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Maintaining your small business’ books is just about the most important part of being a business owner. Without good bookkeeping, it’s nearly impossible to gauge the financial health of your company, understand your cash flows, or plan for the future. Simple bookkeeping goes a long way toward illuminating the financial picture of your business.
Unfortunately, bookkeeping is something many small businesses struggle with. They’re not entirely sure how to set up their books or manage them on a regular basis. The good news is, you don’t need to be a Certified Public Accountant (CPA) to keep good books. All you need is a crash course in bookkeeping 101 and the right software on your side.
Let’s dive into bookkeeping basics: what you need to know to keep your business’ books in good order—and how to get the most of well-accounted finances. Consider this your crash course in bookkeeping.
What is bookkeeping?
Bookkeeping is the proper recording and organization of a business’ financial transactions. It records every instance where money flows into or out of the business and why. The term “bookkeeping” actually stems from the original practice of writing debit and credit transactions in a ledger to account for a business’ financial health. Bookkeeping happens on a daily basis. Today, most bookkeeping happens digitally, through software like QuickBooks or Xero.
Bookkeeping vs. accounting
Many people use “bookkeeping” and “accounting” interchangeably; however, these terms are different. Where bookkeeping involves the physical recording of transactions in the company’s ledger, accounting is the practice of assessing the books to understand and advise on the financial health of the business.
Why is bookkeeping important?
Bookkeeping is a critical part of small business ownership and management. Without routine bookkeeping, there’s virtually no way for a business to monitor and manage cash flow ratios. This hinders accounting efforts, which makes it more difficult for businesses to plan for the future. Here’s a brief look at the benefits of good bookkeeping:
- Cash flow insights. Keeping accurate records of every transaction allows business owners to see, at a glance, if they’re bringing in more money than they’re paying out. Bookkeeping also makes it easy to see where money is coming from and going to, when, and how often.
- Simplified tax preparation. When tax season rolls around, businesses rely on their books to report revenues and file taxes accordingly. Without accurate, up-to-date books, tax season can quickly become a mess and you risk under- or over-paying state and federal tax authorities.
- Auditing transparency. Auditing is a healthy practice for any business. Without current, accurate financial data, it can be difficult for businesses to audit their finances—or comply with an IRS audit. Simple bookkeeping provides the records needed to verify income and expenditures during an audit.
- More accurate accounting. The function of bookkeeping is to provide financial data that informs better accounting insights. Up-to-date books allow a business to take stock of its financial health, plan for the future, make informed financial decisions, and more—all with confidence.
The bottom line is that bookkeeping provides an organized look at a business’ finances, which makes it easier to answer key accounting questions. What kind of margins do you have? Is your cash flow healthy? What will you owe in taxes? Can you afford an upcoming expansion? Bookkeeping provides the crucial financial data necessary to answer these questions and more.
Common types of bookkeeping accounts
The framework for bookkeeping is built on the idea of various accounts, meant to organize the business’ financial transactions. Typically, these accounts break down into the following:
- Cash, which includes Cash Receipts and Cash Disbursements to track cash flow activity.
- Sales, to track all incoming revenue from point-of-sale purchase of products or services.
- Inventory, which includes the value of unsold products you currently possess.
- Purchases, to track raw materials or finished goods purchased for your business.
- Accounts Receivable, to track invoiced funds due from customers or clients.
- Accounts Payable, to track upcoming bills and payments your business owes.
- Loans Payable, to track upcoming payments owed against assets on your books.
- Payroll Expenses, which tracks salaries, benefits, and taxes attributable to employees.
- Owners’ Equity, which is the amount of money or equity owed to an owner.
- Retained Earnings, to track profits that are reinvested in the company for growth.
There are other types of accounts to consider as well, depending on the nature of your business. These can include Rental Income/Expense, Supplies, Utilities, Equipment, and more.
Each of these accounts is further classified based on the type of transaction it represents: Assets, Expenses, Liabilities, Equity, or Revenue. As businesses explore how to do bookkeeping, they’ll begin to identify which accounts represent each of these categories and how it affects the financial picture that bookkeeping paints.
Debits vs. credits and single-entry vs. double-entry
Bookkeeping is a lot more organized than entering incoming and ongoing monetary transactions in the right account. To understand the framework that keeps it all organized, we need to look at two basic bookkeeping concepts: debits vs. credits and single-entry vs. double-entry.
Debits vs. credits
Debits and credits are the two types of transactions that make up bookkeeping. Debits represent incoming money; credits represent outgoing funds. If you get money, such as through a sale, you’ll record a debit. When you record an outgoing transaction, such as a bill payment, you’re recording a credit. In bookkeeping, every transaction is either a debit or a credit.
Single-entry vs. double-entry
In single-entry bookkeeping, every transaction has just one entry; in double-entry bookkeeping, every transaction has both a debit and a credit. Single-entry bookkeeping is tied to cash basis accounting, which is best-suited for very small businesses. Double-entry bookkeeping is part of accrual accounting, which is used by most businesses.
