Understanding the pros and cons of digital record-keeping and automation

By Myriam Delmy and Laura Freschi

In the United States, even the smallest businesses are connected to a digital ecosystem. We’ve found that the firms in the Small Firm Diaries USA study typically prepare records for quarterly or annual tax filings on some type of software, and these records are often linked to other digital financial information including bank and credit card accounts, point-of-sale (POS) and payroll services. 

This means that for the US arm of the study, the research team can draw on existing digital bookkeeping records, a major difference from other countries in the study. In our Kenyan sample by contrast—to take the most digitized of the other Small Firm Diaries countries—20% of firm owners kept no business records at all. Of those 80% who did keep records, the large majority did so using paper receipts, books, or ledgers; while digital record-keeping, primarily through mobile phone apps, was below 15%.

Leveraging digital record-keeping in the US allows us to rely less on frequent transaction surveys, and ask less of firm owners’ time for this purpose. This is potentially a great advantage since firm owners are busy, and more time spent exchanging financial records could mean less time sharing experiences in deeper-dive surveys. Still, interpreting and standardizing firms’ digital financial records is far from simple—maintaining consistent, accurate financial records can be difficult for small firms juggling multiple priorities.

To clean, verify, and then standardize the records we get, our team has engaged two professional bookkeeping specialists who work alongside the field research team (our lead bookkeeping specialist is Myriam Delmy, author of this blog). Though time-consuming and labor-intensive, the data cleaning process has allowed us to glean interesting insights into how small firms keep records, the common errors they make, and how these mistakes affect firm owners’ ability to manage resources. 

Books are digitized, but not always accurate or useful

In the US sample, nearly all the firms (over 95%) keep digital records. Most of these firms use cloud-based accounting software (usually Quickbooks; a few mention Wave or Zero or other free or niche programs). These same firms typically have linked their bookkeeping software to bank accounts, point-of-sale (POS) systems, and credit cards. A minority of the digital record-keepers (about 15%) use Excel or Google Sheets, which are not automatically integrated with bank accounts.

We might think, given high levels of both digitization and bank account integration, that the books are pretty accurate, and we might hope that firm owners are able to use these sophisticated digital tools to manage the business. But here again the picture is complex.

*Photo taken by a SFD USA Relationship Manager

Related to accuracy: when the bookkeepers on our research team review the books, we see a lot of errors. On the profit and loss (P&L) statements, common problems include missing or irregular entries such as rent, cost of goods sold, or bank fees, which we find are not updated regularly but rather back filled at a later date. We also see some common problems on the balance sheet—for instance, “cash” or “uncategorized” accounts that seem unusually large, and turn out to be placeholders used by the firm owners to reconcile their books rather than an accurate reflection of the amount of cash on hand. 

One consequence of these balance-sheet blind spots might be the over- or under- valuation of the firm, which has implications for the firm’s ability to borrow. For example, some firms either don’t record major assets—like an oven at a bakery—or fail to depreciate those assets on the books. Other firms don’t regularly track loan balances, resulting in balance sheets that can’t be deciphered. If these firms have tax accountants, they’d likely clear up these errors when taxes are due. But in the meantime, the persistence of such mistakes in the books makes it hard for firm owners to use them as a reliable tool to run the business. And error-ridden or undecipherable P&L and balance sheets would lead banks to reject applications for larger-sized loans.

Who’s in control? The role of automation

Bank account integration also has a role to play in this equation. Where firm owners have linked their bookkeeping software to bank accounts, point-of-sale systems, and credit cards, the software captures many transactions automatically, which can be helpful. We see two pitfalls, however. One is that automation can give firm owners a false sense of accuracy. We see that owners assume the numbers are right without regularly checking or reconciling them, and small mistakes pile up quietly over time. This may be why we see items as “uncategorized” showing up on the reports.

And, two, even where automated imports do increase technical accuracy and completeness compared to paper records and manual transfer of digital records, it is still possible that owners’ understanding of their business does not increase—that owners still struggle with control tasks (like budget reconciliation, mapping, period close), which are prerequisites for meaningful analysis. This is in line with our observations that most of the firms record transactions primarily to report their annual tax returns—firm owners aren’t using their own financial reports as tools to inform their strategy or access funding.

Fragmented tool stacks can lead to inefficiency

Our team’s bookkeepers have also observed that many firms use a fragmented tool stack, mixing their bookkeeping software with point-of-sale (POS) systems like Square, Toast, or Clover that may not integrate well with one another. 

The lack of integration may stem from the way firm owners are sequencing the adoption of these tools. For instance, firms might start by signing up with a POS system when they open a store so they can sell their products and that’s all they need at first. But as they hire more workers, they realize they also need payroll software. Then, once they are a bit bigger, they may migrate from Excel or pen and paper to Quickbooks to track their sales tax or other transactions to prepare their tax returns. So, at the end of the day, they are paying for three systems, and they may not integrate well together.  

Connecting these observations to broader conversations

It’s interesting to note that the most accessible and visible literature on the topic of small business and record-keeping digitization leans heavily towards benefits. Government agencies, large accounting software vendors, and business associations present a consistently positive and optimistic story line—that use of digital record-keeping, cloud accounting, and related tools is growing quickly for businesses of all sizes, including small business, and that these tools are essential infrastructure that can improve small businesses’ efficiency, accuracy, and resilience. The more balanced of these sources refer to uneven access for vulnerable populations, but generally frame challenges as problems to be solved through increased access or digital and financial literacy training.

On the other hand, the academic literature does capture caveats and risks that echo our bookkeepers’ observations. But these studies are scattered across disciplines, and often originate from outside the US, so they are less visible to the US small business support ecosystem and to small firm owners themselves. Studies like these from Iraq, Ghana, and China present the benefits of digital bookkeeping in a more conditional or contingent way, finding that digital bookkeeping can bring about process efficiency gains, fewer bookkeeping errors, and better awareness of inventory and cash flows.

In general, investments in information communications technologies (ICT) often fail to live up to very high payoff expectations, in part because of publication bias in studies on ICT, but also because these tools don’t automatically translate into measurable productivity or profit gains. In reality, effects are often small. And capturing the full benefits of digital accounting tools specifically is contingent on other, complementary business practices or skills, like basic accounting skills, consistent reconciliation and data checks, and proactively integrating automated reports into everyday management decisions.

Small Firm Diaries USA aims to fill a gap in this data by showing how small firms based in the US manage their bookkeeping in practice. In the coming months, our team will continue to talk to the business owners to understand how factors like skills, cost, and convenience influence their bookkeeping. We will also be able to compare firm’s financial data to survey responses, to get a more complete picture of what is working, what’s not working, and why, and uncover the practices that help some firms thrive while others face persistent challenges. These insights will also provide a clearer picture of the types of support and tools small firm owners value, revealing where current product and service offerings may or may not align with their needs. 

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Myriam Delmy, MBA, is Senior Bookkeeping Specialist on Small Firm Diaries USA. She is an accountant and small business owner. She earned her bachelor’s in accounting from DeSales University and a master’s in business administration in Data Analytics from the University of Southern Indiana. Her work blends strategy, analytics, and real-world experience to drive business.