30-Second Summary:

  • Bookkeeping is simply the process of recording and tracking financial transactions made by a business. 
  • How to choose the right bookkeeping software for your business. 
  • Whether to use cash accounting or accrual accounting. 
  • There are five basic types of accounts involved in bookkeeping. This is what you must know about each. 
  • What is a chart of accounts and how does it relate to each account’s sub-categories.
  • There are three basic rules of double-entry bookkeeping. Be wary of this common mistake made by non-accountants.
  • Make sure to organize and track the certain tasks that you need to complete on a daily, monthly or yearly basis.
  • Read on to learn the key reasons why experts recommend using bookkeeping software.

 

Having a basic understanding of bookkeeping is essential for all business owners. This applies regardless of whether you maintain your own accounts or you have a dedicated team of bookkeepers to manage the process. Bookkeeping isn’t as complicated it sounds. Unless you run multiple businesses with complex segments, you can easily take control of the somewhat straightforward task of maintaining the books. Let’s look at what bookkeeping is and how, being a non-accountant, you can start bookkeeping from today.

What is Bookkeeping?

Bookkeeping is simply the process of recording and tracking financial transactions made by a business. It is similar to how you keep track of your personal income and expenses, with some additional considerations. All the transactions are recorded on the basis of supporting documents. These may include invoices, bills, receipts or any other form of evidence. 

Although used interchangeably, bookkeeping is different from accounting. The former merely involves maintaining the records, whereas the latter involves analyzing, categorizing and presenting useful financial information to the business stakeholders. 

Precisely, the role of a bookkeeper involves sending and receiving invoices, making payments, recording receipts and keeping a track of business debtors and creditors. 

How to Set Up Bookkeeping for Your Business?

The very first step in the process is to decide the right bookkeeping platform. You can use spreadsheet software, such as Microsoft Excel, or dedicated bookkeeping software, such as QuickBooks or FreshBooks. There are pros and cons of each, and you need to perform additional research to make the right choice.

The next consideration is whether to use cash accounting or accrual accounting. Cash accounting is simple – you record the transactions when the cash is received or paid. Accrual accounting is slightly complicated – here you need to record the transactions when they occur, regardless of when the cash is received or paid. For example, if you sell goods on credit on December 20, 2021, and the customer pays on January 05, 2022, you will record the transaction in 2021 under the accrual basis of accounting.

While cash basis sounds easier, it is not recommended unless you run a very small business with no inventories. Many tax authorities only permit accrual basis, which is why you need to adopt it sooner or later.

Types of Accounts

In the context of bookkeeping, the term ‘account’ does not refer to a bank account. Instead, it refers to a category that we use to classify the transactions. There are five basic types of accounts: assets, liabilities, equity, income and expenses. The first three are balance sheet accounts and the last two are income statement accounts. Let’s explore them further.

Balance Sheet Accounts

A balance sheet simply shows the resources owned and owed by the business. At the most basic level, it is illustrated as:

Assets = Liabilities + Equity

  • Assets: These are the resources owned (or controlled) by the business. Common examples include cash, inventory, buildings, accounts receivables etc.
  • Liabilities: These are the obligations and debts of the business (bank loans, account payables etc.)
  • Equity: This is the residue left after liabilities are deducted from the asset. It is the amount owed by the business to its owners (or shareholders)

It is easy to make sense of the balance sheet. Whatever you own is either supplied to you by the owners or lenders as indicated by the equation above.

Income Statement Accounts

The income statement shows the amounts earned or spent by the business. The residue of the two is either profit or loss, which is added or subtracted to balance sheet equity at the end of the period.

Profit (or loss) = Income – Expenses

  • Income: Also referred to as revenue, it includes the amount earned by the business in the ordinary context of its operations
  • Expenses: These are the costs incurred to run the business (cost of sales, administrative expenses, finance costs, etc.)

