Everyone knows that businesses need to keep their books, right? But what does that actually mean? Bookkeeping is the process of keeping track of all financial transactions, recording them accurately and consistently, and maintaining financial records that are easy to understand and analyze. I know, still a lot of words, right? So in actual day-to-day tasks, what does all that mean?
Bookkeeping comes down to a number of tasks that are essential to understanding the financial health of your business. These tasks include recording all of your financial transactions in a ledger or accounting software, reconciling bank statements, and creating financial reports. Here are some of the day-to-day things bookkeepers are responsible for:
Recording Financial Transactions
The first step in bookkeeping is recording all financial transactions made by a business. This includes income, expenditures, and assets. Bookkeepers use specialized software (most people) or manual ledgers (very few people these days) to record all transactions in a timely manner. This ensures that your financial data is always up-to-date and accurate. There are a few different ways you can record financial transactions:
Single-Entry Bookkeeping
Single-entry bookkeeping is the simplest and most straightforward method of bookkeeping. It involves recording transactions in a single column, where each transaction is entered once, either as revenue or an expense. This method is suitable for small businesses with a limited number of transactions, as it does not require any specialized accounting skills or software.
However, single-entry bookkeeping has some significant limitations. It does not provide a complete picture of the business's financial health, as it does not take into account the relationship between transactions or provide any detailed financial reports. Because of this, it’s hard to grow a business if you are using single-entry bookkeeping.
Double-Entry Bookkeeping
Double-entry bookkeeping is the most widely used method of bookkeeping. It involves recording every transaction twice, once as a debit and once as a credit. This method ensures that every transaction has an equal and opposite effect on the financial statements and provides a complete picture of the business's financial health. Double-entry bookkeeping requires more specialized accounting skills and software than single-entry bookkeeping, but it provides more detailed financial reports.
Computerized Bookkeeping
Computerized bookkeeping involves using accounting software (like Quickbooks) to record and organize financial transactions. It is the most efficient and accurate method of bookkeeping, as it eliminates the risk of human error and provides real-time access to financial information. Computerized bookkeeping software also provides features such as automated invoicing, expense tracking, and financial reporting. Most computerized bookkeeping programs are utilizing double-entry bookkeeping, they just do the extra work behind the scenes for you.
So how do you choose the best bookkeeping method for your business? It’s going to depend on several factors, including the size of your business, the number of transactions, your own accounting skills, and/or your ability to afford to pay an accountant. For small businesses with a limited number of transactions, single-entry bookkeeping may be suitable. However, for larger businesses with more complex financial transactions, or business owners looking for growth, double-entry bookkeeping and computerized bookkeeping may be more appropriate.
Classifying Financial Data
Once all financial transactions have been recorded, bookkeepers classify the data into appropriate categories using the chart of accounts. A chart of accounts is a list of all the accounts that a business uses to record its financial transactions. This includes accounts for revenue, expenses, assets, liabilities, and equity. This helps to organize the data and make it easier to understand.
Though the big-picture categories are things like income, expenses, assets, etc., within these categories, you can have even more classifications, for example, under expenses you might have different accounts to separate “Office Supplies”, “Repairs and Maintenance”, “Rent”, and “Cost of Goods Sold”. These categories should be used to help give you a better understanding of where your money is coming from and going to, so each business may have a different set of categories, with different levels of specificity based on their own needs. For example, a business with multiple locations may want sub-categories under their “Rent” account, so that they can tell how much they have paid for each location at a glance.
Checking for Accuracy with Reconciliations
After all financial transactions have been recorded, the next step is to reconcile bank and credit card statements. This involves comparing the business's financial records to those of the bank or credit card company to ensure that all transactions have been accurately recorded. We’re planning to cover this in more detail in a future publication, so stay tuned.
Summarizing Financial Data
After the data has been recorded,classified, and reconciled, bookkeepers summarize the information to provide an overview of the company's financial health. This includes preparing financial statements such as balance sheets, income statements, and cash flow statements. These statements provide a snapshot of the business's financial performance over a specific period. They each give slightly different information about the financial health of your business, and we’ll also get into those in more detail in the future!
Compliance with Laws and Regulations
Bookkeeping is essential for compliance with laws and regulations. It is required by law for all businesses to maintain accurate financial records. (It’s generally good business to avoid the penalties and fines for non-compliance here.) Bookkeeping ensures that businesses are following the correct accounting principles and that all financial transactions are recorded accurately and in compliance with relevant laws and regulations for your specific industry.
Preparing Taxes
Bookkeepers also play a critical role in preparing taxes. The financial data they have recorded and classified is used to complete and file taxes on behalf of the business. Businesses are also required by law to report their income and expenses to the relevant tax authorities. By keeping proper records, businesses can ensure that they are complying with tax laws and regulations, avoid penalties and legal consequences, and maximize their tax deductions.
Helping you Make Sound Financial Decisions
Accurate bookkeeping is essential in order to make sound financial decisions. By providing accurate and up-to-date information on a business's financial position, including tracking income and expenses, bookkeepers can help your business make informed decisions about where to allocate resources. They can identify areas where costs are excessive and make recommendations for how to improve efficiency. For example, if a business is seeing a decline in sales, bookkeepers can help identify the cause and recommend solutions. This allows your business to be proactive in addressing issues and improving operations, and helps you make strategic decisions about how to grow.
Financial statements, taxes, and other reports provide valuable insights into a company's financial performance and growth potential. This information is crucial for business owners, managers, and investors to make informed decisions about current operations and cash flow management, identify areas of weakness, track progress, and make strategic decisions for future growth.
Bookkeeping: Not JUST for Businesses!
Bookkeeping can also help with personal financial management. For individuals, bookkeeping can help them understand their financial situation and make better decisions about their personal finances. By keeping track of income and expenses, individuals can create a budget, identify areas where they can reduce costs, and plan for future financial goals. Bookkeeping also helps individuals to stay organized and on top of their finances, which can be especially important for those with multiple sources of income or a large number of investments.
In this month’s newsletter, we’re going to take a look at some best practices and tips for small business bookkeeping- so don’t forget to subscribe today!