For small business owners, accounting can feel like an afterthought. And when you’re busy selling to customers, it’s easy to fall into the trap of, “I’ll just worry about it later.”
But without proper accounting system and practices in place, you may be exposing your company to working capital shortfalls or tax penalties.
The good news? It doesn’t take long to master the basics of small business accounting. And in this article, we’ll tell you how.
1. Choose the right accounting method
Not all accounting methods are created equal, and there are two popular routes available to you: cash basis and accrual accounting. Which method you choose can have a meaningful impact on visibility into your business operations.
Cash basis accounting recognizes revenue when cash is received and expenses when cash is paid out. Under this method, there are no accounts receivable or accounts payable.
Accrual basis accounting recognizes revenue and expenses when they are earned, regardless of when cash is paid in or out.
So which method should you adopt? It depends on how mature your business is. Most small businesses start with cash accounting, then adopt accrual accounting as they grow since it better monitors a company’s long-term financial health. It also follows accounting’s matching principle.
2. Find a cloud-based accounting software
Long-gone are the days of crunching accounting numbers with an Excel spreadsheet. By choosing a cloud-based accounting provider, you can easily connect to other cloud-based applications, from time-tracking, expense management, and of course, payroll. Consider the following cloud-based solutions:
Check out which accounting solutions Gusto integrates with here. Since many third-party accounting firms also use the latest software, it’s important to pick a software solution that scales as you grow.
Send invoices and collect payments online
Invoicing and collecting payments online with a cloud-based accounting provider is also a win. It will help you:
Invoice as soon as the project is finished
Track the work throughout the engagement
Automate follow-ups, especially if payments are late
Create an online record for clients and regulators
Easily access financial reports
Accept payments instantly
3. Sort out expense tracking
Just as getting cash into your business more quickly is important, it’s also vital you track your expenses closely. One particular area where small businesses get tripped up is collecting, recording, and managing receipts—and this can come back to bite you during tax season.
Without proper expense management, you may miss expenses on your tax return, which means fewer deductions. You may also mis-categorize an expense because the receipt is unclear, and end up triggering an audit.
Even if you’re confident you’re safe on taxes, poor expense management means you have poor insight into your company’s spending. Rather than wait until tax day to organize your expenses, you should consider tracking them as close to real-time as possible to better manage your company’s day-to-day operations.
Most cloud-based accounting providers have an import and export function for expenses that tie into your credit card and bank accounts. There are also providers like Bill.com or Expensify that can help you manage expenses and track reimbursements.
4. Learn some simple ratios
One of the top reasons to invoice online and track expenses is to be more effective in managing your operations. When it comes to measuring your financial performance, use these simple ratios to help you quickly make informed operational decisions.
Days Sales Outstanding
Days Sales Outstanding (DSO) measures the average number of days it takes to collect payment. If you’re having trouble collecting on your receivables, you can get a lengthyDSO.
This means you’re extending a lot of credit to your customers and not collecting cash quickly enough.
A lower DSO means customers are paying faster, while a higher DSO means cash is tied up longer in unpaid invoices, which can strain working capital. In addition, invoices can come at an unpredictable rate. If you’re not matching your revenue with your expenses as they come, you can hit working capital issues.
How to calculate DSO
DSO = (Accounts Receivable ÷ Total Credit Sales) × Number of Days in Period
To calculate it:
Add up your accounts receivable (unpaid invoices) for the period you're measuring.
Divide that by total credit sales for the same period (sales made on credit, not cash sales).
Multiply by the number of days in the period (e.g., 30 for a month, 365 for a year).
Example: if you have $50,000 in accounts receivable, $300,000 in credit sales over 30 days, DSO = (50,000 ÷ 300,000) × 30 ≈ 5 days.
Current Ratio
For your liabilities, consider tracking your Current Ratio, which is a key liquidity ratio. The Current Ratio helps you measure your company’s ability to pay your short-term obligations.
A ratio above 1 generally means you have enough current assets to cover your short-term liabilities, while a ratio below 1 can signal a liquidity risk.
How to calculate Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities
To calculate it:
Add up your current assets (cash, accounts receivable, inventory, and other assets expected to convert to cash within a year).
Add up your current liabilities (accounts payable, short-term debt, and other obligations due within a year).
Divide current assets by current liabilities.
Example: if you have $80,000 in current assets and $40,000 in current liabilities, current ratio = 80,000 ÷ 40,000 = 2.0.
Quick ratio
Like the Current Ratio, the Quick Ratio measures your ability to pay back short-term debts, but with your most liquid assets.
