Running a one-person business is difficult and the mass of details that come with keeping good accounting records can seem overwhelming. But it has to be done, so here are some tips to help you understand sole proprietor bookkeeping.
When you’re a sole proprietor, it’s important to note that the IRS does not see your business as distinct from your personal life. The income you earn through the business is personal income, in the same way it would be if it came from another employer. This has its disadvantages—you don’t get the flexibility and options that come with various types of incorporation or with an LLC. But there is one big advantage and that’s simplicity.
Having said that, you should still maintain separate accounting records for your business activities. The simplicity of sole proprietorship can make it tempting to just use your personal credit card for expenses and your personal bank account for income. That’s understandable and you can do that, but it would be a mistake.
By not separating your business income and expenses from the personal, your life is going to be more complicated at tax time. Want to compile a list of your expenses for the purposes of getting a tax deduction? If they’re separate from the personal, it’s as simple as adding them up. If they’re combined, you’re combing through your credit card statements trying to pick out the ones the charges that were for business—and trying to recall if that gas charge came on a business trip or on vacation.
The same goes for income. When you made that big deposit into your account last February, how much of it was business income and how much was from other sources? The failure to separate the business from the personal sets you up for mistakes and perhaps not getting all the deductions you deserve.
You want your sole proprietorship to be successful enough where you can hire an accountant and simply give them all your receipts. But whether you’re at that point or still on the journey, it’s also important to have your own understanding of the process. Maintain a cash disbursements journal. Understand why you, as a sole proprietor, use a single-entry accounting system as opposed to the more common double-entry format.
Good accounting software is a terrific idea and products ranging from QuickBooks to Xero to Sage, and a whole lot more can solve your accounting challenges. We won’t say that it’s as easy as the commercials Danny DeVito does for QuickBooks make it look, but any of these products will simplify your life. Each product has different features depending on what role your sole proprietorship plays in your life (e.g., side gig or full-time), so pick the one that works best for you.