What is bookkeeping?
No matter what you sell or what services you offer, every business does two things consistently: you make money, and you spend money. You'll need a bookkeeping system to keep track of all that.
This guide will walk you through some of the basics of bookkeeping and show you some tips regarding how you can adopt your own bookkeeping strategy for your small business.
Definition of bookkeeping
Bookkeeping refers to the process of recording financial transactions for a business. This means that every time you make a sale, purchase new supplies, or pay your employees, you make a record with supporting documentation.
This documentation might be in the form of a receipt, invoice, purchase order, or other record to show that the transaction took place.
Modern bookkeeping dates back to the 15th century, though the process has changed considerably over time. In colonial America, bookkeepers used to temporarily record transactions in a "waste book," then transferred to a ledger to balance the accounts and create a permanent record.
Today, financial professionals rely on the latest bookkeeping software to help them keep tabs on a company's financial transactions. These digital tools make it simpler to integrate multiple areas of your business under one platform and minimize mistakes made through manual data entry.
What is the difference between bookkeeping and accounting?
It's not uncommon for the terms "bookkeeping" and "accounting" to be used interchangeably. But while there is overlap between these two processes, bookkeeping and accounting are not quite the same.
Bookkeeping simply refers to the recording of financial data. This means recording debits and credits and organizing these transactions according to the company's chart of accounts.
If the bookkeeping process is largely about collecting data, the accounting process is about interpreting data. Accountants review the financial information gathered by the bookkeeper and analyze this data to create financial reports to assess the business's financial health.
Accountants prepare year-end financial reports for the company, and these reports must adhere to standards set by the Financial Accounting Standards Board (FASB). These professionals also assist with tax preparation and offer strategies to maximize the deductions you take on your annual tax returns.
Certified Public Accountants (CPAs) also supervise the internal controls of computerized bookkeeping systems to preserve accuracy. Many accountants also possess additional certification and specialized training in forensic accounting, managerial accounting, tax accounting, and more.
Why bookkeeping matters for your business
The data stored in your books will help you better understand your business's financial position to make better financial decisions. According to the U.S. Small Business Administration, roughly half of new businesses will close their doors within five years, and only one in three will see their 10th birthday.
As a business owner, it's crucial to stay on top of your financial records and know how your business is performing. Proper bookkeeping practices allow you to:
- Make better budgeting decisions
- Keep your financial records organized
- Prepare for tax filing
- Understand your cash flow
- Assess weak areas of your company's infrastructure
In an era where decisions are based on sound financial data, having the right bookkeeping system can help your small business thrive.
What does a bookkeeper do?
The role of a bookkeeper is relatively straightforward and organized around a basic set of tasks, including:
1. Recording financial transactions
The most regular bookkeeping task involves recording daily transactions and classifying them as assets, liabilities, or other classifications specific to your business. Every financial transaction is recorded in the general ledger, but your chart of accounts will serve as a classification system to help you organize your data.
While it might seem easy to rely on a bank statement to compile this information, accurate bookkeeping demands that the bookkeeper looks at the source documents, such as invoices, receipts, and other direct records of the transaction.
This is why it's great to rely on accounting software, where your invoices and other documents can be stored electronically and accessed from a cloud-based server.
2. Managing asset accounts and liabilities
While your bookkeeping system may include a variety of categories, you can generally organize each financial transaction into one of two categories: assets and liabilities. Assets and liabilities are recorded on the company balance sheet and will be one of several key documents you'll use in your accounting system.
An asset account will include tangible items such as your existing inventory and equipment, but it will also include your accounts receivables. In business, "accounts receivable" refers to the money that your customers owe you for goods or services.
Similarly, your liability accounts will reflect money your business owes to others. This can include payroll, taxes, and accounts payable. Accounts payable refers to the money your company owes to suppliers, banks, and credit card companies.
Every year, the bookkeeper will balance these assets and liabilities using the "key formula" or accounting equation:
Assets = Liabilities + Equity
In this accounting equation, equity refers to the investment that business owners and investors have in the company. The point of the equation is that everything that the business owns (assets) must be balanced against claims against the business (liabilities and equity).
3. Preparing financial statements
The bookkeeper prepares financial statements that can be invaluable for helping business owners assess their performance. The four major financial statements include:
- Income statement (or "profit and loss statement"): shows revenue/expenses over time
- Balance sheet: shows the financial position at a specific point in time
- Cash flow statement: shows movement of cash in and out of your company
- Statement of changes in equity: shows how capital and retained earnings have changed
Be aware, however, that only a licensed accountant can prepare certified financial reports for lenders and investors.
