Every business performs a number transactions on a daily basis to either buy or sell goods or services, and this involves the inflow and outflow of cash. A bookkeeper’s job is to keep track of these transactions and to ensure that they are recorded in a way that is useful for other people who need to understand and interpret it, such as business owner(s) or tax authorities. So what do you do when you are not ready to hire a bookkeeper but want to do things right. We put together this Bookkeeping Basics 101 guide for new business owners who want to get started on the right foot.  

 

Traditionally, bookkeeping was done using physical books (which explains the name), but modern bookkeeping involves complex accounting software that considerably improves bookkeeping accuracy and business productivity.

 

Why is bookkeeping so important (and necessary)?

Too many business owners underestimate the importance of clear, accurate bookkeeping, and it could prove detrimental to the business in the form of lost time, resources and possibly revenue.

 

As a business owner, there are several questions you need answers to, such as:

• What is the business’ monthly and annual revenue?
• What are the fixed, variable and periodic expenses?
• How much does the company profit per month as well as each year?
• Is a sizeable portion of your income locked away in accounts receivable?
• Are your payables getting settled on time?
• Are you over or underpaying on taxes?
• Is your payroll processed accurately and on time?

Accurate bookkeeping helps provide answers to all the above questions (and more) and functions as a primary business management tool.

Here are 5 additional ways in which Bookkeeping helps your business:

#1. Provides data for analysis

Sound financial decision-making requires accurate and timely data; without which the decision maker(s) is shooting in the dark and prone to making costly errors. Bookkeeping provides you with raw data that can be processed into valuable information that highlights areas where your business is successfully performing or under-performing.

This information can be crucial in times when you need to decide whether or not to expand the business, hire more employees or scale down and whether to continue with a product or service offering.

 

#2. Saves money on taxes

One such way proper bookkeeping can save money is through tax deductions. By improperly categorizing transactions, the company may lose out on sizable deductions for the year. On top of missing out on possible claims for deductibles, many businesses also end up improperly paying taxes, which attracts penalties down the road.

 

#3. Prevents inventory theft

A common issue for businesses that sell physical products is inventory shrinkage.  If and when products go missing, messy and poorly managed books make detecting the theft more difficult. Additionally, poor bookkeeping will make correctly categorizing inventory loss events more challenging.

 

#4. Builds confidence in potential investors

When the time comes for expansion and raising capital, one thing every investor wants to see is clear, accurate books. In fact, if you are seeking an investment, it is likely your books will be audited.

There are two main reasons why investors will want your books. The first being analysis – to evaluate whether your business is in a healthy financial state, and viable for the future. Secondly, well-maintained books are a strong sign that you manage your business properly, which is something every investor wants to see.

 

How to set-up your accounts:

If your business is still relatively new, properly setting up your accounts should be a top priority. Issues with the initial setup will lead to costly problems and headaches in the future.

 

Fortunately, the process is simple. Here are the steps you need to take:

#1. Understand double-entry bookkeeping

For every transaction a business completes, there is an inflow (credit) and outflow (debit) on the books. When you purchase a new production unit, for example, there is a debit of cash and a credit to equipment (which is an asset). In bookkeeping, transactions that create inflows into the business are called credits, and transactions that create outflows are called debits.

 

#2. Understand account classes and how they work

There 5 classes of transactions or types of accounts:

Assets: Property owned by the business such as cash, computers, proprietary technology, securities, inventory, etc. Any transaction that increases an asset should be recorded as a debit entry while any decrease in assets should be recorded as a credit entry.

 

Liabilities: These are debts or obligations owed by the business. For example a loan from the bank or goods received on credit, goods still in inventory that have yet to be shipped or services that have not reached completion. An increase in liabilities should be recorded as a credit entry while a decrease in liabilities should be recorded as a debit.

 

Capital: Also called equity, these are assets such as cash or equipment which are directly injected into the business by the owner(s) of the business. A capital transaction should be recorded as a credit entry.

 

Revenues: Not to be confused with assets, revenues refers to the class of transactions that involve revenue-generating activities of the business. The most typical revenue item is sales, which include the depletion of inventory and an increase in an asset, usually either cash or accounts receivable. A revenue transaction should, therefore, be recorded as a credit entry.

 

Expenses: This is a class of transactions for which an asset of the business is expended, to acquire another asset. This could be a transaction such as prepaid electricity. An expense item should be recorded as a debit entry.

 

#3. You will need a chart of accounts

While the classes of accounts remain the same for all businesses, every individual business may have different types of accounts under these headings to record similar transactions. For example, a business might have asset accounts such as:

• Cash
• Equipment
• Accounts Receivable

A chart of accounts is necessary to show every single account identified by the business, in its proper category.

 

#4. Understand the accounting equation

The accounting equation is a simple formula that helps you tell whether or not your books are balanced. At any given point in time, if you have done your double entry bookkeeping accurately, your Assets will always equal the sum of your Liabilities and Equity.

 

This is because every liability and equity transaction provides the business with an asset.

Remember: Assets = Liabilities + Equity

 

#5. Purchase accounting software

If you are completely new to accounting, you might find some of this information a bit overwhelming to process. The good news is that you do not have to start from scratch. There is a variety of accounting software that will simplify everything for you.

Now that you are somewhat familiar with the double entry bookkeeping system, you will be able to navigate your way around accounting software with relative ease.

 

#6. Understand financial reports

There are four financial reports or financial statements which serve different purposes. Your accounting software will be able to generate these reports for you so you don’t need to learn how to do this yourself, but you will need to understand what these reports mean.

 

Income Statement: This is a report that shows how much revenue and expenses the business incurs. The purpose of this report is to demonstrate the profitability of the business.

 

Balance Sheet: The balance sheet provides insights into the asset, liability and equity structure of the business. Even when the income statement shows good profits, if the balance sheet indicates the business is carrying too many liabilities, this will be a cause for concern.

 

Cashflow statement: A cashflow statement demonstrates how cash moves in and out of the business, breaking it down into operating, investment and financing inflows. This report is very important because it demonstrates the true liquidity of a business.

 

Statement of Retained Earnings: This is a report that shows how much equity the owner(s) of the business has. For a sole proprietorship, this statement is less relevant.

 

Bookkeeping is a critical but straightforward business process that can be easily understood with a little time investment. However, the question you need to ask yourself is whether your time will be best spent doing your own bookkeeping, instead of focusing on your core business activities.

With bookkeeping services becoming more flexible over the years, the simplest step to take is to outsource your bookkeeping to a professional bookkeeper with expertise and experience in your industry.

 

Here’s what you can get from a professional bookkeeper:

#1. Initial setup

Your entire chart of accounts and software installation will be put in place by an accounting professional, so all you have to do is start entering data.

 

#2. Properly recorded transactions

The bookkeeper will ensure your transactions are properly recorded and filed away. All you have to do is make sure you keep all receipts and invoices available, and they will take care of the rest.

 

#3. Bills, taxes, and payroll management

A dedicated bookkeeper can also ensure that bills, taxes and payroll payments are completed promptly, and help reduce the chance of incurring any late fees or penalties.

There is no denying that proper bookkeeping is the foundation of a solid business. The process may appear simple enough for a business owner to undertake, especially when the business is just starting off, but over time the workload adds up, particularly when you a business scales and grows.

 

While we believe understanding the basics of bookkeeping are important for every business owner, the actual process is best left to professionals.