Getting Started with Bookkeeping for Handmade Businesses

Over a year and a half ago, I was tearing my hair out over the mess of bookkeeping records I had kept in Wave Apps for my first year in business with Modern Soapmaking. After staring blankly at my computer screen for hours on end trying to understand why my numbers weren't adding up, I decided to take my own advice: do what you are good at, and outsource the rest.

After a little bit of googling, I came across a CPA in Springfield, Missouri whose clean website caught my eye. (Swoon! Designer at heart here!) Before I added his contact information to my spreadsheet of potential peeps to reach out to, I popped over to his FAQ and fell in love (figuratively speaking.)

He was the only accounting professional I came across that had the clarity in their business to outline exactly who would NOT be a good fit for them (and who would be.) Within a couple days, I found myself on the phone with Gabe, nervously explaining that I was a bad business owner who sucked at keeping their numbers straight and practically begged him to fix it. The rest is history.

 Q+A with a CPA: Getting Started with Bookkeeping

Earlier this year, when tons of financial questions started popping up in the Facebook group, I knew I needed to tag him in. I rounded up the most popular questions from members of the Biz of Soapmaking Facebook group, and popped them over to Gabe. This series, Q+A with a CPA, is the result of Gabe lending a little lot of his expertise to help y'all rock your books, numbers, and minds.

Q+A with a CPA: Getting Started with Bookkeeping

To briefly introduce Gabe, he's a personal and small business CPA located in Springfield, Missouri. He's married & has two kidlets, plus he's an entrepreneur so he *gets* us. He's one of those weird folks who enjoys working with numbers (because he's crazy) and studied accounting at Missouri State. He has a slew of happy clients, both locally and nationwide (myself included!).

I've taken all the questions Gabe answered for us and broke them down into four easy-to-digest articles for the Q+A with a CPA series. Today, we're kicking it off with what you should know before getting started with bookkeeping for your handmade soap company:

Q: What are the basic records I should be keeping, and what are the basic files and procedures I should have in place to support the record keeping and reporting?

Gabe says: Technically for any expense that you want to claim as a tax deduction, the safest option would be to keep the receipt for that purchase. Most people don't go into that much detail, but if you want to be technically correct in all you do, that would be the safest option. With the online accounting software available, you can actually "attach" each receipt to every transaction that pertains to your business.

Here are some basic files and procedures you should put in place for your business:

• Upon starting the business, you should open a separate business checking account to run all business transactions through. I know this seems really basic, but you should never pay for business expenses out of your personal account or pay for personal expenses out of the business account. If you need to take a draw from the business, transfer the money from the business account to your personal account.
• You need to come up with a proper system of accounting. The basics would be making sure that your bank account is reconciled each month to your accounting records. QuickBooks is obviously the leader in accounting software, but there are other cheaper and basic options, if you are looking for other alternatives.
• If you want to DIY the bookkeeping, I would recommend paying an accountant to help you setup your accounting files. I know that seems self-serving, but I've cleaned up too many messes from people who went the DIY route to believe differently. Accounting is a foreign language for most people and is an acquired skill. Just because the software companies want you to believe it is so easy a caveman can do it doesn't make that the reality. Remember, they just want you to buy the software. They could care less what you do with it from there. :)
• For any business expense that would be borderline personal vs. business, you should write on the receipt exactly what was purchased and why it was business use. Then scan it and save it to either your accounting software or some sort of online file document system. Obviously, you can save the paper copy, but most of the ink used for receipts fades really quickly.

Q: What financial reports should I, as a business owner, be running and reviewing to see where I am at financially with the business?

Gabe says: On a monthly basis, you need to be looking at your profit and loss, balance sheet, and a cash flow statement.

Specifically, you need to really watch your margins on your products sold on your profit and loss. Many small businesses underprice their products and/or are spending too much to make the product. You need to look at your gross sales compared to your cost of goods sold and understand if that specific margin is large enough to build a true business from. If not, you need to see if you can increase your prices (will the market pay higher prices?) or look at ways of reducing your inputs (costs).

Most other expenses are pretty easy to examine for excess. If your business has employees, you obviously need to be monitoring how the employee expenses are affecting your profit margins.

The balance sheet lists everything you own (your assets), and everything you owe (your liabilities). The difference between the two is your equity. Basically, you want to make sure that you have cash reserves to meet your short term liabilities as well reserves for any major spending that needs to be done in the future. If your liabilities start to exceed your assets, you need to make some changes quickly or else you won't be in business for long.

Your cash flow statement will give you a clear picture of where your cash went for the month. It connects the profit and loss with the balance sheet and gives you a quick picture of your cash flow.

There are other helpful reports, but what those are would be more specific to your individual business.

Q: What is the best way to organize my bookkeeping throughout the year to make taxes easier?

Gabe says: The best way to organize your bookkeeping is to stay on top of it! You have to have self-awareness in this area in business.

If you can't commit to doing in monthly (or at minimum quarterly), then you need to outsource the task. You can't run a business and make sound financial decisions, if you don't know your numbers. Otherwise, you are just guessing. So get with a professional to help you setup a monthly (or quarterly) system to DIY, or find someone to do it for you.

Q: How long do I need to keep bookkeeping records and receipts? Is a digital copy enough or should I have physical copies?

Gabe says: Digital copies are probably better as the ink doesn't fade on a digital copy.

I would recommend keeping all bookkeeping records for at least 7 years. I would keep tax returns for at least 7 years as well, but personally recommend keeping them forever.

As long as the IRS doesn't suspect fraud, they can usually only go back 3 years to correct any tax return errors on your part. The IRS recommends you keep your records for at least 7 years as well.

Q: What is a good way to keep track of and organize receipts for my supply orders so I can easily access them when needed?

Gabe says: The easiest way would be to digitally track all of your purchase orders and receipts inside an accounting software. Then you can easily sort and manipulate past data to get exactly the information you need.

Q: What factors should I consider when choosing cash or accrual accounting and how can I transition when needed because of a change in revenue or business structure?

Gabe says: For almost all small businesses, you report your taxes on a cash basis and you should do your own bookkeeping on an accrual basis. As technology and online banking keep getting "faster" the line becomes blurred between cash vs. accrual. Obviously, you want to track your receivables and payables on an accrual basis, so you can control your cash flow.

If you're asking if it's smart to switch from cash to accrual accounting for tax purposes, you'd want to meet with a tax accountant to discuss the pros and cons of the switch specific to your unique situation.

Getting started with bookkeeping isn't so scary, afterall!?

Gabe definitely has a magic way of making numbers looking awesomesauce instead of impending doom, gloom, and scary! Stay tuned for the second round of Q+A with a CPA, where Gabe answers soapmakers' questions about hiring an accountant/bookkeeper, and outsourcing bookkeeping.