Almost every small business will use double-entry accounting to record a debit and a credit for every transaction. For example, if you sell a product, the bookkeeping entry might look something like this:
- Credit the inventory account to remove the value of the sold item from inventory.
- Debit the cash account in the amount received from the sale of the product.
Double-entry bookkeeping is part of Generally Accepted Accounting Principles (GAAP) because it creates an automatic audit record in a company’s books. The debit must always match the credit. As businesses get familiar with their books and the double-entry method, recording debits and credits will become second-nature. And, conveniently, most major bookkeeping software will automatically record the offsetting entry for you—all you need to do is specify the account!
How to set up bookkeeping for your small business
Now that you understand the basics of what bookkeeping is, why it’s important, and generally how it works, there’s only one thing left to do: set up bookkeeping for your small business. The question is: how?
The process of establishing a reliable bookkeeping system and best practices is simpler than you might think, largely thanks to today’s modern bookkeeping software. Here’s a step-by-step guide to setting up bookkeeping basics for your small business.
Step 1: Choose your software
There are tons of bookkeeping platforms to consider, but it’s best to start with some of the biggest and most reputable. Look at the pricing, features, functions, integrations, and other nuances of software like QuickBooks, Xero, FreshBooks, Wave, and others. Your choice of software will determine how you manage your books, so be sure to get familiar with the UI!
Step 2: Set up the general ledger
The general ledger is where every transaction gets recorded, even before it’s categorized into an account. Any bookkeeping software you choose will automatically create a general ledger for you. Get familiar with the ledger and comfortable categorizing transactions as they’re recorded. Even better: learn to tap into the software’s automations or AI features to quickly categorize general ledger transactions.
Step 3: Create necessary accounts
Remember all those accounts listed above? Make sure you’re creating the appropriate ones for your business and attributing debit and credit transactions to them accordingly. Remember to consider the five basic types of accounts: Assets, Expenses, Liabilities, Equity, and Revenue. You can always add accounts as your scope of operations grows, but it’s best to identify the essential accounts right from the get-go.
Step 4: Start recording transactions
With your software all set up, you can start transacting. Remember to record every single transaction, down to the penny—and attribute debits and credits to the right accounts. Be sure to follow the double-entry bookkeeping standard. Here, it’s a good idea to explore the integrations of your bookkeeping software to automatically import transactions wherever possible. The more you can automate, the less chance there is of user error.
Step 5: Establish a reconciliation schedule
Also called “balancing the books,” reconciliation is the practice of tallying credits and debits to make sure they add up. If they’re equal, the books are balanced and everything is accurate. If they don’t add up, you’ll need to go back and figure out where the debits and credits don’t match up. The good news is that most accounting software will do this for you—all you need to do is review the reconciled figures.
That’s it! When it comes to your business’ bookkeeping, software handles most of the heavy lifting for you. The most important thing to be mindful of in practicing good bookkeeping is to be consistent and thorough in recording and categorizing transactions. It’s all about staying organized.
The importance of bookkeeping cannot be understated
No matter how big your business is or what type of business volume you do on a regular basis, there’s no understating the importance of bookkeeping. You need a clear financial picture of your business’ performance and its cash flows to make good decisions about how to grow and prosper. Bookkeeping provides the data accountants need to advise you when the time comes to make key business decisions. It quite literally pays to do it right.
Get your small business’ bookkeeping off on the right foot with banking tools that make transacting simpler than ever to manage. Let NorthOne help you open a business bank account that’s easily integrated into your bookkeeping software, so you always have the financial transparency needed to succeed.
What exactly does a bookkeeper do?
A bookkeeper is the person in charge of entering a business’ financial transactions into bookkeeping software, then categorizing those transactions accordingly. Bookkeepers also have the responsibility of reconciling accounts, verifying receipts, preparing deposits, processing payroll, purchasing, monitoring accounts receivable, paying bills and much more.
What is bookkeeping and example?
Bookkeeping involves entering and categorizing a business’ financial transactions in an organized, accountable way. For instance, if you sell $1,000 worth of products to a customer, you would subtract (credit) $1,000 from your inventory account and add (debit) $1,000 to your cash account. This is an example of double-entry bookkeeping.
What are the two kinds of bookkeeping?
Bookkeeping can either happen on a single-entry or double-entry basis. This tends to coincide with the cash vs. accrual method of accounting. Single-entry bookkeeping records one entry for transactions, whereas double-entry bookkeeping involves both a debit and a credit for each transaction. Double-entry accounting is the more popular method, because it creates accountability and transparency.
What is difference between accounting and bookkeeping?
Where bookkeeping deals with the physical entry and organization of a business’ financial transactions, accounting is a broader discipline that focuses on using financial data to drive better decision-making. A bookkeeper would enter and categorize financial data so that an accountant can draw conclusions about the health and operation of the business from that data.