Bookkeeping is an essential activity for any business, no matter how big or small. While many business owners think of accounting and finance as complicated and confusing, grasping some basic bookkeeping concepts and terminology can demystify the process. 

This post will explain the fundamentals of bookkeeping in simple terms to help you understand key accounting terms and concepts. With these building blocks, you’ll be better equipped to make sound financial decisions for your business. Read on to learn bookkeeping basics from what bookkeeping entails to recording transactions, common financial statements, and best practices.

What is Bookkeeping? 

Bookkeeping refers to the systematic recording of a business’s financial transactions. It involves tracking income, expenses, assets, liabilities, and equity on a regular, ongoing basis. Bookkeeping provides an organized record of all money flowing in and out of a company.

While accounting and bookkeeping are related, they refer to different financial management activities:

– Bookkeeping: Recording day-to-day financial transactions, like sales, purchases, receipts, payments, etc.

– Accounting: Preparing and analyzing financial reports based on the financial transactions recorded by bookkeeping.

Bookkeeping provides the raw data that accountants then take and interpret into meaningful financial statements and insights. The information in a business’s books allows stakeholders to review the company’s financial health, performance, cash flow, debt levels, and capital over time.

Proper bookkeeping is crucial for understanding your business’s financial position and making sound money management decisions. It’s also necessary for completing your annual tax return.

Importance of Bookkeeping

Here are some of the key reasons bookkeeping is an essential practice for businesses:

– Financial tracking: Bookkeeping provides an accurate, chronological record of all transactions that can be easily referenced as needed.

– Day-to-day oversight: Up-to-date books allow you to monitor sales, profit margins, accounts receivable, payroll, etc. so you can catch issues before they grow.

– Tax reporting: Thorough bookkeeping with the right documentation is vital for filing complete, accurate tax returns. Errors can lead to audits and penalties.

– Financial management: With detailed records, you can analyze sales, costs, profits, cash flow, etc. to strategically manage finances.

– Business insights: The data in your books can reveal important insights on customers, pricing, costs, what drives profitability, seasonal trends and more to inform good business decisions.

– Funding opportunities: Accurate books demonstrate financial responsibility to banks and investors if you seek loans or other outside funding.

– Legal compliance: Complete books are necessary for adhering to business licensing, accounting regulations, and other legal requirements.

In summary, bookkeeping provides the foundational information you need to monitor the health of your business, meet tax responsibilities, and make smart money management choices. Investing time in proper bookkeeping and record keeping will pay long-term dividends for your business success.

Basic Accounting Concepts

Before diving into the specifics of bookkeeping processes and tasks, it’s important to understand a few key accounting terms and concepts. Having a grasp of accounting basics will give you the framework to better understand your business’s books. Let’s review some of the most fundamental accounting building blocks.

Assets

An asset is something of value that your business owns, including:

– Cash and accounts receivable 

– Inventory

– Equipment, machinery, furniture, and vehicles

– Real estate and buildings

– Supplies 

– Patents, copyrights, trademarks

Assets can be physical or intangible. They are items and rights that you can use to operate your company and generate income or value. Assets are typically listed on the balance sheet from most to least liquid (easily converted to cash).

Liabilities 

A liability represents an amount of money or debt obligation that your business owes to outside parties, including:

– Accounts payable (unpaid bills owed to vendors/suppliers)

– Credit card debt 

– Bank loans or lines of credit

– Mortgages

– Rent, utilities, or other bills

– Payroll taxes and sales taxes owed

– Income taxes owed  

Liabilities are settled over time by using company funds to pay off the debts. On the balance sheet, liabilities are listed from shortest to longest-term debts.

Equity

Equity or owner’s equity represents your financial stake in the business as the owner. Equity comes from:

– Your invested capital

– Business profits that are retained rather than distributed

– Increases in company asset values

Equity reflects the funds and assets you have tied to the business. Your equity grows when the company retains earnings or the value of your assets rises. It decreases when the business loses money or asset values decline.

Revenue 

Revenue represents the total income your business earns from sales, services, interest, dividends, and other sources. Different types of revenue include:

– Sales revenue 

– Service revenue

– Rental revenue 

– Interest revenue

– Dividend revenue

Revenue does not equate to profit. Profit is calculated by subtracting expenses from revenue. But steady or increasing revenues over time is a key indicator of business growth and profitability.

Expenses

Expenses represent the costs your business incurs to operate and generate revenue and profits. Common examples include:

– Cost of goods sold – materials and production costs

– Wages and salaries

– Rent 

– Utilities and telephone

– Insurance 

– Office supplies

– Equipment leases

– Advertising 

– Accounting and legal fees

– Loan interest

– Depreciation

Keeping expenses low helps boost profit margins. Properly tracking expenses by category also helps uncover opportunities to cut costs.