That’s how simple bookkeeping is. You record transactions into each account, and at the end of the period, you take profit or loss from an income statement and absorb it into the equity. 

Chart of Accounts

A chart of accounts, as its name depicts, is simply the list of all the accounts maintained by the business. While there are five basic accounts as discussed above, each account has its sub-categories depending on the business type. The chart of accounts has to be created once a business starts maintaining its books. Bookkeeping software, such as QuickBooks, includes a default chart of accounts, which means you can get started right away.

Let’s now move on to the last complication that baffles all the non-accountants, the double entries.

Understanding Double Entries

Non-accountants are often puzzled by the use of debits and credits. While you can use a single-entry bookkeeping system, such as maintaining a cash inflow and outflow book, it is not recommended and is not consistent with the accruals basis of accounting. Therefore, understanding and applying double entries is the only way out in the longer-run.

Double-entry rules are very simple. However, you need to be wary of the common mistake made by non-accountants of associating a debit entry with an increase and a credit entry with a decrease. This is completely incorrect and the perception will prevent you from understanding the very basics of bookkeeping. 

The Rules to Learn

There are three basic rules of double-entry bookkeeping:

  • Every transaction has to be recorded in at least two accounts.
  • The total debit recorded for each transaction must be equal to the total credit.
  • When assets or expenses increase, we record a debit entry. When income, equity or liabilities increase, we record a credit entry.

The third rule only talks about increase, but as long as you remember the rule for increase, you can reverse it for decreases. Therefore, when assets or expenses decrease, we record a credit entry and when income, equity or liabilities decrease, we record a debit entry.

The third rule may sound daunting at first, but if you read and apply it a couple of times, it gets easier and easier. Since many business transactions involve the exchange of cash, a key tip is to start by assessing whether you have received or paid cash. As cash is an asset, a debit entry is recorded when it increases and a credit entry is recorded when it decreases. 

Let’s have a look at some examples:

  • A business sold goods on cash (The entry is to debit cash asset and credit sales income)
  • A business paid rent expense in cash (The entry is to credit cash asset and debit rent expense) 
  • A business purchased a car on loan (The entry is to debit car asset and credit loan liability)

Schedule of Tasks

There are certain tasks that you need to complete on a daily, monthly or yearly basis. These are as follows:

Daily

  • Record all the cash receipts and payments
  • Record all the sales and purchase invoices
  • Prepare vendor payments and follow up with credit customers

Monthly

  • Prepare bank reconciliation statements
  • Prepare other account reconciliations
  • Send out letters or reminders to customers
  • Prepare monthly profitability reports
  • Record accruals for unpaid expenses and unearned income

Yearly

  • Close the books by recording pending entries
  • Prepare the financial statements
  • Prepare and submit tax returns

Key Tips for Non-Accountants

Stick to the Schedule

It is important to perform all the bookkeeping tasks at their defined intervals. Any delays in completing one task adversely affect the completion of other tasks.

Small, Gradual Steps

If you do not maintain any books, you can obviously not become an expert bookkeeper in a day. A good idea is to start small and then gradually improve. For instance, you can start keeping the details of cash inflows and outflows in a spreadsheet. You can then import this spreadsheet into a dedicated software and take your bookkeeping to the next level. 

Utilize Bookkeeping Software

One of the key reasons why experts recommend using bookkeeping software is the automation of tasks. You can just categorize an item once, and the software will do the rest for you. The software can even help identify any errors and provide you with tips to resolve them. Lastly, and most importantly, it can save you from the complexities of debits and credits as it automatically records the relevant double entries when you input common transactions. That’s a real decider for many new entrepreneurs.

Conclusion

The importance of bookkeeping for a business cannot be questioned. It allows you to keep track of your money and provides useful information for business decision-making. By maintaining proper records, you will be able to assess how profitable the business is, how responsive the credit customers are and how quickly your business is expanding. You can follow the guidance provided in this article to start your bookkeeping, or use it to review the work of an existing bookkeeper.