Like any small business, your tax preparation practice will require bookkeeping and accounting. There’s no one method that’s right for every small business, but at the very least you’ll need a business account, an accounting method, bookkeeping software, and a knowledge of how to file quarterly business taxes.
While you already have some of the knowledge and skills you’ll need to successfully keep books for tax purposes, bookkeeping and accounting for the purpose of managing your small business entails a little more.
Creating a business bank account
Once you’ve registered your tax business with your state, you’ll want to make sure you set up a business bank account. This keeps your personal and business finances separate and will make it far easier to keep your books. If you’ve registered your business as an LLC, you’re required to have a business bank account.
Cash vs. accrual-basis method for accounting
With your business bank account ready to go, next you’ll determine whether you’ll use the cash or accrual based method of accounting to keep your books. The cash-based system recognizes revenue and expenses when they actually hit your bank accounts. The accrual method recognizes revenue and expenses as soon as the product or service has been delivered, even if payment hasn’t hit your bank account yet.
For example, let’s say you prepare taxes for a client in February but don’t receive payment until May. With cash accounting, you won’t recognize that revenue until May. With accrual-basis accounting, you’ll recognize it in February. The cash system is somewhat simpler since the accrual-basis method requires double entries for each transaction – a debit in the account that decreased and a credit in the account that increased (such as accounts receivable and accounts payable).
Most large businesses are required to use the accrual method. As a small business owner, the choice is up to you. Though it does take more work, accrual-basis the more common method as it often gives a more accurate picture of your finances. However, using the cash method can save you valuable time as you won’t need double entries for each transaction. If your expenses are straightforward and you typically receive payment quickly after you perform services for clients, you might opt for the time-saving cash method.
Bookkeeping & payroll software
You already know that the right professional tax software makes all the difference when you’re filing your clients’ taxes. The same holds true for bookkeeping and accounting software. Ideally, your bookkeeping software can sync with your business account so you can avoid manual entries and can generate financial reports and statements automatically.
It should allow you to upload scanned receipts to your expense entries and choose between cash and accrual-basis methods. If you have employees (or seasonal contractors during tax season), you’ll also want to invest in payroll software like Workful.
Entering and categorizing transactions
With your method of accounting and bookkeeping software in place, you can then begin to categorize transactions imported from your bank account. If you’re using accrual-basis accounting, you’ll enter transactions manually when they occur and then reconcile them with the payments that hit your bank account. It’s a good idea to review your transactions and attach any relevant scanned receipts or invoices at least weekly. This way, keeping your books will never become a daunting task, and you won’t lose copies of your receipts.
Tracking profit, loss, and cash flow
At least once a quarter, try to review key financial statements like your profit and loss sheets and cash flow sheets. As long as you’ve been keeping up with your books, your bookkeeping software can probably generate these reports for you automatically.
The profit and loss sheet includes your expenses and revenue in any given time frame (usually per month). For tax preparers, this information will allow you to monitor profits or losses in off-season compared to busy season, making it easier to set income goals for each quarter.
A cash flow sheet helps you keep a pulse on the money going in and out of accounts. If you use the cash-basis method of accounting to keep your books, you’ll already have a strong sense of your cash flow. But if you use the accrual-basis method, you’ll want to review your cash flow sheets regularly. Your books could show higher amounts than the actual cash in your accounts if you have outstanding invoices to clients.
Another common financial sheet is the balance sheet, which compares assets and liabilities (i.e. what your business owns vs. debts). Balance sheets tend to be less relevant for professional tax businesses than they might be for other small businesses. Thanks to the industry’s low cost of entry, many tax preparers never take on major debt for their business, and assets are often limited to computers and other office technology. Still, if you do have significant debts or assets like office space, or if you are thinking of taking on debt to expand your tax practice, a balance sheet can help give you an accurate idea of what your business is worth.
Should you hire a bookkeeper or accountant?
It depends on the size of your tax practice, your budget, and the time you want to devote to bookkeeping. If you’re operating as a sole proprietor, your expenses and revenue are probably relatively simple, and you can likely manage your books easily. The larger your practice, the more sense it makes to hire bookkeeping or accounting help, as you’ll spend significant time keeping your own books.
This article was last edited on September 13, 2021.