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Accounting and bookkeeping

Bookkeeping: An Introduction To Bookkeeping

Every business needs to have a reliable bookkeeping system that is based on accounting rules and principles.

Proper recording of business activities and transactions enhances the decision-making process for small business owners.

It was observed that lack of bookkeeping strategies lead to the inability of small business owners to sustain their business growth over a period of time.

Furthermore, small business owners who were undertaking the task of maintaining bookkeeping records themselves were unable to maintain proper financial records. This acted as a barrier to their business growth.

Also, many small business owners had access to accounting and bookkeeping software to undertake such accounting tasks. However, due to a lack of time and expertise, small business owners collaborated with bookkeepers to undertake bookkeeping services and help sustain their small businesses.

Thus, given the importance of bookkeeping in business decision making and success, let us try to understand what is bookkeeping, who is a bookkeeper and bookkeeping services, and what comes under bookkeeping.

What is Bookkeeping?

As per the Bookkeeping definition, Bookkeeping refers to the practice of recording and tracking the financial transactions of your business entity on a day to day basis.

Typical financial transactions and tasks in bookkeeping include:

  • Billing customers for goods and services sold to them
  • Recording and organising invoices received from customers
  • Verifying, recording, and organising the invoices received from suppliers
  • Making payments to suppliers
  • Processing payroll
  • Preparing financial reports etc

In today’s world, manual bookkeeping is replaced with online bookkeeping undertaken with the help of accounting and bookkeeping software like Quickbooks.

Such a systematic recording and organising of financial transactions ensures that the records of each financial transaction are correct and up to date.

Thus, proper bookkeeping ensures the accuracy of accounting information which is vital to the entire process of bookkeeping and accounting.

Who are Bookkeepers?

A bookkeeper is an accounting professional who provides bookkeeping services of recording the financial transactions of your business occurring on a day to day basis. These transactions include sales, purchases, payroll, accounts receivable, accounts payable, and other related transactions.

They are the ones who maintain a record of how the finances of your business flow in and out of your business entity each day.

Relative to the accountants, bookkeepers do not have the formal training or knowledge as they are just responsible for maintaining records of business transactions into an accounting system.

On the other hand, accountants are the professionals having proper accounting knowledge and training. They use the information a bookkeeper keeps track of in order to prepare financial reports, analyse trends, and undertake projections.

Why Is Bookkeeping Important?

Bookkeeping is important as it helps your business entity to maintain accurate financial records.

Furthermore, the accuracy of financial records ensures that such records give a true and fair view of the financial performance of your business.

This further helps in making strategic decisions and setting standards with regard to the sales and income goals of your business.

Since poor bookkeeping is one of the major reasons why businesses fail, the following are the points that will help in convincing you as a business owner as to why bookkeeping is so important.

As per the concept and Bookkeeping definition, Bookkeeping helps in:

  • creating budgets as income and expenses are properly organised. Such budgets help you in planning for future expenses and the resources you intend to purchase.
  • preparing and filing tax returns as the financial information is organised properly so that you do not have to search for receipts or invoices during the tax filing period.
  • organising financial data on one central system since different stakeholders like the tax department, employees, customers, investors, and lenders may request such information at any time. The inability to provide such financial information specific to the tax department may call for penalties or fees.
  • analysing the performance of the business as bookkeepers prepare financial statements on a regular basis that can be used to make such an analysis. Furthermore, analysing financial statements also helps you to keep track of what comes in and goes out of business.
  • making better decisions as all the financial information is available in an organised manner.
  • planning for strategic purposes as well as taxation. Past financial records help you as a business to plan for the future and these records also play an important role in planning taxes.
  • preparing accurate financial statements that showcase the financial performance of your business to the investors. This helps them in determining the value of their investment.
  • controlling the finances of your business, that is, it gives a snapshot of how and where you need to spend money into your business.
  • determining the profitability of your business with the help of an income statement. Furthermore, analysing income statements for the past periods helps you observe trends and understand business cycles.
  • improving cash flows as the regular recording of expenses, income, receivables, and liabilities helps you keep track of when your customers make payments and when the supplier invoices are paid.

What are the Activities Involved in Bookkeeping?

As per the concept and Bookkeeping definition, the following are the activities that a bookkeeper may undertake or offer as bookkeeping services:

  • Recording financial transactions and balancing books of accounts
  • Reconciling books of accounts with bank statements and other documents to ensure accuracy
  • Preparing monthly financial and accounting reports like balance sheet, income statement and cash flow statement, aged receivables, and aged payables
  • Preparing and sending invoices to customers and tracking customer payments to ensure payments are made on time
  • Ensuring that invoices from suppliers are error-free and paid in time
  • Calculate payroll and appropriate deductions like tax, leave entitlements, retirement contributions, etc
  • Preparing tax returns including sales tax returns, business income tax returns, payroll tax returns, etc
  • Other functions like preparing budgets and forecasts, assisting in preparing annual reports, etc

Accrual Vs Cash Basis of Accounting

Generally, two methods of accounting are practiced worldwide in order to undertake small business bookkeeping in a proper manner. These methods include cash basis and accrual basis of accounting.

The major difference between these two methods of accounting is the timing when sales and purchases are recorded in your books of accounts.

The following table showcases in detail the difference between cash basis and accrual basis of accounting.

S.NoParameterCash Basis of AccountingAccrual Basis of Accounting
DefinitionRecognizes revenue when cash is received and expenses when cash is paidRevenues and expenses are recorded or recognized when they are earned regardless of when cash is received or paid
Outstanding or Prepaid TransactionsDoes not recognize prepaid or outstanding expenses and accrued or unearned incomesRecognizes prepaid our outstanding expenses and accrued or unearned incomes
Level of IncomeIncome statement showcases a relatively lower amount of incomeIncome statement showcases a relatively higher amount of income
Status of CashTracks the amount of cash that comes in and goes out of businessDoes not provide a snapshot of cash flow. Hence, your business can appear profitable, but may not have sufficient cash
Long Term or Short Term ViewDoes not take into account prepaid or outstanding expenses and accrued or unearned incomes, this providing short term liquidity view of your businessGives a more realistic view of incomes earned and expenses incurred during an accounting period, thus providing a long term view of your business
TaxesTaxes are not paid on the amount of money that has not been receivedTaxes are paid on the amount of money that you are yet to receive
SuitabilityMajorly small businesses and sole proprietors having no inventory use this methodBusinesses having revenue of over 5 million dollars need to necessarily use this method.
Ease of UseEasy to use as this method takes into account cash transactionsRelatively more complicated as it takes into account items like prepaid expenses and unearned revenue

Definition – Accrual Accounting

Accrual basis of accounting is an accounting method that measures the position and performance of your business by identifying the economic events that occur during the course of business. This is irrespective of when the cash is received or paid during the course of business.

In other words, the accrual basis of accounting emphasizes that your business revenues are recognised when they are earned and not when the cash is actually received. Such a principle is based on the matching concept of accounting.

As per the matching concept, expenses incurred by your firm in a particular accounting period must match with the revenues generated during the same period.

In other words, the expenses incurred by your firm during a specific accounting period must be deducted from the revenues earned during the same period. This is because as per the accrual basis of accounting, you must recognise revenues on the sale of goods or services and not when you receive cash for such sales.

Similarly, you must recognise the expenses the moment you use an asset or service in order to generate revenue and not when cash is paid for such an expense.

Definition- Cash Basis of Accounting

Cash basis of accounting refers to a method of accounting whereby you record business transactions for income earned or expenses incurred in the books of accounts only when cash is received or paid with regard to such transactions.

This means that as a business you record income only when your customers pay for the goods supplied or the services rendered.

Likewise, expenses are recorded only when they are actually incurred by your business entity in order to undertake day to day operations.

You must remember that the cash basis of accounting is typically used to record petty day to day transactions such as daily receipts, etc.

Grow Your Business with QuickBooks

Why Bookkeeping Matters?

Following are the reasons why small business bookkeeping is important:

Calculation of Taxes

Small Business Bookkeeping is important as it helps you as a business to determine net profit in order to calculate your taxes.

Net profit is nothing but the profit that is left after deducting the cost of goods sold, expenses, depreciation, and interest from revenue.

