Table of Contents
- Bookkeeping 101: Basics for Beginners
- What Is Bookkeeping?
- Accountant vs. Bookkeeper
- The Basic Account Types
- How To Do Bookkeeping for Small Business
- Create Your Chart of Accounts
- Record Transactions
- Reconcile Transactions
- Run Financial Statements
- When To Hire A Bookkeeper vs. Doing It Yourself
Bookkeeping 101: Basics for Beginners
So, you need to do some bookkeeping. Or is it accounting? No, wait. Maybe it’s CPA-ing.
That can’t even be a real word.
It’s no surprise that people use all those terms – and more – interchangeably. They all sound relatively the same and all share an industry that involves money and numbers, so they’re all the same, right?
Wrong. Well, kinda. Sorta. If this were Facebook, we’d say ‘It’s complicated.’
Not every bookkeeper is an accountant – though every accountant is technically qualified to be a bookkeeper – and while both need to be sticklers for accuracy and knowledgeable about key financial topics, the main difference between a bookkeeper and an accountant is that an accountant has a bachelor’s degree in accounting or similar.
Clear as mud, right? Right. Right.
So, first things first: Let’s define what bookkeeping actually is.
Bookkeeping is the recording of a business’s financial transactions with financial implications that need to be recorded.
So far, so good. Sounds simple enough. But we get it: If you’re not a bookkeeper by trade, the vocabulary and math are enough to leave you feeling overwhelmed – and underqualified.
But fear not – here, we’ll break down bookkeeping basics so entrepreneurs, small business owners and intrepid leaders just like you can feel confident as you wade into these uncharted waters.
What Is Bookkeeping?
Now, let’s dig a little deeper. Deep breaths – you’ve got this.
Bookkeeping tracks your business’ financial transactions with entries to specific accounts using a debit and credit system.
Every entry represents a different transaction, and every accounting system has a chart of accounts that lists accounts as correlating categories. Think of it as a detailed filing system, recorded either by hand or using software.
There is typically at least one account for every item on your company’s balance sheet and income statement.
And bookkeeping is a simple – we promise – four-step process:
- Analyze financial transactions and assign them to specific accounts
- Write original journal entries that credit and debit the appropriate accounts
- Post entries to ledger accounts
- Adjust entries at the end of each accounting period.
This process is based on two basic fundamentals.
- Every debit must have an equal credit.
- All accounts must balance.
Sure, it can be a little tedious. And yes, it requires an accurate eye for detail. But whether you’re balancing the books yourself as a small business owner or hiring a bookkeeper, accurate bookkeeping will help you understand more about your financial health, and allow you to make informed decisions about the future of your organization.
And with all that managed to perfection, your accountant just might shed a tear of joy preparing your financial statements. You’ve been warned.
Accountant vs. Bookkeeper
Let’s get right to demystifying the differences – and similarities – between a bookkeeper and accountant.
Bookkeepers have two to four years experience or an associate’s degree, with their work overseen by either an accountant or the small business owner whose books they are doing. They record financial transactions, which lay the foundation for …
Accountants have a bachelor’s degree in accounting – or a finance degree considered an adequate substitute – and interpret, classify, analyze, report and summarize financial data.
Simply put, the main difference between a bookkeeper and accountant is that bookkeepers handle the day-to-day task of recording financial transactions, whereas accountants interpret, communicate, and report on the financial data.
Learn more about the similarities, differences and responsibilities of bookkeepers and accountants here so you know when to hire each.
The Basic Account Types
When a company buys or sells goods and services, a bookkeeper updates the business accounting books to keep track of funds coming in and going out.
Easy enough, right?
Then, businesses need to list their accounts by creating a general ledger – called a Chart of Accounts – which we’ll cover more in a bit.
For now, let’s demystify the five – yup, just five – basic account types necessary for bookkeeping.
Anything of value in your business is considered an asset, including cash, resources owned by your business, like accounts receivable (A/R), balance, and inventory, computers, and furniture.
These are the obligations and debts owed by your business, like accounts payable (A/P), such as your accounts payable (A/P) and any loans your business owes.
- Revenue or Income
Revenue, also called income, is any money earned by your business either through products sold or services rendered.
This is all the cash that flows out from your business, such as utilities and employee salaries.
Your equity is the value that remains after you subtract your business liabilities from your business assets. It represents your financial interest in the business, such as stock or retained earnings.
With these basic bookkeeping principles understood, it’s time to put pen to paper.
How To Do Bookkeeping for Small Business
Step 1: Create Your Chart of Accounts
A chart of accounts is – at its simplest – just a list of all your financial accounts. But ‘list’ doesn’t exactly have the same ring or panache – and certainly doesn’t evoke the same intimidation as ‘chart of accounts,’ now does it?
‘Chart of accounts:’ Demystified. You don’t scare us. Not anymore, anyway.
Your ‘list’ is created to meet your unique needs and the accounts listed therein represent the five typical financial buckets of most businesses as listed above and can be customized for your exact needs.
