What Exactly Is Bookkeeping? A Small-Business Owner’s Manual
Good bookkeeping is required in order to have the financial information needed to make intelligent business judgments.
Among the first issues that new company owners confront is maintaining track of their company’s books. Excellent bookkeeping is important not only to submit your tax returns each year, but also to have the business information you need to make smarter business choices.
Even with this innate understanding of the need for bookkeeping, many business owners are perplexed. What is bookkeeping, exactly? What exactly is the distinction between bookkeeping and accounting? What exactly is bookkeeping, and what can you demand from your bookkeeper?
Concept of bookkeeping
Bookkeeping is roughly described as the tracking of a company’s business activities. It is a component of a company’s overall accounting procedure. Bookkeeping might be done on a daily basis or as seldom as annually.
In his book Review of Arithmetic, Geometry, Ratio, and Proportion, in the late 15th century, Luca Pacioli, an Italian mathematician and Franciscan monk, defined double-entry bookkeeping.
That’s correct: “modern” bookkeeping dates back more than 500 years. Whereas the fundamentals of accounting have remained unchanged for over 500 years, the method of bookkeeping has. Previously, bookkeeping was done manually with physical books called journals and ledgers. Since bookkeeping is based on double-entry accounting, activities must be recorded twice (the journal and the ledger). Before financial statements could be issued, the books would have to be matched each month (known as a “trial balance”).
In other terms, bookkeeping was a full-time job for a company.
The introduction of automated accounting software dramatically reduced the tedium of bookkeeping. Technologies such as optical character recognition (OCR) and banking streams have come close to replacing the conventional bookkeeping procedure. Data entry can now take place as soon as you photograph a receipt using your mobile phone. And, thanks to daily bank feed upkeep, reconciliations are practically real-time, giving the end-of-month closure process a breeze. Now, a single bookkeeper can handle the bookkeeping for multiple enterprises in less than eight hours each day.
Accounting vs. Bookkeeping: What’s the Difference?
Numerous individuals use the terms “accounting” and “bookkeeping” interchangeably. Although many bookkeepers today perform traditional accounting functions such as advising customers on their finances, there is a distinction between bookkeeping and accounting.
Bookkeeping is primarily focused on information management and recording. Bookkeepers ensure that all the information in the books is correct and that the books are balanced at the end of each month. In essence, they have finished the very first step in financial accounting.
Accountants, on the other hand, evaluate a business’s financial condition as well as provide financial recommendations to the company owner based on the data given by bookkeepers. Most accountants also work with lenders, possible buyers, and investors to create tax returns, independent reviews, and certified accounting records.
Accountants usually have a bachelor’s degree in accounting, and numerous go on to become Certified Public Accountants (CPAs) or Certified Management Accountants (CMAs) (CMAs). Bookkeepers may have accounting credentials, but the majority have technical certificates or on-the-job experience.
Bookkeeping terminologies
Bookkeeping does have its own vocabulary, and bookkeepers and accountants frequently overlook the fact that business owners may not be proficient in it. The terminology listed below are some of the most prominent accounting terms you will come across whether doing bookkeeping or dealing with a bookkeeper or accountant. This is not a comprehensive dictionary, but rather a primer:
The accounting equation
The accounting equation is the essential equation for keeping your books in order. Assets = Liabilities + Equity is the equation. The accounting equation can be seen in practice on your company’s balance sheet.
Assets
Everything your company holds. Cash, buildings, vehicles, patents, and outstanding invoices owed by consumers (accounts receivable) are just a few examples of assets.
Liabilities
What your organization owes. Liabilities comprise credit card balances, sums owed to contractors (accounts payable), mortgage balances, and unpaid tax obligations.
Equity
What is owing to the company’s owner or stockholders? Deferred revenue comprise money put in by the owners (contributions) or money made but not collected from the firm (retained earnings), as well as other sorts of significant contribution such as stock issued.
General ledger
Assets, liabilities, equity, revenue, and expenditures are all recorded in the general ledger. Your company’s books are made up of these five categories of accounts.
Chart of Accounts
The list of classifications is what you are using to categorize your company’s transactions. Consider the chart of accounts to be a sort of filing system for your company’s operations.
Debits and credits
Every bookkeeping activity contains two sides (recall that double-entry accounting is used). The debit side is one side of the transaction, while the credit side is the other. Debits add to assets and credits subtract from expenses. Credits enhance income, equity, and liabilities whereas debits decrease them.
Accrual and Cash Basis
Accrual basis accounting records revenue and expenditures as they occur. Cash basis accounting records income when it is collected and costs when it is paid. More information can be found in our accrual vs. cash basis accounting guide.
