Legalities: How to keep the records

Bookkeeping basics
There is no special record-keeping system required or approved by the IRS. At a minimum, though, your records must clearly show your business income and summarize transactions through original and supporting documents.

To keep track of business transactions, you need to write them down, usually in specialized books called journals or ledgers. You can buy simplified paper versions in office supply stores or download them from the SBA Shareware Library. There are also several computer software programs that are easy to use.

Record-keeping is all about numbers. Once you've compiled the numbers required for tax purposes, they have to be submitted, along with the payments, to the IRS.

Hire a professional accountant
Hiring an accountant can take a lot of pressure off the small business owner who is concentrating on sales, marketing and operations. A good accountant can help set up a basic record-keeping system that works for your line of business.

While business owners can often handle the day-to-day bookkeeping themselves or with a bookkeeper, most are advised to let an accountant handle complicated tasks such as preparing tax returns and financial statements.

There are many ways to arrange professional accounting services. The Online Women's Business Center in partnership with the SBA has created a database of accounting firms, associations and nonprofit business accounting centers for more information. The American Association of Certified Public Accountants also has an online brochure aimed at business owners, advising them how to choose an accountant.

Once your bookkeeping/accounting team is in place, whether it's in-house or comprised of outside help, you need to make some important decisions on how you'll keep the records.

Pick a tax year
There are two types of annual accounting periods on which you can base the way you keep records and report income and expenses. You can choose either the calendar year or the fiscal year.

• The calendar tax year is a period of 12 consecutive months beginning Jan. 1 and ending Dec. 31.
• The fiscal tax year is a period of 12 consecutive months ending on the last day of any month other than December. Basically, it's a 52- or 53-week period ending on a specific day of the week that falls either in the last week of a specific month or nearest the last day of a month.

Select an accounting method
You must choose an accounting method to determine how you will report income and expenses in your books and on your tax returns. There are two basic types of accounting systems to choose from: accrual and cash basis. Check with your accountant, as there are instances when a company is required to use the accrual method.

• Cash basis -- Most small businesses use cash basis, or "real-time" accounting, whereby transactions are recorded when they happen. For example, when you are paid for a service, you record it as cash in, even if the service was performed a month ago.
• In accrual accounting, you record the income when it's earned, not received. It's the same with expenses: You record the utility bill when you get it, not when you pay it. Many businesses with inventories use the accrual method.

Cash, accrual or a combination of both methods are all acceptable by the IRS as long as records are clear and accurate and you use the same accounting method every year.

You must ask the IRS for approval if you want to change.

Choose a bookkeeping system.

• Single-entry system -- The simplest bookkeeping system to maintain is the single entry system, which records the movement of income and expenses through a daily summary of cash receipts, and a monthly summary of cash receipts and disbursements.

• Double-entry system -- The field of accounting is based on the double-entry system, which records transactions into journals and ledgers. With this system, daily transactions, including sales, purchases, cash receipts, accounts receivable and accounts payable, are recorded in journals. Each account has a side for debits and a side for credits. You enter every transaction as a debit in one account and a credit in another. It's more time-consuming, but can be more accurate as it tends to be self-balancing.

The journal information is later summed up and transferred to a general ledger. From the ledger, you or your accountant can formulate the most important business financial statements, the balance sheet and income statement.

TIP: Many businesses have a business checking account, separate from personal checking, using the checkbook as the main record of daily expense transactions. By depositing all receipts into the checking account and writing checks for all business expenses, you can keep good daily transaction records. These records can be transferred to your books.

Preparing a financial statement
At the end of your accounting year, you will have to balance the books for tax purposes and to check on the financial health of the company. The financial statement that shows this information is called the balance sheet, and it's similar to the personal net worth statement.

Most of the numbers needed to enter into this spreadsheet can be compiled from the general ledger after all the journal entries have been posted.

A sample double-entry business balance sheet would look like this: