 – Service Revenue

• 5000 – Cost of Sales – Subcontractors (if relevant)

• 6100 – Office Rent

• 6200 – Software Subscriptions

• 6300 – Marketing & Advertising

• 6400 – Travel & Meals

• 6500 – Phone & Internet

• 6600 – Professional Fees

• 6700 – Bank & Processing Fees

Start lean. You can always add accounts as you go—but avoid so many categories that every transaction feels like a puzzle.

5. How to Track Income Properly

Now let’s talk about getting money into the system.

5.1 Types of Income

Common income types include:

• Product sales (e.g., e-commerce or retail).

• Service revenue (consulting, design, coaching).

• Subscription or recurring revenue.

• Other income (interest, rebates, one-off reimbursements).

You may want separate income accounts if you sell multiple lines (e.g., “Web Design” vs. “Brand Strategy”) to see which is most profitable.

5.2 Capturing Sales

You’ll usually record income in one of these ways:

• Invoices (B2B services, project work)

  • On accrual: revenue is recorded when the invoice is issued.

  • On cash: revenue is recorded when the invoice is paid.

• Sales receipts / POS (retail, restaurants)

  • Revenue recorded daily based on point-of-sale reports.

• Online platforms (Shopify, Etsy, Stripe, PayPal)

  • Revenue recorded from payout reports and platform statements.

Best practice:

• Connect your bank and payment processors to your accounting software so incoming payments are imported automatically.

• Match each deposit to invoices or sales receipts instead of treating every deposit as a single lump “Sales” figure (especially if deposits batch many transactions).

5.3 Sales Tax and Other Levies

In many jurisdictions:

• You collect sales tax from customers and hold it on behalf of the government.

• This is not income; it’s a liability (Sales Tax Payable).

Set up a separate liability account for collected taxes, and use your software’s sales tax handling features where possible.

5.4 Accounts Receivable (If Accrual)

If you invoice customers and allow payment terms:

• Each invoice creates accounts receivable (A/R).

• When payment comes in, you record it as reducing A/R, not just as new income again.

This lets you:

• See who owes you money and for how long.

• Chase late payments.

• Understand true sales performance even if cash hasn’t arrived yet.

6. How to Track Expenses Properly

Expenses are where things often get messy—and where you lose money if you’re sloppy.

6.1 What Counts as a Business Expense?

In the U.S., the IRS generally allows you to deduct expenses that are “ordinary and necessary” for running your trade or business. Its business expense resources highlight categories like rent, employees’ pay, taxes, insurance, and more.

In practice, this means:

• The expense has a business purpose.

• It’s common or accepted in your industry.

• It’s helpful and appropriate for your business.

6.2 Common Small Business Expense Categories (With Examples)

Here are typical expense buckets and real-world examples:

1. Rent and Utilities

• Office rent, co-working space.

• Warehouse or retail space lease.

• Electricity, water, gas.

• Internet and phone lines.

2. Payroll and Contractors

• Salaries and wages.

• Employer payroll taxes.

• Benefits (health insurance, retirement contributions).

• Freelancers, consultants, or agencies (e.g., marketing contractor).

3. Inventory and Cost of Goods Sold (COGS)

• Wholesale purchases of products you resell.

• Raw materials for production.

• Packaging and freight-in.

4. Software Subscriptions

• Accounting software (QuickBooks, Xero).

• Project management (Asana, Trello).

• CRM tools.

• Cloud storage (Google Drive, Dropbox).

• Design tools (Adobe Creative Cloud, Canva).

5. Marketing and Advertising

• Social media ads.

• Google Ads.

• Sponsorships.

• Content creation services.

• Website hosting and domain fees (often lumped in here or in “Software”).

6. Travel and Meals

• Flights, trains, or mileage for business trips.

• Hotels for business travel.

• Meals with clients or business partners (often with partial deductibility depending on jurisdiction).

7. Vehicle Expenses

• Fuel, repairs, insurance, and depreciation for a business vehicle.

• Alternatively, mileage allowances (depending on local tax rules).

8. Insurance

• General liability.

• Professional indemnity (errors and omissions).

• Workers’ compensation.

• Property insurance.

9. Professional Fees

• Accountant or bookkeeper.

• Legal advice.

• Tax planning services.

10. Bank and Processing Fees

• Credit card processing fees (Stripe, PayPal, merchant accounts).

• Monthly bank account fees.

• Wire transfer charges.

6.3 Categorizing Expenses Correctly

Good categorization means:

• You can clearly see where money is going.

• You can support deductions in a tax audit.

• Your profit and loss (P&L) statement actually tells a story.

Tips:

• Pick clear, obvious names for accounts (e.g., “Marketing & Advertising” instead of “Miscellaneous”).

• Avoid a giant “Miscellaneous” category—it hides where money is going.

• Be consistent: don’t classify a Zoom subscription as “Software” one month and “Telecom” the next.

6.4 Capital Expenditures vs. Regular Expenses

Some purchases aren’t expensed all at once.