In keeping with the double-entry system of accounting, a minimum of two accounts is needed for every transaction – so at least one account is debited and at least one account is credited.
Here are some general rules about debiting and crediting the accounts.
Expense accounts are debited and have debit balances.
Revenue accounts are credited and have credit balances.
Asset accounts normally have debit balances.
To increase an asset account, debit the account.
To decrease an asset account, credit the account.
Liability accounts normally have credit balances.
To increase a liability account, credit the account.
To decrease a liability account, debit the account.
See? Not so bad. Your chart of accounts is really just a glorified list of every classification of incoming and outgoing money.
Here, check out a sample Chart of Accounts for context – and maybe even inspiration.
Now, it’s time to set it up.
Step 2: Record Transactions
It’s critical that every debit and credit transaction is recorded correctly and in the right account or your account balances won’t match and you won’t be able to close your books.
And that a happy business owner – and accountant – does not make.
To record a transaction, identify the accounts that will be debited and credited.
So, let’s say, for example, that you just purchased a new widget system for which you paid $2,000 cash.
This will impact two accounts: cash (an asset account) and equipment (also an asset).
By making this purchase, you’re decreasing your cash and increasing your equipment, you’d record a $2,000 debit for the equipment account and a $2,000 credit for the cash account.
Step 3: Reconcile Transactions
Once you receive your monthly bank statement, you need to reconcile the transactions on the statement with those posted in your ledger or accounting software.
This will give you an accurate bird’s eye view of what checks are still outstanding, post any bank transactions, and add additional charges, such as account fees. It will also provide you with an accurate cash balance.
Step 4: Run Financial Statements
Now that you’ve reconciled – or balanced – your books, you need to take a closer look to holistically understand your company’s financial health.
The What: This report shows a company’s assets, liabilities, and owner equity or capital on a particular date. This is a snapshot in time, not a report that shows over a period of time.
The Why: Just because the P&L shows the company is ‘profitable’ doesn’t mean the business is in good shape.
Often, the balance sheet is overlooked and is actually one of the most important if not the most important – financial statements. A company can be profitable while incurring a lot of debt.
Debt means restricted cash flow and without positive cash flow, businesses fail. The balance sheet can be used to identify trends and make more informed financial accounting decisions. It is also important to lenders as they will use it to determine a company’s creditworthiness.
Statement of Profit & Loss (also known as an Income Statement)
The What: Also known as an Income Statement or P&L for short, this report shows a company’s income and expenses for a particular time period, though monthly and annually are the most common times reviewed.
The Why: The P&L shows the performance of the company, summarizing the total revenues and expenses incurred by the business, showing the profitability, such as net income or net loss, over a specified period of time, usually a month, quarter or year.
The Income Statement is used internally and externally to evaluate profitability and help assess the level of risk for an investor or creditor. In order to have a viable and valuable company, revenues must exceed expenses.
Cash Flow Statement
The What: This report shows how changes in balance sheet accounts and income affect cash and cash equivalents.
The Why: This report helps inform long-term decisions and the best use of this report – aside from seeing where changes in cash and other cash assets are – is to help estimate future cash flow which will assist with budgeting and decision-making.
Check out a few more financial reports you could run.
When To Hire A Bookkeeper vs. Doing It Yourself
As we’ve previously discussed, deciding whether to hire a bookkeeper or do it yourself is much like deciding whether to change your own oil or hire a mechanic.
Sure, you could do it yourself and save some money – that is, if you know what you’re doing – or you could end up making a huge mess and, potentially, some costly mistakes. There are many reasons to hire a virtual small business bookkeeper.
And when it comes to deciding whether you can handle your bookkeeping or whether it’s better left in the hands of a professional, it’s often helpful to ask yourself some soul-searching questions.
Gut-check time: Ask yourself …
- Are you behind on your books?
- Do you keep receipts in a shoebox?
- Have you divvied your bookkeeping tasks to employees who aren’t bookkeepers?
- Have you pinned all your hopes on TurboTax?
- Are your invoices still unsent or regularly late?
- Have your sales increased but your profits haven’t?
- Are your bank statements not reconciled?
- Are your books only updated just before tax season?
- Do you lose sleep wondering if you missed tax deductions?
- Do you lack confidence in your bookkeeping skills?
- Do you have unpredictable cash flow?
- Does bookkeeping take time away from dreaming, growing or leading?
- Do you wonder if you’re overpaying someone to clean up your messes?
Listen. You can do this. You can absolutely do your own bookkeeping.
But there may come a time where your business outgrows your skills. Or when you reach the point where handling your own bookkeeping isn’t the best use of your time.
Your finances are not the place to be experimenting, holding your breath, fingers crossed and hoping for the best.
So if you are one day ready to wave the white flag on handling your red and black margins, let one of BELAY’s experienced remote bookkeepers help.
You’ll regain your peace of mind – and wonder why you waited so long.
Related BELAY article: 7 Ways A Bookkeeper Can Save You Money