Whether you’re fresh out of school and ready to take on an entry-level position or you have your own small business to manage, learning the art of bookkeeping is invaluable — especially come tax season.
Accurately maintaining the books for your business helps you build a strong foundation of proper accounting practices. Tracking your business’s finances is crucial — it establishes that you’re adhering to the accounting equation and provides a snapshot of your business’s stability. Being able to trace your company’s records and provide proof in an audit by the Canada Revenue Agency (CRA) is crucial. Time invested in your business to learn bookkeeping is time well-spent. Here you’ll learn the different types of bookkeeping, terms and definitions, and some overall tips, like streamlining your bookkeeping to maximize efficiency.
Before you open your doors, choose your business’ fiscal year and the method of accounting to maintain the books. You also can select your reporting cycles and processes, and the frequency of these reports based on the size and nature of your business. An asset depreciation method, such as half-year depreciation, also needs to be selected.
Next, choose how you’re going to receive your income—either as a salary or dividends. There are benefits of paying yourself in dividends, such as the ability to split dividends with a family member, tax-free. Then, decide how to store your bookkeeping records safely. There’s manually recording all financial information and storing in filing cabinets, but this method can be prone to theft or damage. Safe storage of small business bookkeeping records now exists in the cloud, on servers not located on your physical property.
Whichever storage method you choose, make sure business records are kept up-to-date. Using QuickBooks software programs, your entries can be automated, minimizing the risk of errors and eliminating the need for manual entries.
Table of contents:
- The Basics of Bookkeeping and Accounting
- Learning Bookkeeping Terms and Definitions
- Implementing GAAP
- What Is Net Present Value?
- The LIFO Accounting Method
- The FIFO Accounting Method
- Historical Cost
- Accounts Receivable & Accounts Payable
- Arm’s Length and Why It’s Important
- Hiring a Professional CPA
When organizing your books it’s important to decide which method of accounting you will use.
There are two basic methods of accounting:
Your bookkeeping processes are much more simplified when you use the cash accounting method. If your business qualifies as a corporation, you must use accrual-based accounting. Cash accounting means you only make entries to your general ledger when cash moves in or out of your business. You might begin as a sole proprietor but then transition to a corporation. In this situation, you’ll need to switch your accounting method to accrual based.
It doesn’t matter the size of your business, setting up a petty cash fund adds flexibility to your payment types. If you need something for your business, especially at the last minute and if you’re not exactly sure of the cost. Either weekly or monthly, you can reconcile your petty cash to zero out this general ledger account. Remember to perform regular bank reconciliations to maintain the integrity of your accounting procedures.
The best ways to learn any trade are:
- Immersing yourself in the field
- Learning the lingo
- Double-Entry Accounting Explained
If you take a bookkeeping or accounting class online or in-person, you gain beneficial knowledge regarding essential bookkeeping and accounting principles. You can then apply this knowledge to day-to-day operations. These classes may also offer internships providing opportunities to get on-the-job professional experience. You’ll also become acquainted with performing some of the primary functions of a bookkeeper that will help you avoid common bookkeeping mistakes. For example, incorrectly recording the transfer of personal assets into your company.
This immersion presents you with terms you might not have heard before. However, to support your learning we have prepared a guide to key accounting terms, such as Single- and Double-Entry Accounting, Net Present Value, GAAP, LIFO, FIFO, and Historical Cost.
Single-Entry Accounting Explained
This kind of accounting for the various transactions occurring in your business uses just a single entry per transaction which you maintain in a journal or a log book. Think of your checkbook register whenever you deposit money into your account, you make an entry in your register stating the date and the amount. When you write a check for something, like an electricity bill, you write out who the check was made out to, the date, and the amount of the deposit. On the far right, you keep a running balance of what remains in your checking account. This is the same approach used in single-entry accounting.