A Quick Ratio above 1 means the business could cover short-term obligations without relying on inventory sales. It’s a more conservative test than the Current Ratio, since it strips out the least liquid current asset.
How to calculate Quick Ratio
Quick Ratio = (Current Assets − Inventory) ÷ Current Liabilities
To calculate it:
Add up your most liquid assets—cash, cash equivalents, accounts receivable, and marketable securities (skip inventory and prepaid expenses, since those aren't quickly convertible to cash).
Add up your current liabilities (accounts payable, short-term debt, and other obligations due within a year).
Divide the liquid assets by current liabilities.
Example: if you have $80,000 in current assets, $30,000 of which is inventory, and $40,000 in current liabilities, quick ratio = (80,000 − 30,000) ÷ 40,000 = 1.25.
5. Take advantage of automated reports
Good reporting can help you answer questions like:
Which invoices are outstanding, and how old are they?
How much have I spent, and on what?
What work will I be able to bill for soon, and for how much?
How much cash does our business have right now?
Your cloud-based accounting provider can help auto-generate some important reports, so you can better understand your business. Here are some reports and financial statements to watch out for:
Balance sheet: This statement is a snapshot of what your business owns and owes at a given moment—assets, liabilities, and owner's equity.
Accounts receivable aging: This report helps categorize your accounts receivable based upon the length of time of the outstanding invoice.
Expense report: It’s important to have an itemized and categorized report of your expenses for both budgeting and tax reporting purposes.
Profit and loss statement (P&L): The P&L statement is a summary of your revenue, expenses (like cost of goods sold), and profit over a period of time. It’s sometimes referred to as an income statement.
Cash flow statement: This report shows the actual cash moving in and out of your business over a period of time, broken into operating, investing, and financing activities.
Budget vs. actual report: Compares planned budget to actual income and expenses, and shows where the business is over or under budget in real time.
Sales tax report: Summarizes sales tax collected and owed, which comes in handy at filing time.
General ledger: The full record of every transaction, categorized by account. This report is more granular than the others and is useful for a deeper audit trail.
Now that you’ve mastered the basics of small business accounting for your day-to-day operations, you’ll want to watch out for the end of the year. Don’t worry, we have a checklist for that (and many of the important end of year reports can be generated by your accounting platform).
If you haven’t done so already, consider switching your payroll provider to Gusto at the end of the year. Like accounting, payroll processing is so much easier with the right software—especially one that integrates with all the popular cloud-based accounting providers.
Now that you’ve learned the basic ins and outs of small business accounting, consider bringing in an external bookkeeper or accountant to help you manage your books as you grow.
FAQs
What's the difference between cash basis and accrual accounting?
Cash basis accounting records revenue when cash is received and expenses when they're paid, with no accounts receivable or payable involved. Accrual accounting records revenue and expenses when they're earned or incurred, regardless of when cash moves. Most small businesses start with cash basis, then switch to accrual as they grow, since it better reflects long-term financial health and follows the matching principle.
What financial reports should a small business generate regularly?
Small businesses should regularly generate a balance sheet, profit and loss (P&L) statement, and cash flow statement, since together these give a complete financial picture. Other useful reports include accounts receivable aging, expense reports, budget vs. actual comparisons, sales tax reports, and the general ledger. Most cloud-based accounting software can auto-generate these.
What's the difference between the current ratio and the quick ratio?
The current ratio measures a company's ability to cover short-term liabilities using all current assets, including inventory and receivables. The quick ratio measures the same ability but only counts the most liquid assets, excluding inventory. Both help small businesses gauge short-term financial health, but the quick ratio gives a more conservative view.
Is cloud-based accounting software worth it for a small business?
Yes. Cloud-based accounting software connects easily with other tools like time tracking, expense management, and payroll, and can auto-generate key financial reports. It also scales as a business grows and simplifies working with outside bookkeepers or accountants, who typically use the same platforms. For most small businesses, it replaces manual tracking with error-prone guesswork.
What is Days Sales Outstanding (DSO) and why does it matter?
Days Sales Outstanding (DSO) measures the average number of days it takes a business to collect payment after a sale. A high DSO means a business is extending too much credit and collecting cash too slowly, which can expose it to working capital shortfalls. Tracking DSO helps small businesses stay on top of collections and cash flow.
Quick note: This is not to be taken as tax advice. Since tax rules change over time and can vary by location and industry, consult a CPA or tax advisor for specific guidance. Find an accountant