This means that you can calculate your taxes only when you know total income and total expenses. Thus, the only way to calculate income and track expenses is to ensure that you have proper, accurate, and up to date books of accounts which is only possible via availing bookkeeping services for small businesses.

Measure Financial Position

The basic financial statements like income statement, balance sheet, and cash flow statement help in understanding the financial position of your business.

The preparation of such financial statements in an accurate way is possible only when all the financial transactions occurring during the course of business are recorded and organised in a proper manner by availing bookkeeping services for small businesses.

Thus, with the help of online bookkeeping as well as basic financial statements you get to know the amount that flows in and out of business. Further, it also helps you to understand increasing costs and the products and services that are generating most sales.

Consideration of Tax Deductions

The Income Tax Department allows certain tax deductions, that is expenses that you can deduct from your taxable income in order to save on taxes. Unless you have accurate and up to date books of accounts, it is not possible to keep a track of such tax deductions.

With proper online bookkeeping in place, you can give detailed information as well as documents like receipts to your chartered accountant during the tax filing period so that he can calculate tax deductions that you are eligible to pay.

Borrowings, Loans, and Advances

In case you want to avail loans from financial institutions like banks, it is mandatory for you as a business to maintain your books of accounts regularly and accurately.

Proper books of accounts help you generate financial statements which are a must while availing business loans from a bank or seeking investments from equity investors.

These financial statements help lenders and investors to understand the financial position of your business before lending any amount of money.

It is quite important for them to review accounts like revenue, cash flow, assets, and liabilities before giving loans for making investments in your business.

Tracking Errors

Maintaining and organising your books of accounts on a day to day basis help you as a business to keep track of erroneous transactions.

In such a case, there is no need for you to wait until the end of the year to reconcile your statements against the bank statement in order to track who committed the mistake with regard to such erroneous transactions.

Bookkeeping Vs Accounting

Double Entry Bookkeeping and accounting are used interchangeably. However, both concepts are different.

As per bookkeeping definition, bookkeeping is a process of identifying and recording financial transactions of your business. However, accounting is the process of summarising, interpreting, and communicating financial information of your business to various stakeholders including owners, investors, creditors, employees, etc so that they can make informed decisions.

1.MeaningBookkeeping is an activity that involves the recording of business transactions in an orderly mannerAccounting is an activity concerned with recording, interpreting, and summarizing business transactions.
2.NatureBookkeeping is mechanical or clerical in nature. In other words, it is mostly done by computers in today’s world.Accounting is analytical in nature as it involves knowledge, understanding, and skill of the person or the accountant undertaking such an activity.
3.Basis of AccountingBookkeeping is the foundation of accounting.Accounting starts where bookkeeping ends.
4.Interpreting Financial PositionBookkeeping cannot be used to determine the financial position of the business.Financial information is determined on the basis of the accounting reports so generated.
5.Preparing Financial StatementsFinancial Statements are not a part of Bookkeeping.Financial Statements are prepared using financial data recorded in books of accounting.
6.MethodologyBookkeeping is undertaken according to the basic accounting concepts and conventions.Various methods of analyzing and interpreting financial statements differ from business to business.
7.Decision MakingBookkeeping does not help in decision making.Accounting records help various stakeholders in taking business decisions.
8.Methods/DisciplinesSingle Entry and Double Entry Bookkeeping are the various methods used for recording transactions by various businesses.Various disciplines of accounting include Financial Accounting, Cost Accounting and Management Accounting
9.ToolsJournal, Ledger and Trial BalanceProfit and Loss Statement, Balance Sheet and Cash Flow Statement

Setting Up Bookkeeping for Business

Bookkeeping for small businesses is an important task to consider once you get your business registered.

In order to understand how the bookkeeping process would be implemented in your business, you need to follow the steps below:

  • Open Checking Account

Open a business checking account to organise your funds

  • Separate Personal and Business Expenses

Separate your business and personal expenses as mixing both the accounts would lead to unneeded stress that you may have to undergo while filing taxes.

