“Accounting isn’t rocket science.”

While that may be true, many of us lack familiarity with even basic accounting concepts. If you own a small business, or you’re planning to start one, you know there is a load of financial terms and jargon that you must understand, such as double-entry accounting, accounts payable, capital expenditure, etc.

These terms may sound complex and intimidating, but they can actually be relatively easy to grasp.

Because of a lack of financial literacy, small business owners tend to outsource accounting services to chartered accountants or small financial services firms, which may prove expensive.

In addition, outsourcing can lead to reduced transparency, as financial transactions are not assessed in-house. Instead, it’s always a best practice to become more educated about key accounting concepts to avoid failure.

JPMorgan Chase Institute analyzed cash flow transactions of 1.3 million small businesses between October 2012 and February 2018 and found that small businesses failed because of highly volatile cash flow transactions—a fate that could have been avoided if they’d had a better knowledge of cash flow management best practices.

Small business owners with limited knowledge of key accounting concepts may overlook the financial management of their business to focus their energy on areas they understand better—such as customer relationship management, hiring, marketing, and sales—and end up overpaying on taxes or failing to meet financial compliance.

In this small business accounting 101 guide, we will briefly define six accounting concepts and their key challenges and how accounting tools can help you address the challenges.

Overview of key accounting concepts

Overview of key accounting concepts Accounts payable: Build a robust invoice management system

Definition: Money owed to your creditors (suppliers or vendors) for the purchase of goods or services makes up your accounts payable (AP).

In other words, AP is essentially a line of credit that your vendors or suppliers provide you by allowing you to make payments at a later date.

Once you purchase a product or service from a vendor, your small business is issued an invoice. The invoice acts as a record of the purchase that you have made and is entered into your small business balance sheet.

AP is an integral part of business to business (B2B) transactions. When inventory is bought in bulk, businesses are issued an invoice, instead of a receipt, which is more commonly used in customer-driven transactions as a proof of purchase. Robust invoice management is key to accounts payable success.

There are two components to AP: the credit issued and the short-term period you have to pay back the credit. While creating your balance sheets, AP plays an integral role in creating the correct balance sheet or bookkeeping accounts to avoid financial data errors.

Once you have made the payment to your creditors, the AP amount is deducted in lieu of the payment.

Key accounts payable challenges

  • Transposition errors through manual data entry: Generally results from unintentional data entry errors such as switching two digits or misplacing a decimal point, which can lead to compliance issues.
  • Poor invoice management: Paper-based invoice tracking can lead to financial losses during the accounts payable processes as your business might not be able to benefit from discounts and negotiate payment terms with suppliers, based on your terms.
  • Lack of AP digital footprint: Small businesses largely process AP information related to invoices and other supplier payment details based on paper and spreadsheets, which slows down the processing of AP and leads to clunkier records.

How software helps your small business address these accounts payable challenges

  • Create a standard invoicing process: Small businesses receive invoices from suppliers in multiple formats such as MS Word, PDF, and email attachments. Accounting tools help your small business AP department convert all paper financial information into digital format. Many accounting solutions also leverage optical character recognition technology that reads information directly from invoices without requiring manual data entry.
  • Integrate finance data from multiple sources: Accounting tools create a centralized database for invoice and expense management that is collected from emails. They also integrate invoice data from other third-party solutions.
  • Eliminate data errors through automated bank reconciliation: One of the biggest tasks for small business finance departments is reconciling errors that have crept into bank statements through data entry errors. Accounting tools automate bank reconciliation each time an entry is made in the ledger with the bank account statement, reducing financial data errors.

Click here to learn more about accounts payable tools

accounts payable dashboard

Example of accounts payable dashboard in an accounting tool (Source)

accounts payable dashboard Accounts receivable: Track payments to maintain cash flow volume

Definition: Accounts receivable (AR) is the opposite of AP, as it is the money your debtors (clients or customers) owe you for the purchase of goods or services.

AR is a part of the debit transaction in your accounts ledger that indicates short-term loans (usually extended for a month after you issue the invoice) owed to you by other businesses. AR transactions are registered as current assets in the balance sheet.

In AR, sale of goods is registered once you give an invoice to your customers for the payment to be made later. After the payment is made, the AR amount against the vendor or suppliers is deducted and the cash segment in your balance sheet is increased.

A common pitfall for new small business owners comes with confusing AR with AP, since they both involve invoice management. However, the bigger challenge is that AR has a direct impact on your cash flow, as delay in payment by your debtors may result in a delay for you to pay your own creditors.

Key accounts receivable challenges

  • Late payments affect your cash flow: If your debtors default on payments they owe you for the purchase of goods, then your cash flow is affected, and you’ll have a hard time paying your own creditors.
  • Reducing days sales outstanding (DSO): Defined as the average number of days to collect payment post the sale of goods or services, small business often end up with a poor DSO ratio when AR collection payments are not made on time.

How software helps your small business address these accounts receivable challenges

  • Track customer payments online: With the help of accounting tools, you can encourage customers that owe you money to make payments online. Accounting tools can link to the customer’s bank account or credit card, so you can give them the option of making recurring payments that are automatically debited.
  • Automate notifications and reminders to customers: Instead of your accounts receivable department chasing your customers down to make payments, accounting tools send automatic payment or invoice reminders through email or SMS messages.
  • Predict cash flow volumes: Accounting tools can warn your accounting department of low cash volumes in the short and long term. These tools provide real-time analysis of your cash flow since late payments in AR can reduce your cash flow dramatically.

Click here to learn more about accounts receivable tools

Example of AR in accounting tools with a list of pending payments from customers

Example of AR in accounting tools with a list of pending payments from customers (Source)

Example of AR in accounting tools with a list of pending payments from customers Bookkeeping: Meticulously record every financial transaction

Definition: Bookkeeping is at the core of AP and AR, since the primary activity involved in this accounting process is recording all financial transactions.

From sales receipts and invoices to expense payments that are made to your suppliers, bookkeeping ensures that all transactions are recorded on a regular basis.

In the history of accounting, bookkeeping was a primordial form of accounting that met the needs of a single entry. It was only after Luca Paciolo created the double-entry system in 1494 that the complexity of bookkeeping increased.

Bookkeeping is an integral part of the balance sheet and accounting ledgers. A bookkeeper’s core function is to keep financial records up-to-date, as opposed to analyzing financial transactions, which is the primary role of an accountant.

Key bookkeeping challenges

  • Not recording personal expenses within business expenses: Whether you are self-employed or a small business owner with 50 employees, it is mandatory to let your accounting clerks know if you have made additional payments out of your pocket to ensure project budget costs are within the allocated funds.
  • Not updating records frequently enough: Accounting clerks face a challenge in collaborating with other departments such as sales and marketing to ensure all expense and sales receipts are submitted by end of the quarter or fiscal year so that all records are up-to-date.
  • High volume transactions: The accuracy of manually entering transactions in accounts ledgers is reduced when there is a high volume financial transactions to enter, for example, upon receiving multiple invoices during the close of quarter or financial year.

How software can help your small business address these bookkeeping challenges

  • Integration with primary financial sources: Accounting tools integrate with other third-party tools such as CRM, sales, HR, etc. which may act as the primary source of retrieving certain financial data. For example, travel expenses submitted on a sales tool.
  • Automated ledger entries: Manual data entry is reduced significantly with the use of accounting tools, as all debit and credit transactions are made and recorded electronically.
  • Real-time entry of financial data: Accounting tools provide a real-time analysis of your profit and loss, balance sheet, or income statement as financial entries are made more frequently.

Click here to learn more about bookkeeping tools

Example of bookkeeping dashboard

Example of bookkeeping in an accounting tool (Source)

Example of bookkeeping dashboard Expense management: Track internal costs incurred within your business

Definition: The process of automating the reimbursement of expenses that have been submitted by employees is known as expense management. Examples of business expenses include travel, hotel, entertainment, etc., that are incurred for business purposes such as client meetings.

Expense management comprises three phases: submission of expense receipts, auditing the receipts through the accounting department, and finally, adding the approved expenses to the balance sheet.

Expense management only factors in internal expenses that are incurred by your employees and not payments made to your suppliers and vendors. An expense is calculated as a liability in a balance sheet.

Key expense management challenges

  • Inefficiencies in tracking expense claims: With paper-based expense submissions, tracking expenses is clunkier and delays occur in the accounting department. Paper-based expense submissions also makes it more difficult to ensure requirements and qualifications are met.
  • Approving expenses based on compliance policies: The accounting department must scan through every detail a receipt to make sure that the stipulated amount meets the company’s expense policy. With larger volumes of receipts, the accounting department may inadvertently approve an expense that does not meet the requirements.

