What Are the Accounting Principles for a Sole Proprietor?
Sole proprietorships are businesses that are intimately linked legally and financially with their owner operators. When a sole proprietorship loses money, its owner takes a personal loss and when it earns money he is taxed on it as personal income. Accounting principles for a sole proprietorship should create enough of a division between a business owner's personal and business finances to determine which expenditures are legitimately tax deductible. At the same time, a sole proprietor's accounting system should integrate the connection between business and personal finances by tracking the flow of funds between different accounts.
Sole proprietors are not required to have separate bank accounts for their businesses. However, they are required to keep track of which transactions are personal expenses and which accrue to their businesses. Keeping a separate business account makes it simpler for a sole proprietor to separate business and personal purchases. A sole proprietor who does not have a separate business account can track purchases and business revenue by keeping sales and purchase ledgers, and entering relevant information using purchase receipts and billing invoices.
For a sole proprietorship, taxable profit is the amount left over after subtracting operating expenses from gross revenue. Sole proprietors are liable for income taxes on this net amount regardless of whether or not the owners withdrew money for personal use. Sole proprietorship accounting for tax purposes should track profit by tallying income and expenses. However, sole proprietorship accounting for cash flow and business management purposes should also focus on how much money the owner withdraws or adds to business operating funds.
A sole proprietor's personal credit is the basis for his business financing prospects. A sole proprietor's strategy for funding cash flow shortfalls depends on the owner's personal resources and ability to provide operating capital out of personal accounts and also on his tolerance for risk and willingness to incur personal debt. Sole proprietorship accounting should be as objective as possible when evaluating these options, making careful projections and considering multiple scenarios.
A sole proprietor has the final decision-making power when making business purchases, but she won't be able to buy anything if she doesn't have the money. Sole proprietorship accounting can facilitate purchasing processes by providing information about cash flow and profit. These numbers should offer insights as to whether the purchase has the potential to improve the company's bottom line by introducing efficiencies or lowering costs and whether the business has the resources to afford the expenditure.