Bookkeeping is a simple word that can inspire dread for most of the business owners. Besides, keeping track of your business’ finances may seem overwhelming. However, it can be annoying, but bookkeeping is a non-negotiable part of your business. This bookkeeping 101 guide gives you an in-depth look at expenses and revenue.
Small businesses can choose a simple bookkeeping system that may record each financial transaction in the same manner as a checkbook. Contrarily, companies with more complex financial transactions usually opt for a double-entry accounting process. Nevertheless, if learning the ropes of small-business bookkeeping sounds intimidating, don’t fear. Instead, just keep reading the tips we list below.
What is Bookkeeping?
Bookkeeping is the process of recording each financial transaction made by a business firm from the opening to the closing. Depending on the type of accounting system, you record each financial transaction and is based on support documentation. Moreover, that document can be a receipt, an invoice, or a purchase order shows the transaction took place.
Bookkeeping is the principal way business owners can figure out their business is profitable. Along with that, bookkeeping helps to identify specific areas of profit expansion. Interestingly, you can also record bookkeeping transactions with a hand journal or using spreadsheet software like Microsoft Exel. But now, most businesses use specialized bookkeeping software that shows that financial transactions.
Is Bookkeeping Important For Your Business?
One of the primary decisions you have to make while setting up your bookkeeping system is whether to use an accrual accounting system or not. In case you are operating a small, one-person business from home or a one-person office, you might want to stick with cash accounting.
With cash accounting, you record your transaction when cash changes hands. But with accrual accounting, you will record purchases or sales immediately, even if the money does not change its hands. Sometimes, firms start their business with cash accounting and switch to accrual accounting once they grow.
Further, you also need to figure out as a new business owner that you will use a single-entry or a double-entry bookkeeping system. Single entry is more like keeping a checkbook as you record transactions when you pay bills and make deposits to your company account. However, it only works if your company is relatively small, with a low transaction volume.
If your company is large and complex, you need a double-entry bookkeeping system. At least two entries are made for each transaction, like at least one debit is made to one account and one credit to another account. This is fundamental to double-entry accounting.
Understanding Assets, Liabilities, and Equity
Effective bookkeeping requires an understanding of the company’s basic accounts. These accounts and their sub-accounts make up for the company’s chart of accounts. For instance, assets, liabilities, and equity make up for the accounts that compose the company’s balance sheet. As a business owner or a founder, you might not be aware of the ins and outs of this process. This is where a bookkeeper comes in. As per Entreprenuer.com,
“Not many founders have backgrounds in finance or even a working knowledge of accounts payable, accounts receivable and taxes. It’s better that a professional who took courses and was certified in these areas handle those aspects of the business.
What are assets? They are company-owned such as its inventory and accounts. It also includes fixed assets like factories, equipment, and land. Further, in balance sheets, the asset accounts are listed in order of their liquidity. Asset accounts start with the cash account as it is entirely liquid.
After cash, there is inventory, receivables, and fixed asset accounts. However, these are tangible assets as you can touch them. Balance sheets also have a company’s intangible assets like customer benevolence, which can also be listed.
Liabilities are what the company owes. They are the obligations and debts owed by the business. Like company owes to their suppliers, loans, mortgages, and any other debt on their books. The liability accounts on a balance sheet that includes both current as well as long term liabilities.
Current liabilities are usually payable accounts and accruals. Accounts payable are what the business owes to suppliers and bank loans. Accruals consist of taxes that include sales tax, federal, state, and medicare tax on employees you normally pay quarterly. Long term liabilities have a maturity of greater than one year and include items like mortgage loans.
Equity is the investment that a business owner or any other investor has in the firm. Further, the equity accounts include all the claims the owner has against the company.
In bookkeeping, you have to balance the books at the end of the year. Of which the bookkeeper has to keep track of these items carefully. There is an accounting equation used to make sure that books always balance.
Assests= Liabilities + Equity
The accounting equation stands for everything the business owns is balanced against the company.
Understanding Income Statement: Revenue, Expenses, and Costs
You develop an income statement using revenue from sales, expenses, and costs. To follow bookkeeping 101, you need to record each financial transaction in the accounts journal that falls into one of these categories.
It comprises of all the income a business receives while selling its products or services.
Costs or cost of goods sold is all the money a business spends to buy or manufacture the goods. It also accounts for the services it sells to its customers. Along with that, the purchase amount on the chart of accounts tracks the purchased goods.
Expenses include all the money that is spent to run the firm. However, it is not explicitly related to a product or service that is sold. For instance, an expense account is salaries or selling and administrative expenses.
Hence, a bookkeeper is responsible for identifying the accounts in which transactions are recorded. To illustrate, if a business makes a cash sale to a customer and your business uses double-entry bookkeeping, you will record the cash you receive in the asset account, ‘Cash,’ and record the sale in the revenue account ‘Sales.’
Now that you have created your set of financial accounts and picked a bookkeeping system, now it’s time to record what’s happening with your money. Bookkeeping 101 also states that you should register all debit and credit transactions correctly and in the right account. Else, your account balances will not match, and you won’t be able to close your books.