Whether you are the CEO of a large conglomerate or an entrepreneur starting a new business, it pays to have a working knowledge of bookkeeping. Even if your business is not much more than a self-supporting hobby, you need to know if you’re spending more than you’re making, right?
Small business owners rely on their bookkeeping records to monitor the movement of money, how much cash they have on hand, and the financial health of their enterprise.
But bookkeeping can be about so much more than merely indicating if you are making or losing money. It is the lifeblood of your company. Virtually every decision you make involves money and your books and records keep track of that.
Keeping track of where your money is coming from gives you insight into your largest and smallest streams of income. Knowing that can help you focus your marketing efforts.
Keeping track of where your money is going can show you where it is being used effectively and where it is being wasted. For shopkeepers and makers of goods it tracks inventory costs.
Good bookkeeping reports on your financial success (or failure, uggg), helps you file your tax returns every year, and is used when applying for a business loan.
What is bookkeeping exactly?
In accountant-ese, bookkeeping is the act of recording a company’s financial business transactions. The transactions that count as revenue largely consist of cash payments by your customers and clients, but also include any interest paid on bank and savings account balances. Transactions considered expenses consist of checks, debit, and credit card activity paid to your vendors and employees, as well as various other business expenses.
These individual transactions are stored within an organized framework termed “books” and are used to create your financial reports.
Back in the caveman days, “books” used to consist of sheets of columnar ledger paper in a bound notebook. Now, of course, electronic “books”, aka accounting programs, keep a much better record. Accounting software ranges anywhere from the most basic to complex ERP (enterprise resource planning) systems.
Bookkeeping entails a lot more besides tracking money going in and out though. Bookkeepers send invoices to clients and maintains their outstanding balances. They pay your vendors and employees and monitors what you owe them.
Bookkeeping and accounting can be used interchangeably to a large degree. It is generally assumed, however, that accounting deals with more than just recording cash transactions.
If your company is following GAAP (generally accepted accounting principles) then there are stringent rules to follow. Accruals must be added at the end of the month to record outstanding and non-cash activities. Estimates are made to properly calculate eventualities such as bad debt estimates and inventory spoilage or obsolescence.
On a monthly basis, the accountant closes the books and then reviews the trial balance and general ledger (reports all the transactions in each account) for accuracy and reasonableness. Once they are satisfied it is free from material misstatements, the financial statements are issued.
Whew, made me tired just thinking of all that!
Then, what are “books”?
Like I said before your books track all the financial activity in your organization. If you are a cash-basis business the financial activity is nothing more than the money going in and out (except for a few additional transactions).
Your books are separated into categories of accounts, namely five. These categories then appear in either the Balance Sheet or Income Statement (or Profit and Loss Statement).
Within each of those five categories are individual accounts. So, for example, under Expenses you might create accounts for Office Supplies and Utilities. That way you can separately track the sum of transactions for each of them.
Your Balance Sheet will include the value of three of those categories: assets, liabilities, and owner’s equity. This leads to the accounting equation, assets + liabilities = owner’s equity. Notice I said “value” not “sum”. The Balance Sheet is a picture-in-time of where your company stands value-wise.
Your Income Statement reports the other two categories: income and expenses. This statement is the sum of income, minus expenses, within a period of time. This is the easier of the two statements to understand because we use the same method of income minus expenses in our personal life.
A full set of books would include at least these two statements (Balance Sheet and Income Statement). A third report that is now included is the Cash Flow Statement. This report breaks out the cash transactions into operating activities, investing activities and financing activities.
And to maintain a full set of books involves doubly-entry accounting (or bookkeeping). A double-entry bookkeeping system requires an equal and opposite entry into individual accounts. That means that two entries are made for each transaction, a debit and a credit.
What if I Want to Maintain a Full Set of Books?
Double-entry accounting can get complicated rather quickly. Never fear because the accounting program is here to save the day!
There are several popular products, like QuickBooks and FreshBooks, that promise to help the non-accountant create accurate books. Basically, the screens that you see look just like a blank check or deposit statement. You fill in the blanks and choose the appropriate account. Once you complete the document and click “Save” a double-entry transaction is automatically created.
These programs even walk you through setting up a chart of accounts. This is a list of all the accounts that are particular to your industry and business model.
Can I Do Something Less Complicated?
I am happy to tell you yes, but with a few caveats. The answer depends on the type of business you have, the form of ownership, and the volume of transactions, to name a few. But, if you are just starting your business and it’s only you (a sole proprietorship) by all means keep it simple.
Performing your own bookkeeping would involve nothing more than maintaining a running list of money coming in and money going out (i.e., transactions). This type of bookkeeping is categorized as cash basis, single-entry bookkeeping.
At the end of the year your business transactions are divided into two buckets, total revenue and total expenses. Subtracting one from the other equals your net profit or loss (and we hope it’s the former). That’s all there is to it! This document is basically your Income Statement and is used to enter onto your tax return to determine the income tax you owe.
I have harped on this in other posts, but this is a good reason why it is important to maintain a business bank account separate from your personal account.
What if My Business is More Involved?
The above scenario is the simplest form of business. If you are planning on encountering any of the situations listed below, however, you might need to create a full set of books.
- Having more than one owner
- Purchasing inventory
- Selling goods online
- Paying employees
- Applying for a loan
Each of these situations involves additional tracking of financial information. This could be for reasons such as keeping a running balance of ownership value or calculating the cost of goods sold. Selling your goods over the internet involves paying sales tax to the various states.
And if you plan to add employees, you will need to track how much you owe them (for compensation) and the government (for payroll taxes). There is a whole slew of laws surrounding employee compensation and taxes. You certainly don’t want to get penalized for not correctly adhering to the applicable laws.
What if I Don’t Have Time for all This Bookkeeping?
I get it, you are starting or expanding your business. You don’t have time to spending scratching your head over debits and credits.
You do have a few options that might save you some time though.
- Open a bank account to use just for your business (me, harping). Once a month export the activity into Excel, sort into income and expenses, and sum. Boom, instant books!
- Use a spreadsheet such as Excel or Google Sheets and keep a running list of your income and expenses as I described above.
- Purchase a subscription to a simple accounting system. The more popular ones allow you to link it to your bank account. That way bills that are paid and deposits that are made are automatically transferred to your bookkeeping software.
- Outsource to a bookkeeper or public accountant. Bookkeepers will generally charge less, but some accounting firms offer monthly bookkeeping services at a reduced rate.
In Summary
I know this is a lot of information to take in at one time. Of all the things a small business owner must juggle, keeping a complete and accurate set of books probably doesn’t rate very high.
You might be able to kick the bookkeeping can down the road for a while, but you will eventually need to get your financial affairs in order. That involves gathering all your records, be it electronic or paper, and creating a set of books.
The IRS or your loan officer or a venture capitalist will want to be assured that whatever financial data you show them are complete and accurate. Just remember, the small tasks you put off today can become an insurmountable obstacle twelve months later.
