How the Bookkeeping Process Works
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Every single day, businesses make a lot of financial transactions. A financial transaction is an agreement, or communication, between a buyer and seller to exchange goods, services, or assets for payment. Those transactions need to be continually tracked; otherwise, the financial records will be a mess and there can be monetary consequences.
Who does the responsibility of tracking and monitoring these important transactions go to? Someone needs to do it. If you, the business owner, manage the finances, you will be wrapped up in a very time-consuming process that takes up a great deal of your time, time that could be spent building your business. If you have a bookkeeper, they will use a bookkeeping system to manage the paperwork and you can do what you do best, focus on growing your business.
Bookkeeping is the activity of recording all the financial transactions performed and done by the company. The term “company” includes large corporations, medium-scale businesses, small-scale businesses, and home businesses.
Bookkeeping is not limited only to companies and corporations, though. Organizations such as a club or even single individuals also do bookkeeping.
It is important for a company owner to know the basics of bookkeeping.
First, he should know what bookkeeping entails. Bookkeepers keep records of what the company bought, sold, what they owe, and what’s paid off. Bookkeeping also allows owners to keep track of their financial inventories, and to determine their company’s financial standing.
A business owner should be aware of the aim of bookkeeping. This is one of the basics of bookkeeping that the owner should know about. Why is it needed in business?
Bookkeeping shares two basic goals. First, it keeps track of the company’s income and expenses. Keeping track of these financial transactions enables the business owner to improve his chances of making a profit.
Secondly, bookkeeping aims to collect financial information that is needed for filing the business’s tax returns.
The basics of bookkeeping sound simple enough. Given the right tools and knowledge, it can be. All that is needed is for the owner and the bookkeeper to remind themselves of those two goals.
There are no fixed ways to keep and monitor the records. As long as the records of the business’s income and expenses are accurate and clean, the business won’t have a problem. The Internal Revenue Service will find them acceptable.
The basics of bookkeeping also involve the actual process of keeping the books easy to understand and read. The process is broken down into three steps.
First, the owner or the bookkeeper must keep the receipts and other acceptable financial records such as deposit slips for all expenditures of the business.
Second, the business’s income and expenditure records should be summarized on a periodic basis, whether daily, weekly or monthly.
Third, those summaries will be used to formulate financial reports that will state how much profit the business is making and how much it is losing. The financial report will also show how much the business is worth at a specific point in time.
In the past, bookkeeping was done by using a paper ledger, a pen, or a pencil. However, due to the increasing complexity of tax regulations, the likelihood of committing calculation errors and the desire for efficient office organization, most companies, organizations, groups and individuals use accounting software to make this task easier.
Businesses and organizations use either of two common bookkeeping method—single-entry or double-entry.
Single-entry bookkeeping is a straightforward method where one entry is made for each transaction in your books. The single-entry method will suit small private companies and sole proprietorships that do not buy or sell on credit, own little to no physical assets, and hold small amounts of inventory.
Double-entry bookkeeping is more robust. It follows the principle that every transaction affects at least two accounts, and they are recorded as debits and credits. For example, if you make a sale for $10, your cash account will be debited for $10 and your sales account will be credited by the same amount. In the double-entry system, the total credits must always equal the total debits. When this happens, your books are “balanced.”
Using the double-entry method for bookkeeping makes more sense if your business is large, public, or buys and sells on credit. Enterprises often choose the double-entry system because it leaves less room for error. In a way, it ‘double-checks’ your books because each transaction is recorded as two matching but offsetting accounts.
The next step is choosing between a cash or accrual basis for your bookkeeping. This decision will depend on when your business recognizes its revenue and expenses.
In cash-based, you recognize revenue when you receive cash into your business. Expenses are recognized when they are paid for. The purchases or sales made on credit will not go into your books until the cash exchanges.
In the accrual method, revenue is recognized when it is earned. The actual cash does not have to enter or exit for the transaction to be recorded. You can mark your sales and purchases made on credit right away.
Both a cash and accrual basis can work with single- or double-entry bookkeeping. In general however, the single-entry method is the foundation for cash-based bookkeeping. Transactions are recorded as single entries which are either cash coming in or going out. The accrual basis works better with the double-entry system.