Bookkeeping; what is it and why do I need it?
Bookkeeping is necessary for your business as it organises your entire business’ accounts and cash flow. A bookkeeper records and notes the financial transactions of your business, for example, sending invoices, making payments, managing accounts and preparing financial statements.
Bookkeepers record all these transactions in a general ledger. Without this organised ledger, the accounting side of your business wouldn’t be able to run. An accurate ledger allows the accountants to identify financial problems or financial advantages early.
However, not every business is big enough to have different people bookkeeping and accounting. Thankfully, being your own business’ bookkeeper is certainly manageable. In order to set up effective bookkeeping, your business should set up these types of accounts:
Note: An account doesn’t refer to an individual bank account in bookkeeping. It refers to a record of all the financial transactions of a certain type.
- Cash: this ledger often has two parts, cash receipts and cash payments.
- Inventory: If you are a small business that sells products, you should keep an account of your inventory.
- Accounts receivable: Enterprises, such as cafes, which often accept credit accounts will have accounts receivable. The bookkeepers job is to use this ledger to generate invoices and send out bills to your credit customers.
- Accounts payable: This is the opposite to accounts receivable. This ledger contains all the costs you owe your suppliers. Here they are your creditors.
- Loans payable: This is similar to accounts payable except you are usually indebted to large sums of money. This ledger deals with loans you have had and need to keep track of.
- Sales: This account tracks any sales made, cash or credit.
- Payroll: This account tracks the cost of paying your employees.
- Owner’s Draw: This is the amount the owner takes from his own small business.
There are two types of bookkeeping, single-entry and double-entry bookkeeping. At present double-entry bookkeeping is the most common form of bookkeeping. It has been most certainly tried and tested, being used commonly since the 12th Century. Below we’ll teach you how to double-entry bookkeep.
How do I double entry bookkeep?
- Starting with the basics, when your small business carries out a transaction, a document should be produced. For example, a sales invoice would be raised when your business sells a product.
- These are then noted down in bookkeeping journals which record the date, the name of the person/company, a description of the transaction and the amount. These journals are commonly referred to as day books as they record the daily transactions of your business.
3. The value of the transaction will then be entered into a ledger. One ledger represents one account. Each ledger is laid out in a T format. Depending on the type of account, the value of the transaction will be either entered on the LHS or RHS of the ledger.
4. As seen above, the business has spent £3000. In double-entry bookkeeping there are always two accounts affected by one transaction to keep the books balanced. One value is entered into the debit section of one account ledger. The other value is entered into the credit section of another account ledger. Noting the transaction down twice will be crucial to using the account equation and keeping your books balanced.
5. The ledger accounts are kept in order by a list called Chart of Accounts. Here is where you order the individual accounts, such as accounts receivable and Owner’s Draw, as mentioned above.
6. The accounts are balanced using the accounting equation:
Assets = Equity + Liabilities
The main thing to keep in mind with this equation is that it revolves around keeping an even balance.
Here is an example:
Your business gains £800 worth of assets from a grant you have applied to after reading our blog about the best ways to source funding. At this point, in the bank account, you’d mark down £800 – this is your asset.
However, the equation isn’t balanced. Because your business is now worth £800, you need to mark down £800 in the capital account too – this is your equity.
Without any liabilities, your business’ assets would equal its equity. What is a liability you may ask? A liability is a financial obligation. For example, you are legally responsible to:
- Pay back money owed to suppliers for items purchased (Accounts Payable)
- Pay back loans. However, these can take years to pay back in some cases. This type of liability is called long term liability and it can often loom over your business accounts.
Going back to your business that is worth £800. Let’s say you decide to take a loan of £3000 to grow your business. The first entry you would make would be to your bank account of £3000 – your business has just gained £3000. The next entry you would make would be into your loans payable account of £3000. Now your accounts would be balanced:
Assets = Equity + Liability
(£800+£3000) = (£800) + (£3000)
7. Next a trial balance would be run to ensure that the books are equal. Here you would total all the debit ledger accounts and the credit ledger accounts to see if they are equal.
If they’re not, then you will need to find which transaction you haven’t entered twice or whether you have mistyped the price of a transaction.
The most important characteristic for a bookkeeper is accuracy. It is imperative for the whole of the business’ finances.
Single Entry Bookkeeping
This is simply a list of money in and money out. Single entry bookkeeping works well for micro-businesses. It is easy to maintain, but more prone to mistakes being made.
Using Accounting Software
For many small businesses it may be easier to buy accounting software. Afterall, the very fact that we can just download accounting software is itself a new idea only surfacing in the last 10 years.
You no longer need to learn how to bookkeep – although learning how to yourself gives you far more flexibility to make ledgers you and your accountants can better understand and which suit your business needs best.
Despite this, accounting software is pretty versatile, just be careful to research the best accounting software for you.
If you found this helpful you may want to check out our other blogs. These are designed to help small business owners grow their business and learn about the environment they’ll be working in.
If you haven’t set-up your business, have you thought about setting up a limited company with a business currents account? If so, the MachFast App allows you to do just this, free of charge.
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