Bookkeeping 101: All you need to know about this overlooked yet vital process for businesses
It is no secret that all businesses, no matter how big or small it is, carry out operations and activities in a bid to make money. But even if you have a competent business model, or offer a great service or product, it will certainly go kaput without an organized recording of monetary transactions.
This is why bookkeeping is extremely important more than entrepreneurs realize. It helps you budget well through recording all transactions from the working activities carried out by your company. And with proper budgeting, comes a clear financial roadmap that can help you plan the growth of your business.
Bookkeeping is a must to keep finances in check. Without accurate and up-to-date books, everything becomes guesswork—and that will pose severe problems in terms of finance and tax returns.
However, before we delve deeper into this overlooked yet extremely vital process in business, we have to understand first the very basics of what bookkeeping truly is.
What is Bookkeeping?
Bookkeeping is the process of identifying every financial transaction made through the course of your company operations, from the firm’s opening down to its closing. To do that, experts—or what we call bookkeepers—record every transaction through supporting documents. These can be in the form of a receipt, an invoice, a purchase order, or any other applicable financial record that can prove the transaction took place.
These transactions can be logged in a journal or through spreadsheet programs. Given the age and technology we live in now, many businesses utilize bookkeeping programs for their finance books. Bookkeepers must have the right understanding of the company’s chart of accounts as well as the debits and credits in order to balance the books.
The difference between Bookkeeping and Accounting
One common misconception many entrepreneurs and business owners have about bookkeeping and accounting is that they are one and the same, when in fact, that is far from the case. Bookkeeping serves mostly at a preliminary capacity for the actual accounting function. What does this mean? A bookkeeper, for instance, records all financial transactions in the accounting journal. He/she then identifies each of them and organizes them based on the company’s chart of account.
The recorded transactions must be summarized at the end of specific time periods, like every end of the quarter or the year. At the end of such period, the accountant will then analyze and review these recorded financial information. He/she will also arrange year-end financial statements and proper accounts for the business, which must adhere to the Generally Accepted Accounting Principles (GAAP)—the standards established by the Financial Accounting Standards Board (FASB).
History of Bookkeeping
Did you know that bookkeeping dates to as early as 6,000 BC? It is not a practice recently established by the human race. Historical records show that almost all ancient civilizations had some manner of financial records, with historians and experts discovering traces of commercial contracts like farm operations in the ancient ruins of great kingdoms.
Authors and historians David Oldroyd and Alisdair Dobie, in their book “The Routledge Companion to Accounting History”, said that the early accounting systems date to ancient Mesopotamia, while early auditing systems go as far as the times of the ancient Egyptians and Babylonians.
Experts also noted that government already had access to extensive monetary date by the time of the Roman Empire.
The emergence of modern-day Bookkeeping
In the late 15th century, Italian mathematician Frater Luca Pacioli published a book called “Everything About Arithmetic, Geometry and Proportion”, wherein he comprehensively described the modern standard accounting system—which we now know as the double-entry system. He then highlighted the importance of journals and ledgers in properly recording financial transactions, which are now widely used as bookkeeping instruments by most companies today. His commitment to champion these then modern instruments won him several accolades, and made him the “Father of Modern Day Bookkeeping”.
Many experts over the years, however, contested Pacioli’s book, noting that the double-entry system he supposedly introduced was not an original idea because it had been used several generations prior. These experts believe that the system was actually documented by Benedetto Cotrugli in his book “Of Commerce and the Perfect Merchant”, which was released in 1458.
Before the computers
Not long before computers were invented, bookkeeping was done manually—experts doing spreadsheets and maintaining paper ledgers by hand, as well as keeping these records in filing cabinets. Since the risk of human error was high, bookkeepers in this era had to have tremendous attention to detail and good skills with numbers.
With the evolution of technology, professions—including bookkeeping—have been revolutionized. Many applications have emerged among accounting and bookkeeping firms that have made the process of bookkeeping a lot more advanced, such as spreadsheet programs like Microsoft Excel, among others.
Another evolution that changed bookkeeping practices is the rise of the internet, which paved the way for seamless bookkeeping. With cloud applications, bookkeeping software have become readily available. Innovation has also allowed the profession to become more efficient and attainable, especially as various programs are now capable of handling complex tasks—simplifying the procedures that used to require immense attention to detail and skills with numbers.
ndeed, bookkeeping has undergone a long and arduous journey to evolve into the field that it is today. Many experts also project that cryptocurrencies and smarter programs will soon emerge as new systems in bookkeeping.
Setting up bookkeeping for the business
Now that you have understood the basics of bookkeeping, it’s time to set thee right system for your books!
The first thing you have to decide when setting up your bookkeeping system is whether you will use a cash or an accrual accounting system. But what is the difference between the two? It is mostly in the timing of the recording of transactions.
For one, cash-based accounting means you log the revenue and expenses when money changes hands (or when the payment leaves the hands of the buyer and goes into the hands of the seller). This system, similar to what it’s called, only focuses on cash.
Accrual accounting, on the other hand, is the process of recording all sales transactions immediately, even before money has been exchanged. It is a more complex yet accurate system because it covers all facets of the company’s operations—from cash, credit, to advances.
Many businesses that start small usually start by cash accounting and just switch to accrual accounting once they grow further.
Another factor to take into consideration is whether to use single-entry or double-entry bookkeeping. Single-entry means recording only one side of a transaction, much like keeping a check register. This system works with businesses with low volumes of transactions.
Double-entry, meanwhile, records at least two sides of all transaction. This means that at least one debit is made to one account, and at least one credit is made to another. Both sides of all transactions are logged, making it easy to spot mistakes and errors. This system works for all types of business.
The next thing to determine when setting up a bookkeeping system is what software or program to use. Many companies use computer software to stay abreast of their accounting journal and bookkeeping entries. The small ones use basic spreadsheets (like Microsoft Excel) while the bigger ones utilize complex software to maintain their books.
Lastly, firms must establish its chart of accounts, a list of financial accounts to be used by the bookkeeper for recording transactions in the company’s general ledger.
Bookkeeping: The basics
To understand bookkeeping a little deeper, it is vital to understand the three major factors associated with this process: Balance Sheet, Income Statement, as well as Cash Flow Statement
The first one, the Balance Sheet, basically presents the company’s exact financial status—including its assets, its liabilities, and its owner’s equity. Assets are the resources the company uses to operate its activities, while the Liabilities are the firm’s debts. The Owner’s Equity, on the other hand, is the share of company assets owned by the shareholders or owners.
These three main components must always be balanced. This is why the statement operates on the equation: Assets = Equity + Liabilities.
The Income Statement is what many entrepreneurs call the Profit and Loss (P&L) Statement. It shows how much money was spent and how much revenue was made during a specific time period. This Statement covers the Total Revenue, the income for services provided and products sold; Total Cost of Goods Sold (COGS), the expenses directly linked to producing sales revenue; and the Total Expenses, or the expenses you have to pay to keep the business going.
These points allow the bookkeeper to calculate the business’ net income.
Cash Flow Statement, meanwhile, indicate the firm’s sources of revenue, what the cash was used for, as well as the change in balance over time as a result of those expenses.
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