Still, bookkeepers can provide these basic internal documents that you can use to evaluate the financial results of your business processes.
Frequent financial reporting can help you better understand your business. For instance, the income statement can show you how your business spends money over the year and highlight how an expense account (such as wages or administrative expenses) impacts your bottom line.
4. Closing at the end of the period
A bookkeeper will close the books at the end of every accounting period. This involves:
- Reconciling all bank statements, credit card balances, and loan amounts
- Reconciling accounts payable and accounts receivable
- Reviewing financial statements for accuracy and completeness
It's also wise to lock the books at the end of the period, preventing further alteration once they've been closed. This still allows authorized users to access the financial information but prevents the data from being tampered with.
Types of bookkeeping methods
Companies will need to choose between different types of accounting and bookkeeping systems.
Single-entry vs. double-entry bookkeeping
Single-entry bookkeeping is the simplest form of bookkeeping and is similar to balancing your personal checkbook. You'll record all of your financial transactions one time in your accounting records. You can record this data as either positive or negative or use a two-column ledger that divides income and expenses.
The single entry system works well for businesses with small numbers of transactions. As your business grows, you may need to adopt the double-entry bookkeeping system. In the double-entry system, you can split your general ledger in two. You'll record debits in one account and credits in the other. You'll use both of these accounts when recording journal entries.
For example, if you take out a business loan for $10,000, you'll record this value twice: as a $10,000 credit, and $10,000 as a liability (since you'll have to pay it back). Only the double-entry system can help you manage both the increase in cash and your outstanding debt.
Accrual basis vs. cash basis accounting
You'll also need to choose between two different accounting methods: accrual and cash-based accounting.
Cash basis accounting transactions are recorded only when cash changes hands. For instance, you'll record income when a customer pays you and when you pay your bills.
Modern cash basis accounting is excellent for smaller companies or those who produce products on demand. ECommerce platforms can quickly adapt this method to keep track of their books.
In accrual basis accounting, you'll record each financial transaction, regardless of whether money changes hands. If you send a customer an invoice, you'll record the amount, then record the amount that the customer pays you.
The accrual method is ideal for larger companies or service-oriented businesses. This method gives you a more accurate picture of when the work was performed and when the customer paid their bill. These insights can also help you identify problems with outstanding and unpaid invoices, which can negatively impact your cash flow.
Bookkeeping options for small business
As a small business owner, you have three basic options when it comes to bookkeeping:
Hiring an in-house bookkeeper
Your first option is to hire a professional. You can rely on an in-house bookkeeper to handle your books, perform data entry, and manage your chart of accounts.
The advantage of this is that you'll get someone with experience and expertise in handling your business data and someone already familiar with accounting software. The downside is that you'll now have another staff member to employ, and this salary can cut into your bottom line.
Some business owners choose to outsource their financial needs to an accounting firm. Even small firms can provide expert guidance in helping you prepare important documents or assisting with tax strategy. These services are usually much cheaper than hiring a full-time staff member.
While you might choose to hire an accountant for specialized services or tax preparation, you can always handle the books yourself. And with today's accounting software, you'll be able to keep accurate, organized records of every aspect of your business.
The very best tools will allow you to send invoices, accept payments, and generate reports from the same integrated platform.
Integrated solutions for modern business
Invoice2go can provide a comprehensive system that integrates your invoicing process with your books. This way, you'll always have direct access to your essential financial information and can even generate reports that will help you assess your business performance.
Take a 30-day tour of these key features by signing up today. Our clients use these tools to get paid faster, save time, and focus on their core business.
Frequently asked questions
Here are some of the most commonly-asked questions about the bookkeeping process:
According to the employment website Indeed.com, the average bookkeeper makes $21.58 per hour, translating into just over $40,000 per year. If you hire a CPA, however, you could end up spending as much as $150,000, according to the journal Accounting Today.
Costs can vary based on your industry, the person's education and experience, and the amount of work you ask them to perform. But these numbers show that it can often be more affordable to rely on your own software.
Technically, there are no educational requirements to become a bookkeeper, though most possess at least a bachelor's degree in a field such as business or mathematics.
Beyond this, bookkeepers need to have experience in data entry and some basic accounting practices discussed above. Ideally, bookkeepers will also have excellent communication skills to help others understand business data.
As a general rule, the more data, the better. The one exception is petty cash, which refers to a small amount of money a business keeps on hand for small purchases such as stamps, office supplies, or the occasional meal. Petty cash is not typically recorded in the general ledger.