  • Select a Bookkeeping Method

Choose a bookkeeping method that is, single entry or double-entry bookkeeping system. If you are starting your business, then the single entry system is appropriate to use as journal entries are recorded only once as either expense or income while assets and liabilities are tracked separately. Otherwise, the double-entry bookkeeping system is used where every business transaction involves at least two accounts. That is for every debit there exists a credit. Typically, double-entry is preferably used over the single entry system of accounting.

  • Select an Accounting Method

Choose an accounting method, that is a cash or accrual basis of accounting. Many small businesses while starting use the cash basis of accounting as it is easy to use and there is no need to recognise accounts receivable or accounts payable. However, the accrual accounting method is preferred widely as it gives a fair view of the performance of the business. This is because it takes into account accounts receivable and accounts payable.

  • Categorise Transactions With Proper Tools

Select the correct tools for categorising transactions into various heads like assets, liabilities, revenue, expenses, and equity. For this, you can either use cloud accounting and bookkeeping software like QuickBooks or use tools like spreadsheets or Excel templates.

  • Categorise Transactions Regularly

Ensure that you categorise your business transactions regularly and accurately. This would help the bookkeepers in claiming tax deductions that your business is eligible for.

  • Using Tools for Storing Documents

Use tools to store your financial documents like receipts and other records so that you do not have the burden of collecting documents while filing tax returns.

Understand Balancing the Books

It may be the case that when you deduct liabilities from assets the resulting figure may not be equal to the amount of equity that you have in your business.

It means that there is a need to balance your books of accounts with the help of a trial balance.

Trial Balance is a technique to check the accuracy of debit and credit amounts recorded in various ledger accounts.

Therefore, in case there are any errors committed while preparing bookkeeping records, those errors can be rectified with the help of a trial balance.

Errors of Omission or Commission

Typically, a trial balance is prepared at the end of the financial year. However, you can prepare it at the end of every month or quarter so that it’s easier to rectify the errors. So, to track the errors, first, you need to check whether any entry was omitted or recorded twice.

Errors of Principle

Following this, you can look for errors committed due to the violation of accounting principles. That is an incorrect classification of expenditure or receipt between capital or revenue. Such an error may lead to under or overstating of income or assets or liabilities, etc.

Compensating Errors

Then, there can be errors that are committed in such a way that the net effect of the errors on the debit and credit accounts is nil.

Check if the Difference is Divisible by 2

After looking for such errors if the trial balance still does not match, you can check if the difference between debit and credit columns is divisible by 2. This would bring to the forefront a possibility that an amount equal to one half of the difference may have been recorded on the wrong side of another ledger account.

Check if the Difference is Divisible by 9

In addition to this, you can also check if the difference is divisible by 9 or is a multiple of 9. Checking this would ensure that the error could have been made due to the transposition of numbers like 459 is recorded as 954.

Income Statement and Bookkeeping

The income statement is one of the basic financial statements reporting the net income of your business for a specific accounting period.

Such a statement reflects the actual financial transactions in terms of income and expenses recorded in the accounting system.

Accordingly, the accounts in the income statement are categorised as operating revenues, operating expenses, other revenues and gains, and other expenses and losses. It is important to note that unlike the assets and liabilities accounts, the amounts in the income statement accounts at the end of the financial year are not carried forward to the following year.

Instead, these balances are shifted to retained earnings of your business or owner’s capital account. Thus, this means that the income statement accounts would begin with zero balances each accounting year. This is the reason why income statement accounts are called temporary accounts.

Hence, if you have a positive net income, that is when revenues are more than expenses, it will lead to an increase in your owner’s capital.

However, a negative net income balance would decrease the owner’s capital.

Now this connection between the balance sheet and income statement is important for bookkeepers and accountants as they want to ensure that the net income amount showcased in the income statement is correct.

Remote Bookkeeping

As a small business, you might have to undertake a lot of activities like sales, marketing, payroll, bookkeeping, etc all by yourself.

This is to ensure that as a small business you minimise your expenses and hence increase profitability. However, engaging yourself in all such secondary activities leads to loss of time.

But, technological advances have allowed businesses to reduce their burden and focus on the core activities of their business.