Reconciliation
The practice of comparing the balances of various accounts (checking, credit cards, loans, etc.) to reports from an outside source, typically a bank.
Income
The revenue generated by your company’s sales.
Expenses
Money spent by your company on activities and maintenance.
Cost of goods
Money spent by your company to generate revenue.
Profit
What your company made after deducting the cost of items sold and costs. Profit does not equate to cash on hand.
Typical bookkeeping duties
To different individuals, bookkeeping implies various meanings. Some bookkeepers specialize entirely in “write up” work, which entails quickly collecting the books, typically for tax preparation reasons. Other bookkeepers offer “full-service” services and can even act as your corporation’s economic controller.
There are four basic categories of full-charge bookkeeping tasks.
1) Data entry
Data entry entails entering your company’s activities into your accounting system. As previously stated, much of the data entry is now fully automated, either using OCR or bank feeds.
However, data entry entails more than simply entering numbers into software. Proper data entry requires
Source document verification:
It is the phase that is frequently overlooked when doing bookkeeping directly from bank feeds. Preferably, your data entry should come from source documents such as receipts or bills, rather than the bank feed. This guarantees that only legitimate business transactions are recorded in your accounting system. Today’s bookkeeping technology enables you to take a picture of or scan in your source papers, and then OCR technology extracts the relevant information and does most of the data entry for you. This ensures you may retain documentation validation while also benefiting from your accounting software’s time-saving technology.
Accurate classification of transactions:
Every entry in your bookkeeping system has an effect on at least two accounts in your company’s chart of accounts. Good data entry-or data management if you use automation for data entry-ensures that activities are assigned to the correct accounts. Appropriate transaction classification allows you to generate financial planning reports that may be utilized to make strategic company decisions.
Accurate identification of transactions:
One disadvantage of certain bookkeeping systems is that the artificial intelligence behind them can make errors that a person would not make while entering the information. The most prevalent of these errors is associating the incorrect payee name with a payment. You must ensure that your transactions are properly identified. This is especially crucial when making payments to vendors who will require a 1099 Form at the conclusion of the tax year.
2) Administration of the office
Many office administration responsibilities, including client billing, vendor payments, and payroll, are classified as bookkeeping tasks. While accounts receivable, payable, and payroll have an influence on your books, some of these responsibilities can be handled by somebody else instead of your bookkeeper. Others, including payroll, can be outsourced to separate firms that specialize in the job.
If your bookkeeper invoices your clients or pays your suppliers and staff, make sure you have adequate regulations in place to prevent fraud.
3) Closing of the period
At the end of the accounting period, company books must be concluded. At the end of the term, every bank, credit card, and loan accounts must be reconciled.
Accounts payable and receivable reconciliation
Adjusting for any anticipated income or expenditures, amortization, or other exceptional occurrences
Examining the income reports for completeness and correctness
After the period closing has been accomplished, the books are locked so that they cannot be modified (optional, but highly recommended).
4) Internal management reports
Certified financial reports for creditors, purchasers, and investors can only be prepared by a licensed CPA. Your bookkeeper, on the other hand, can generate internal management reports for your company.
Your bookkeeper can create three types of internal management reports for your company:
1) A balance sheet is a picture of your resources, debts, and equity at a specific point in time. It’s your company’s version of the accounting equation: Assets = Liabilities + Equity in reality.
2) Your income statement (also known as a profit and loss statement or P&L) summarizes your company’s revenue and costs for a specific time period (a month, quarter, year, etc.). It reveals whether your company made a profit or suffered a loss.
3) For accrual-basis firms, your cash flow statement rationalizes the income statement to the balance sheet and addresses the query, “Where did the cash go?”
A cash basis or an accrual basis can be used to generate the balance sheet and income statement (the cash flow statement is always an accrual basis report). Despite the fact that accrual basis statements are more precise, most company owners consider cash basis reports simpler to comprehend.
Additional auxiliary reports for your firm, such as accounts receivable and accounts payable aging statements, may be prepared by your bookkeeper. These unaudited accounting records and auxiliary reports can be used to make business choices based on your accounting system’s data, but they must not be portrayed as inspected, authorized, or formal financial statements.
Not all creditors and investors demand verified or certified financial accounts. Nevertheless, before presenting your bookkeeper’s financial accounts to a third party for evaluation, you should have an accountant evaluate them for accuracy and consistency. Even if you’re not eager for money, you should have your financial statements reviewed by an accountant at least once every year.