How software can help your small business address these expense management challenges

  • Mobile accounting: With the help of mobile devices and their built-in cameras, employees can take a snapshot of their expense receipts and directly upload them to the expense management portal to create a digital copy of paper-based receipts.
  • Easy visualization of expense data: Most accounting tools feature a separate dashboard for expense management that segregates expense data into separate categories such as hotel, meals, flights, etc.
  • Faster processing of reimbursements: Since all expense information is uploaded digitally, it is easier for the accounting department to approve reimbursements since data is segregated into different categories.

Click here to learn more about expense management tools

Example of expense management dashboard

Example of expense management in an accounting tool (Source)

Example of expense management dashboard Tax management: Evaluate your tax liability

Definition: Assessing your small businesses tax obligation in a financial year based on your total revenue is known as tax management.

Tax regulations are one of the most difficult components of finance and accounting to understand, since the regulations change frequently. For example, the Tax Cuts and Jobs Act (TCJA) is one recent change in tax regulations that has affected the tax rate for businesses across industries.

To ensure that your small business meets the right tax liability, you must identify in which category you fall based on the tax rate, e.g., C-corp or S-corp.

Tax planning and tax management are often interchanged and confused. While tax planning seeks to minimize your business’s tax liability, tax management focuses on complying with tax regulations and filing returns on time.

Key tax management challenges

  • Lack of knowledge about tax liability: Small business, especially self-employed contract workers, often struggle to understand which tax bracket their business falls into and therefore can’t accurately estimate their tax liability.
  • Filing tax returns incorrectly: A tax return form often has multiple fields of information, that when entered incorrectly results in incorrect filing.
  • Overpaying taxes: Small business owners often don’t understand the tax rate or the tax category (C-corp or S-corp) of their business, which can lead them to over or underestimate their tax liability.

How software can help your small business address these tax management challenges

  • Updated tax regulations: Accounting tools have dedicated tax dashboards and modules that calculate your business’s tax liability based on the latest tax regulations.
  • Integration with third-party tax modules: Most accounting tools integrate with more specialized tax management tools. You do not have to purchase a full-fledged accounting tool if your need is only for tax management. For example if you already have CRM tool, you may opt to choose a third-party solution that offers a stand-alone tax module.

Click here to learn more about tax management tools

Example of tax management dashboard
Example of tax management in accounting tools (Source)

Example of tax management dashboard Financial compliance: Maintain financial compliance and avoid penalties

Definition: Devising and implementing financial best practices in relation to industry regulations is known as financial compliance. Just like any other business, small businesses must ensure the prevention of financial fraud, otherwise, they risk being charged hefty penalties.

Generally Accepted Accounting Principles (GAAP) are the most widely followed accounting standards by international banks and businesses for preparing financial statements.

Financial compliance is industry-specific and typically governs all businesses regardless of size. For example, the Dodd-Frank Act or Sarbanes Oxley regulations are applicable to all businesses, regardless of size.

Key financial compliance challenges

  • Navigating federal versus state compliance regulations: Federal compliance regulations apply throughout the U.S.; however, you will also need to know how to address state regulations as you expand your businesses.
  • Penalties due to inaccurate financial records: Financial data needs to be accurate from AP to AR, and all financial transactions need to be recorded in the balance sheet to avoid any type of financial fraud.

How software can help your small business address these financial compliance challenges

  • Reduced financial risks: Accounting tools offer compliance modules with dashboard reports. They improve the quality of internal audits with regular updates to track changing regulatory compliance, and therefore reducing financial risks.
  • Advanced fraud detection: Financial documents in an accounting tool are cryptographically encrypted. With user-access management for each document, financial fraud can be detected and even prevented.

Click here to learn more about financial compliance tools

Example of a compliance dashboard

Example of compliance dashboard in an accounting tool (Source)

Recommended actions

Now that you’re familiar with some of the core concepts, here are some key actions you can take to further your understanding of these key financial concepts:

  • Enhance your accounting and finance knowledge further by exploring online e-learning courses, including distance learning and instructor-led training.
  • Focus on one key aspect of accounting at a time to gain an in-depth understanding. Get hands-on experience with accounting tasks such as invoice management before moving on to the next accounting concept.
  • Implement an accounting solution that has all the core features of accounting and financial management such as expense management, invoice management, and bookkeeping, with an integration option to add other stand-alone accounting tools that will offer additional features when required.

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