If you look at online reviews lately, the term "accounting software" gets applied to anything capable of adding two numbers together. So expense trackers, invoicing applications and other lightweight software in the cloud get lumped in with real, double entry accounting applications like Wave. It drives me nuts.
But is that bad?
Actually, yes, it is. And not just because I like promoting Wave. When small business owners use a "lite" software tool to do their accounting, it can cost them money and hurt their business.
If you're running a business, you need to use a double entry accounting system. (What's double entry and how do you recognize it? See the end of this post.) The good news is that you don't even need to know what double entry is! The double entry work happens behind the scenes, and sets you up for better success, with more money in your pocket, without requiring any special work from you.
But don't take my word for it. I asked some independent small business accountants for their perspective on whether double entry accounting matters. Here are some of the reasons they gave:
Reason 1: Double entry accounting will minimize your income tax.
Deductions and proper reporting can make a huge difference to any business. “It matters for every small business, even little ones that sell things on Etsy,” says William Lopez, Partner at TropezCPA and Founder of AdvisorFi in West Palm Beach, Florida. “I tell them, ‘You use a computer to log onto Etsy? OK, that’s a fixed asset we need to depreciate to save you money'."
"For bigger businesses, I tell them about a client whose tax bill I chopped from $150,000 to $30,000 just by flipping the accounting method and utilizing the double entry side of things. Without double entry, I can’t do that.”
Reason 2: You have a business loan. Or you might want one some day.
"Without real double entry accounting, you might not be able to get a loan in the first place,” says Anna Abbruzzese, president of Actium Consulting Inc. in Toronto, Ontario. “Lenders want to see a balance sheet,” and you can only get a balance sheet with double entry.
Think of the stuff you need in order to get a personal loan or mortgage: The bank wants to know your assets like cars, property, investments and so on. Same goes for your business loan. A balance sheet will provide the right info. An expense tracker or income/invoice tool will not.
Once you have the loan, you need to track it properly, too, and you can't do that without double entry. “Invoicing applications might track your income and expenses. However, a loan isn't income,” says Maggie Geiser, an accounting and bookkeeping advisor in Vancouver, British Columbia. “The interest that you pay on that loan is an expense, but the principal you pay is not. How do you track that without proper double entry?”
Reason 3: You want to be awesome.
“Research shows those who use full double entry accounting are more confident and have a better understanding of what they need and what they can do to make their business more of a success,” says Abbruzzese.
Reason 4: You want your business to grow.
“If you think your business is going to grow at all, and you want to develop good business habits,” Geiser says, “double entry is absolutely the way to go because it will discipline you and get you looking at the reports you ought to be looking at.”
Reason 5: Business decisions matter to you.
“You can’t make accurate decisions without having a complete financial picture,” says Andrew Wall, CPA, CMA, a partner at Wall & Associates in Toronto. “And without double entry accounting and without a balance sheet, you don’t know the financial position of the company.”
Lopez adds, “Within the balance sheet I derive a lot of intelligence, like: How efficient is your company? Are you even aware that it takes you 40 days to get paid from an invoice?”
“Especially with small businesses where things are changing — and changing rapidly — people need to be able to make informed decisions quickly and accurately,” Wall concludes.
There's more, of course. Anna Abbruzzese told me, "We would never work with a single entry accounting system. Ever.” But ask your own accountant and form your own opinions.
When is it OK to not use double entry?
There used to be 3 good reasons to avoid old-school double entry accounting software:
- It was too hard to use.
- It was too expensive.
- It took too much time.
That's no longer the case, especially with Wave. So today, in the same time and with the same effort it would take you to do it wrong with "lite" software, you can do it right with a double entry accounting system in the cloud.
"Lite" software may have its purpose — some of it is pretty great at its intended purpose, like invoicing or expense tracking. But don't confuse it with accounting, or you could wind up paying for it, now and down the road.
How do I know if my software is real accounting or "lite" accounting?
Here's what you need to look for, or ask for:
- Simply asking if something is double entry is usually enough. A real double entry application will tell you that's how they crunch your numbers.
- If the software doesn't give you a Balance Sheet, or only has a work-around solution to get you close to a Balance Sheet, then it's not real double entry. A Balance Sheet is a critical report that any accountant will need to save you money. And as you get more experienced, you'll be able to learn from it, too.
- A proper accounting application allows you to create Journal Entries or Journal Transactions. This is the old-school way of entering info into an accounting application, and it illustrates what double entry means. In each Journal Transaction there are two offsetting entries. It allows you to track where money came from and where it went, and a whole lot more. If your software doesn't allow you to use Journal Entries/Transactions, it's not real accounting.
If the software you're considering covers these 3 bases, you're probably looking at a real, double entry accounting application. Of course, Wave offers all these features and then some.
As I mention above, the great news is that you don't actually need to know what's happening under the hood of a double entry system. What's important is that it is a double entry system, and that those powerful tools and reports are available for you and/or your accountant when you need them.
So next time you see someone say "accounting software" when what they mean is "expense tracking" or "invoicing tool," please join me in sending them the graphic at the top of this post! You can get it any time from http://bit.ly/REALaccounting .