This method of bookkeeping is generally best-suited for freelancers, sole proprietors, and small businesses. While there are some businesses in which single-entry accounting is sufficient, the majority of businesses choose (or must use) double-entry accounting. For instance, sole proprietorships and other related small businesses find single-entry bookkeeping adequate for the nature of their small business. This is also known as cash basis accounting. Some of the reasons a company might opt for single-entry are:
- If they use cash basis bookkeeping
- They have a very low number of daily transactions
- They don’t offer credit to customers or clients
- There are a low number of employees
- They own very few physical business assets
- The company is a privately held company, sole proprietorship, or partnership
Some of the advantages of this type of bookkeeping include:
- Little to no financial or accounting background required
- No accountant necessary
- No accounting software required
There are also disadvantages to using this bookkeeping method, such as:
- Insufficient records
- Insufficiently audited business statements
- Lack of information to gauge the company’s financial standing
Double-Entry Accounting Explained
In contrast to single-entry accounting, double-entry accounting is just that—it relies on entering at least two entries per financial transaction. This is completed in the following manner:
Say you’ve just paid a supplier’s invoice. In this transaction, there are two effects:
- Your cash balance has gone down
- Your level of supplies has gone up
This is reflected in the double-entry system of accounting by debiting your Cash account and crediting Supplies for the exact same amount.
Most businesses choose this form of accounting, even though it presents certain complexities and isn’t as easy as the single-entry alternative. Also, to use a double-entry method, you must have some form of accounting training. You will need to understand terms such as debits and credits and be able to formulate and read financial statements.
All publicly-held companies must use double-entry. Without it, it’s not possible to meet the stringent reporting requirements of governmental and regulatory agencies–not to mention be able to affirmatively track aspects of their company, such as assets, expenses, and revenues.
Some of the reasons in favor of double-entry accounting include:
- Fewer errors
- Statements balance
- All transactions are tracked dually
Single-entry bookkeeping’s simplicity doesn’t allow for GAAP conformation. This inability to conform to GAAP’s requirements may not apply to very small businesses which only need to be able to illustrate a method of meeting reporting requirements for taxes and employees. Any company that must highlight cash flow retained earnings, or any other changes in a position financially must use a double-entry accounting system.
Whichever accounting method you choose, the best way to make sure you’re dotting your i’s and crossing your t’s is to maintain order in the way you manage your bookkeeping. You can do so by implementing GAAP. What is GAAP? GAAP stands for Generally Accepted Accounting Principles, which are the best methods you can use to track and manage your business financials. Why? These are methods used by most people in the accounting profession, so if your bookkeeping is ever questioned, your methods will be accepted by others. A few ways you can begin using GAAP are standardizing your chart of accounts, classifying your assets on the company’s balance sheets, and implementing a three-way matching system to ensure you never double-pay an invoice or pay for products not ordered or received.
The Net Present Value (NPV) of your business is a calculation that helps you analyze potential projects or investments that might be worth your while. The NPV calculation is a snapshot of a period of time that illustrates how much money you’ve had come in versus how much you’ve paid out. It helps you estimate whether a given project or investment would result in more money coming in, or if you’d lose money on the venture. Understanding how to calculate Net Present Value is beneficial for your long-term financial planning.
What is LIFO accounting? LIFO means Last In, First Out. It is one of the methods you can use to determine the current worth of your inventory if you operate a retail business. This accounting method presumes that your most recent (last in) products will be the first to sell (first out). If your inventory costs fluctuate between the first and last items, this bookkeeping method helps keep the most accurate records possible.
If you manufacture goods, your inventory accounting entries will reflect several stages of completion. If you produce wooden furniture, some of your inventory may be unfinished wood products, furniture currently on the assembly line, and finished pieces. In your ledger, the finished goods inventory will reflect the number of each type you have at any time. After some of your finished items have sold, you can track the cost of goods sold by including all direct costs. This can be done using the traditional method or with activity-based costing. You can figure both your direct and indirect costs by performing a cost assignment to each type of good you produce or service you provide.
