Bookkeeping is keeping a record of everyday transactions occurring in a business in an organized manner. A person who does this job is known as a bookkeeper. Bookkeeping allows a company or an organization to know its current financial situation. It plays an important role in forming the company’s account statement at the end of every year. Without it, the company won’t be able to know the flow of money in the company.
Why is Bookkeeping important?
Bookkeeping lets a company know where it stands. The company gets to know whether it is profitable or not. If not, the company can develop strategies and plans for the future and can go in a positive direction. It allows the company to clearly see areas where profit can be expanded as it is well organized.
Small companies hire bookkeepers to keep a record of the transaction in the company as it is cheaper than hiring a full-time accountant.
The most important aspect of bookkeeping is that you can look back at past records and get the required information instantly. Therefore the management of money becomes easy and less time-consuming. An investor can know better about a company and make intelligent decisions when investing in that company through the company’s book.
Some basics about business accounts
There are 5 important types of accounts in business-
- Assets– cash and resources that the business owns
- Liabilities– obligations and debts owed by the business
- Revenue– total money earned by the business
- Expenses– flow out of the cash from the business in any form
- Equity– subtracting liabilities from the assets gives you equity.
Bookkeeping involves keeping a record of these accounts like supplies-asset, rental income revenue, etc.
Methods of bookkeeping
- Single Entry- It is the most basic form in which each entry is entered only once. If you want to keep a book for your home or small business and shop you can use this method. You do not require a trained person for keeping this type of record.
- Double Entry- This is more complex than the single-entry bookkeeping system as the book should be always balanced in this type of system. It has two things debit and credit. If an amount is debited from one account it should be credited in another account. This is the preference of most companies and big organizations.
Accrual vs Cash basis of accounting
Before keeping a book you need to decide which basis of accounting you will follow. You can choose between the cash basis of accounting or accrual basis of accounting.
In the cash basis of accounting a transaction is recorded only when cash is given or received whereas on the accrual basis of accounting a transaction is recorded even if there is no flow of cash.
Let us consider we took some raw material but we will pay for it later. This transaction would not be recorded if we are following the cash basis of accounting as no transfer of money is there at the moment but would be recorded if you are following the accrual basis of accounting.
Bookkeeping vs Accounting
Bookkeeping is the basis of accounting, and not it’s alternate. Accounting requires special skill and knowledge whereas bookkeeping can be done by anyone. Book-keeping consists of recording financial transactions in a logical fashion. Accounting concerns itself with summarizing such recorded financial transactions.
Basic steps
Here are some basic steps of bookkeeping you should know:
Set up your business account
Choose your account type and create a general ledger (GL) for it. You can use a spreadsheet or online or offline bookkeeping software for maintaining GL. Software is expensive but is a one time buy.
Decide the bookkeeping method you want to follow and account basis you would use
As discussed above you can choose between the single-entry bookkeeping method or double-entry bookkeeping method as per your requirement. A debit is entered on the left side whereas credit on right.
If you are keeping the book of a large organization it would be better if you use double entry.
There are some rules you need to keep in mind while following double-entry bookkeeping:
- For each transaction, the total amount entered on the left side of an account must be equal to the total amount entered on the right side of another account
- For each transaction, the total of the debit amounts must be equal to the total of the credit amounts.
- Debits must equal credits.
Record every transaction correctly and in its respective account.
Let imagine if you bought some equipment worth Rs 5000. So you would make two entries. One in cash account debit of Rs 5000 on left and in equipment account credit of Rs 5000 on right.
Balancing the book
When you go through the book after a quarter or six months the total should match. This means that the book is balanced.
When you enter entries to the account in general ledger you should adjust the account balances accordingly. When you combine two accounts the adjusted balance should satisfy the equation
Assets = Liabilities + Equity
If two sides of the equation don’t match then you need to search for errors in the past entries.
Make a financial report.
The last step is to make a financial report. By closely examining the book, develop a financial report to know where your business stands. You can make use of this report to implement future strategies and decisions.
Some types of financial reports are:
- Profit and loss (P&L) statement, business revenues, costs, and expenses are broken over a period of time (e.g., quarter) in this report. The P&L helps you analyze your sales and expenses and make future decisions.
- Cash flow statement. The statement of cash flow is similar to the P&L, but non-cash items such as depreciation are not included. Your earning and expenditure are well organized in the cash flow statement.
Understanding basics would help you in making a well-organized book thus helping in managing your finance. Therefore it is a good practice and would help in growing your business potential.