• Capital expenditures (CapEx): Long-term assets like equipment, vehicles, or major renovations.

• Instead of expensing them entirely in the year of purchase, you may capitalize and depreciate them over several years, following tax rules.

Your accountant can help you decide:

• What should be capitalized.

• How to record depreciation.

6.5 Owner’s Draws vs. Expenses

If you’re a sole proprietor or single-member LLC:

• Money you take out for yourself is usually an owner’s draw, not a business expense.

• It reduces equity, not profit.

Don’t categorize your personal withdrawals as “Salary” or “Miscellaneous Expense”—that will distort your P&L.

7. Documentation and Recordkeeping for Taxes

Good bookkeeping is half the battle. Proof is the other half.

7.1 What Records Should You Keep?

The IRS says you can use any recordkeeping system that clearly shows income and expenses. But it expects you to keep documentation like receipts, invoices, bank statements, and other records that support the items on your return.

Typical records to keep:

• Income

  • Invoices issued.

  • Sales receipts.

  • Bank deposit details.

  • Forms 1099 (if in the U.S.).

• Expenses

  • Receipts (paper or digital).

  • Bills from suppliers.

  • Credit card statements.

  • Contracts and agreements.

• Bank and credit card records

  • Bank statements.

  • Credit card statements.

  • Loan statements.

• Payroll records

  • Timesheets, pay stubs.

  • Payroll tax filings.

• Asset records

  • Purchase invoices for equipment and vehicles.

  • Records of improvements.

Even third-party resources summarizing IRS rules emphasize keeping tax documents, receipts, and financial records for several years because they’re essential for verifying income and deductions.

7.2 How Long Should You Keep Records?

The IRS generally suggests keeping records for at least three years, but sometimes longer depending on circumstances. Many professional advisors recommend retaining business tax records for up to seven years to be safe.

As a practical rule of thumb:

• Keep tax returns and supporting documents: 3–7 years.

• Keep employment tax records: at least 4 years after the tax is due or paid.

• Keep property and asset records: as long as you own the asset plus several years after selling it.

When in doubt, keep it. Storage is cheap; audits are not.

7.3 Paper vs. Digital

The IRS allows electronic records as long as they are accurate, complete, and accessible.

Practical approach:

• Scan or photograph receipts and store them in the cloud (e.g., Google Drive, Dropbox, or your accounting software).

• Use consistent filenames or tagging (e.g., “2026-01-15_AirlineTicket_Conference.pdf”).

• Back up your data.

8. Building a Simple Bookkeeping Routine

The secret to staying on top of this stuff is rhythm, not heroics.

8.1 Daily or Weekly Tasks

• Import and review transactions

  • If you use software, check new bank/credit card imports.

• Categorize income and expenses

  • Assign each transaction to the right account.

• Attach documents

  • Upload or link receipts and invoices to their transactions.

• Send invoices and follow up on unpaid ones

  • Keep accounts receivable under control.

This can take 15–30 minutes a day or 1–2 hours once a week for many small businesses.

8.2 Monthly Tasks

• Reconcile bank and credit card accounts

  • Match your accounting records to actual bank statements.

• Review your profit and loss (P&L)

  • Compare this month to last month or the same month last year.

• Review your balance sheet

  • Check cash balances, outstanding receivables, and payables.

• Check cash flow

  • Look at upcoming bills and expected income.

8.3 Quarterly Tasks

• Estimate taxes (if required in your jurisdiction)

  • Use year-to-date profit to estimate income and self-employment taxes.

• Adjust for accruals and prepayments

  • If you’re on accrual and working with an accountant, they may adjust things like prepaid expenses or deferred revenue.

• Review major expense trends

  • Are subscriptions creeping up?

  • Has your marketing spend increased and is it paying off?

8.4 Year-End Tasks

• Close the books

  • Ensure all transactions are recorded, reconciled, and categorized.

• Prepare financial statements

  • Profit and loss, balance sheet, cash flow statement.

• Provide reports to your accountant/CPA

  • Make tax filing much smoother.

• Review your year

  • Which products, clients, or projects were most profitable?

  • Where did you overspend?

  • What should you do differently next year?

9. Tools and Systems: Spreadsheets vs. Accounting Software vs. Pros

Let’s compare your options more directly.

9.1 Spreadsheets

Pros

• Free or very low cost.

• Flexible; you can design your own structure.

• Good for very simple, very small operations.

Cons

• Easy to make formula errors.

• No automatic bank feeds (unless you build complex imports).

• No built-in invoicing, A/R, or A/P tracking.

• Harder to produce standard reports (P&L, balance sheet, cash flow) correctly.

Spreadsheets are okay for a side hustle with a handful of transactions but will likely break as you grow.

9.2 Accounting Software (QuickBooks, Xero, etc.)

Modern small-business accounting software:

• Imports bank and credit card transactions automatically.

• Lets you create invoices and receive payments.