FIFO, or first-in, first-out, is a method of valuing inventory. It’s basically an assumption for cost-flow purposes that states the first goods you purchased are the first goods you sold. This assumption most closely resembles an actual flow of products earning it the distinction as the most correct valuing method in theory. Consider your local supermarket — the first gallons of milk the store purchased to sell to customers are the first gallons sold usually. Otherwise, a lot of milk (product) would spoil, thus creating a loss for the store. This also applies to stores selling items such as computers or cell phones. If they don’t sell the first products they acquired, they run the risk of those items becoming obsolete and no longer needed or useful – thereby also creating a loss for the company.
When creating the company’s balance sheet, the FIFO method of valuation offers costs that most closely resemble the costs most recently incurred. On the other hand, it also matches older costs of inventory purchases against revenues currently coming in, which means revenue vs. cost is not necessarily properly reflected, resulting in a potentially higher than actual gross margin.
Your goal in bookkeeping is to keep the most accurately detailed account of business financials. To do so, you must factor in the historical cost of certain items. Determining the historical cost of something you’ve purchased or acquired is merely accounting for the purchase or acquisition at the then-rate you paid. This means you’ll have an accurate valuation of the item and your expenses related to depreciation are accurate. Historical cost may factor in when you’re accounting for lump-sum purchases.
After you have sold goods or provided a service, you invoice the purchaser. Once the invoice has been presented, the amount of the sale is now owed to you. This is money that you’re due to receive, hence its placement in your general ledger under Accounts Receivable. Tracking purchasers who have paid against those who haven’t illustrate your company’s accounts receivable turnover ratio.
Any monies you owe to suppliers or other agencies for goods or services provided are placed under Accounts Payable. Accounts Payable is an expense account that lets you know how much money you owe to your creditors. Rent, business insurance, and software subscriptions are expenses you pay before receiving the benefit of the service—these are prepaid expenses. When you account for deferred expenses, your bookkeeping will reflect the month you actually enjoy the benefit of the expense rather than the month in which you paid it. As illustrated above, between the two basic methods of accounting (cash or accrual), you can best account for prepaid expenses using the accrual method.
A common expense some small businesses incur is payroll. If your business incorporates brick-and-mortar sales with online sales, payroll will be significantly different between the two. To analyze which type of sales amount to the largest profit for your company, you must segregate in-person sales from online sales.
As you balance Accounts Receivable against Accounts Payable, the result is your net income. Divide this amount by net sales amount to obtain your profit margin. If the ratio of income to debt is small, you’re operating with a narrow profit margin. Analyze where you can cut some costs, and you can improve a narrow profit margin. You can also track your gross margin weekly, biweekly, or monthly based on your sales.
In day-to-day business, you’re going to come in contact with other businesses, entities, and people with which you may have transactions. Arm’s length in business terms refers to how you might handle business with a friend or family member versus someone you don’t know. Friends and family tend to make deals with one another, while acquaintances have their bottom line in mind. When you enter into a transaction with an arm’s length approach, other companies will know that your company is solid.
Love owning your own business, but don’t enjoy dealing with accounting? Many business owners admit they’re reluctant accountants. Maybe you’d rather be on the sales floor, mingling with customers, explaining the amazing benefits of your service or product. Or perhaps you’ve never enjoyed working with numbers. If this sounds familiar, check out some bookkeeping tips for reluctant accountants. It could help make the entire process more relatable.
Outsourcing your bookkeeping and accounting to a professional CPA isn’t out of the question either. Some business owners simply have better faith in the abilities of someone who manages books for a living, not to mention a professional who knows the ins and outs of business taxes. It can even help put an end to bookkeeping errors for small business. Both bookkeepers and accountants play a role in the successful management of your small business.
Bottom line, knowing how to maintain financial control and keep track of your finances means your business stands on firm ground.