One such change is referred to as Remote Bookkeeping also referred to as Virtual Bookkeeping or Online Bookkeeping.

Remote Bookkeeping means giving remote access to your financial documents and online bookkeeping software to a virtual bookkeeper. The free bookkeeping software makes it easy for you as a business owner to upload receipts and invoices to a secure cloud accounting system.

Therefore, the remote bookkeeper can access the data recorded in your cloud accounting software. Furthermore, he also gets access to the financial data recorded in your online bookkeeping software as a result of integrating your bank accounts.

This data helps the bookkeeper to make entries regularly and reconcile bank statements with your financial reports.

Besides this, a remote bookkeeper can also create and send invoices to customers and suppliers, pay bills, and process payroll.

Thus, remote bookkeeping helps you to focus on the core activities of your business, lowering the cost and helps you manage your business in a better way.

Double Entry Bookkeeping

Double Entry system of accounting refers to a concept that every business transaction must be recorded in a minimum of two accounts. That is each business transaction has an equal and opposite impact on at least two separate accounts.

This is based on the following accounting equation:

Assets = Liabilities + Owners Equity

This accounting equation showcases that the assets of your business are always equal to the sum of the claims of owners and the outsiders. This means that at any given point in time, the resources of your business are always equal to the claims of the stakeholders who have provided funds for such resources.

In the double-entry system of accounting, the business transactions are entered as debits and credits. Furthermore, debit in one account sets off the credit in another account.

So, as a result, the sum of all debits must be equal to the sum of all credits. Thus, the double-entry system of accounting is based on the dual aspect of accounting in which every transaction involves give and take effect.

This effect is the basis of all the business transactions and thus is the foundation of the double-entry system of accounting.

Bookkeeping for Dummies

Bookkeepers record and organise the financial data of your business in an accurate and complete manner.

Accuracy of financial data is of utmost importance in bookkeeping as all business functions and decisions are based on the financial records.

An efficient bookkeeping system includes preparing the chart of accounts, passing journal entries, and summarising your business transactions in general ledger accounts.

Thus, bookkeeping is a process that allows you to track your business transactions in a step by step procedure. Following are the steps that you need to follow in order to undertake bookkeeping:

  • Record transactions including sales and purchases made by your business entity
  • Enter the transactions in the original books of accounts known as journal
  • Post the journal entries to separate general ledger accounts. These accounts may include sales, purchases, cash, bank, expense, debtors, creditors, etc
  • Following this, prepare a trial balance to check the accuracy of the debit and credit amounts recorded in various ledger accounts
  • Rectify the errors of trial balance if any by preparing ba separate worksheet and adjusting the accounts
  • After you have worked out the adjustments in the worksheet, record these adjustments to the requisite general ledger accounts
  • Then prepare basic financial statements including the income statement and balance sheet using the rectified account balances
  • Finally, close the books of accounts for revenue or expense accounts for the given accounting period
  • Repeat this process with zero balances for income and expense accounts in the next accounting period.

Who is a Certified Bookkeeper?

A Certified Bookkeeper is the accounting professional who has the skillset, understanding, and experience of performing duties of a bookkeeper.

The core duties of a bookkeeper include recording financial transactions, reconciliation of bank statements with financial statements, creating and sending invoices, collecting accounts receivable and paying accounts payable, processing payroll, etc.

Thus, a certified bookkeeper needs to have a great amount of financial expertise in order to perform core duties. So, in order to become a certified bookkeeper, an accounting professional needs bookkeeping certification.

Thus, in order to obtain bookkeeping certification, an accounting professional has to first pass a four-part public bookkeeping examination and must possess an appropriate bachelor’s degree in accounting.

In addition to this, he also must possess relevant experience in bookkeeping and accounting. Also, the bookkeepers need to complete and submit the application for a bookkeeping license. But, he can do so only if all the above requirements are met.

In other words, those accounting professionals who pass the exam and meet other requirements like relevant work experience, abide by the Professional Code of Conduct, possess an appropriate bachelor’s degree, have CPE credits, etc. can obtain the bookkeeping certification.

The benefit of possessing bookkeeping certification is that you have the requisite knowledge and skill set which is important for the bookkeeping profession.

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