• Tracks accounts receivable and payable.

• Organizes your chart of accounts.

• Generates standardized financial reports.

• Keeps a central repository for receipts and documents.

Guides from providers like QuickBooks emphasize that you can start with a pre-built chart of accounts and customize it, making setup easier for non-accountants.

Given how quickly small businesses are adopting digital tools—and how many still struggle without them—moving to proper accounting software is one of the lowest-friction upgrades you can make.

9.3 When to Hire an Accountant or Bookkeeper

You should strongly consider professional help when:

• You’re overwhelmed or consistently behind on your books.

• You manage inventory, multiple revenue streams, or employees.

• You’re approaching tax season and don’t feel confident.

• You’re seeking financing or investors who need clean financial statements.

Typical setup:

• Bookkeeper

  • Handles day-to-day data entry, reconciliations, and categorization.

• Accountant / CPA

  • Handles higher-level tasks: tax strategy, financial analysis, compliance, and year-end adjustments.

You can still stay involved by reviewing regular reports and asking questions—but you’re not stuck entering every receipt yourself.

10. Example: A Month in the Life of a Simple Small Business

Let’s make this concrete.

Imagine you run a small marketing agency with one part-time assistant.

10.1 Starting Setup

You:

• Open a business checking account and a business credit card.

• Choose accrual accounting because you invoice clients.

• Use QuickBooks Online with a simple chart of accounts (Service Revenue, Software, Marketing, Rent, Payroll, etc.).

10.2 Transactions in March

During March:

Income

• You send 3 invoices:

  • Client A: $3,000 (paid in March)

  • Client B: $2,000 (paid in April)

  • Client C: $4,000 (paid in March)

• You receive a $200 refund from a software vendor.

Expenses

• Office rent: $1,200

• Software subscriptions (Zoom, Adobe, project management): $250

• Facebook and Google Ads for your own lead generation: $600

• Contractor payment: $1,500

• Travel to a conference: $800 (hotel + flight)

• Meals with two prospects: $120

• Phone & internet: $150

10.3 How You Record It (Accrual Basis)

Income

• Revenue for March:

  • Client A invoice: $3,000

  • Client B invoice: $2,000

  • Client C invoice: $4,000
    → Total revenue recognized in March: $9,000

• Cash collected in March: $7,000 (A + C)

• Accounts receivable at month end: $2,000 (Client B)

Expenses

All expenses listed above are recorded in March when incurred (billed or paid), regardless of whether they hit your bank in early or late March.

Total expenses:

• Rent: $1,200

• Software: $250

• Marketing: $600

• Contractor: $1,500

• Travel: $800

• Meals: $120

• Phone & internet: $150
  → Total: $4,620

Profit

• Revenue: $9,000

• Expenses: $4,620
  → Net income for March: $4,380

Your cash position might look different because one client hasn’t paid yet and some expenses hit the credit card. But your profit reflects the real economic activity of the month.

10.4 What You Can See From This

With proper tracking, you can:

• See that contractor costs and marketing are your biggest spend items this month.

• Review whether the ads generated enough new business to justify the $600.

• Know you have $2,000 coming in from Client B in April, which helps with cash planning.

• Provide your accountant with a clean P&L, balance sheet, and supporting records at year-end.

11. Putting It All Together: A Simple Roadmap

Here’s a practical step-by-step summary you can follow:

1. Separate your money

   • Open business bank and credit card accounts.

   • Stop using personal accounts for business purchases.

2. Pick an accounting method

   • Likely cash if extremely simple; accrual if you invoice or manage inventory. Confirm with a professional.

3. Choose your system

   • Spreadsheets only if tiny and simple.

   • Otherwise, sign up for a reputable accounting platform.

4. Set up a basic chart of accounts

   • Include core accounts for income, COGS, and major expense categories.

   • Avoid overly granular or vague “miscellaneous” categories.

5. Track income

   • Issue invoices or record sales correctly.

   • Use bank feeds to capture incoming payments.

   • Separate sales tax collected into a liability account if applicable.

6. Track expenses

   • Categorize every expense into the right bucket.

   • Keep receipts and supporting documentation (digital is fine).

   • Distinguish between operating expenses, capital expenditures, and owner draws.

7. Create a routine

   • Weekly: categorize and reconcile transactions.

   • Monthly: review P&L, balance sheet, and cash flow.

   • Quarterly: review trends, plan for taxes.

   • Year-end: close books and work with a tax professional.

8. Get help when needed

   • Bring in a bookkeeper to keep you current.

   • Use a CPA or accountant for tax, compliance, and strategic planning.

Final Thoughts

Small business accounting doesn’t need to be mysterious or intimidating. At its core, it’s a disciplined way of answering a few simple questions:

• How much is coming in?

• Where is it going?

• What’s left over?

• What does that say about the health of my business?

By keeping your accounts clean, your categories consistent, and your records organized, you’ll not only stay on the right side of tax authorities—you’ll give yourself the clarity and confidence to grow.