Introduction
Starting a small business is exciting — and the bookkeeping doesn’t have to be scary. The two foundational choices you make at the beginning (accounting method and chart of accounts) shape how easy it will be to track performance, prepare taxes, and make decisions. This guide walks you through both choices with practical examples and an actionable checklist.
1. Cash vs. Accrual — which one to choose? (practical rules)
- Cash basis: record income when cash arrives and expenses when cash is paid.
- Best for: sole proprietors, freelancers, small businesses with simple transactions and low inventory.
- Pros: simple, matches bank cash flow, easier for tax calculation when allowed.
- Cons: can hide accruals (owed revenue or unpaid bills), not accepted for larger businesses or where inventory is material.
- Accrual basis: record income when earned and expenses when incurred, regardless of cash timing.
- Best for: growing businesses, those with inventory, or anyone needing accurate performance measurement.
- Pros: matches revenues & expenses to the right period; better for planning.
- Cons: requires more bookkeeping and adjusting entries.
Rule of thumb: If you sell products or hold inventory, prefer accrual. If you’re service-only with simple cash flows and want simplicity, cash basis is acceptable.
2. Chart of Accounts — simple structure every small business needs
A chart of accounts (CoA) is the backbone of your bookkeeping. Keep it lean at the start — too many accounts create confusion.
Essential account groups and sample accounts:
- Assets: Cash (Bank), Accounts Receivable, Inventory, Prepaid Expenses, Equipment (Net)
- Liabilities: Accounts Payable, Short-term Loans, Accrued Expenses, Taxes Payable
- Equity: Owner’s Capital, Owner’s Drawings, Retained Earnings
- Revenue: Sales, Service Income, Other Income
- Expenses: Cost of Goods Sold (COGS), Rent, Utilities, Advertising, Wages, Bank Fees, Depreciation, Office Supplies
Sample numbering (simple):
1000s = Assets, 2000s = Liabilities, 3000s = Equity, 4000s = Revenues, 5000s = Expenses.
Example: 1010 Cash — 4010 Sales — 5010 Rent Expense.
3. First-month setup — opening entries & simple example
- Owner invests $5,000 cash:
- Debit Cash (1010) $5,000 → Credit Owner’s Capital (3010) $5,000.
- Buy equipment $1,200 cash:
- Debit Equipment (1060) $1,200 → Credit Cash (1010) $1,200.
- Buy initial inventory $800 on credit:
- Debit Inventory (1100) $800 → Credit Accounts Payable (2010) $800.
After these opening entries, reconcile bank balance and file invoices/receipts digitally.
4. Practical setup tips (speed & accuracy)
- Keep accounts few and clear — expand only when you need to report a new item separately.
- Use subaccounts for grouping (e.g., 5010 Office Supplies → 5011 Stationery, 5012 Software).
- Name accounts consistently (e.g., always use “Sales” not sometimes “Revenue”).
- Save a PDF copy of your chart of accounts and the accounting policy (chosen method, depreciation policy) — useful for taxes or an accountant.
5. Tools & a simple starter template
- Spreadsheet: Good first step. Columns: Date, Reference, Description, Debit Account, Credit Account, Amount. You can manually post to ledger sheets.
- Free software: Wave (free), then upgrade to QuickBooks / Xero when volume grows.
- Template offer: I can provide a ready-to-use Excel/Google Sheets chart-of-accounts + basic journal template tuned for small businesses.
6. Quick checklist before you close month 1
- Bank account opened and matched to “Cash” account.
- Chart of Accounts saved and numbered.
- All opening purchases recorded with receipts attached.
- Decide and document accounting method (cash vs accrual).
- Set up a folder structure (digital) for invoices, receipts, payroll docs, and tax forms.