These basic accounting terms and concepts form the building blocks of bookkeeping. Transactions are recorded in the books by recognizing how each financial event impacts these items. Understanding these fundamentals will help you better work with your bookkeeper and understand the story your books tell about your business.

Key Accounting Principles

Bookkeeping not only involves tracking revenues, expenses, assets, liabilities, and equity, but also following certain accounting guidelines and principles. Adhering to a standard set of accounting principles ensures your books fairly and accurately represent your company’s financial operations. Let’s look at three important concepts.

Double Entry Bookkeeping

Most modern bookkeeping uses the double entry method. This means that for every financial transaction recorded, two corresponding and balancing ledger entries are made. 

For example, recording a sale of $100 might include:

– Debit of $100 to Accounts Receivable 

– Credit of $100 to Revenue

This practice helps ensure the accounting equation balances – Assets = Liabilities + Equity. Having a balanced set of books also serves as an accuracy check. If entries aren’t balanced, it signals an error.

Accrual Basis vs. Cash Basis     

There are two primary accounting methods for recording revenue and expenses – accrual basis and cash basis:

Accrual basis: Revenue is recorded when sales are made or services completed, not necessarily when cash is received. Expenses are recorded when incurred, not necessarily when paid.

Cash basis: Revenue and expenses are only recorded when cash actually exchanges hands.

Accrual accounting portrays a more accurate picture of obligations and performance over time. However, cash basis is simpler to track transactions directly tied to cash inflows/outflows.

Debits and Credits

The words debit and credit can be confusing since they have different common meanings. But in accounting, their use is just a conventions for recording the two sides of a transaction:

– Debits – Increase asset or expense accounts

– Credits – Increase liability, equity, and revenue accounts 

Whether an account is increased with a debit or credit depends on its normal balance side:

– Asset accounts – normally debit balanced  

– Liability accounts – normally credit balanced

– Equity accounts – normally credit balanced

– Revenue accounts – normally credit balanced

– Expense accounts – normally debit balanced

The memorization of debits and credits and which types of accounts increase on which side can be challenging at first. But over time and through use, it will become second nature. Just remember they exist to track increases and decreases in account balances based on each transaction.

Common Bookkeeping Tasks

Now that we’ve covered some essential accounting terms and concepts, let’s explore the practical bookkeeping tasks you’ll need to perform regularly to maintain orderly, accurate business records.

Recording Transactions

Recording every business transaction in your company books is at the heart of bookkeeping. This means every:

– Customer invoice

– Vendor bill 

– Expense receipt

– Bank deposit

– Purchase made with a company card

– Payroll disbursement

– Equipment purchase or sale

– And other transactions

Recording transactions accurately is crucial for maintaining up-to-date books that reflect a current and factual financial picture. Transactions are typically recorded in journals, categorized by the type of activity. Examples include:

– Sales journal

– Cash receipts journal

– Purchase journal  

– Cash disbursements journal

– Payroll journal

– General journal

Journals organize transactions by type before they are posted to the general ledger. Consistently and promptly recording transactions takes dedication. But clean, precise books pay dividends.

Reconciling Accounts

Account reconciliation is also a key bookkeeping task. This includes reconciling bank accounts, credit card statements, vendor statements, and customer invoices with your recorded transactions each month. 

Reconciling involves:

– Comparing your recorded balances and transactions to third party statements

– Matching up charges, checks, and discrepancies 

– Identifying any missing or duplicated entries

– Investigating discrepancies 

– Making adjustments or corrections as needed

While time consuming, proper reconciliation ensures accounts are accurate, matched, and error-free. It also catches any unauthorized transactions.

Tracking Accounts Receivable and Accounts Payable

Detailed tracking of who owes money to your business as well as what is owed to vendors is another bookkeeping fundamental. Steps include:

For accounts receivable:

– Maintaining aging reports on outstanding customer invoices and balances

– Sending invoice reminders and collecting on overdue accounts

– Providing documentation and info needed for any credit claims 

For accounts payable:  

– Maintaining aging reports to ensure supplier bills are paid on time

– Taking discounts where offered for early payment

– Getting 1099s from vendors at year-end 

Keeping accounts receivable and payable organized minimizes late fees and helps avoid problems.

Calculating Depreciation 

For any equipment, vehicles, buildings, or other fixed assets purchased, depreciation expense needs to be tracked. Depreciation represents the gradual using up of an asset over time.

Bookkeepers calculate and record depreciation expense over the useful lifespan of assets. This allows the cost of the asset to be properly expensed and matched to revenue. Tracking depreciation also informs asset replacement planning.

Preparing Financial Statements

While compiling financial statements from the books is generally the accountant’s role, bookkeepers need to ensure clean, complete records to allow for statement preparation. Key financial statements prepared for businesses include:

Income statement – Shows revenues, expenses, and profit/loss over a period. Allows analyzing profit drivers and trends.

Balance sheet – Provides a snapshot of assets, liabilities, and equity on a specific date. Communicates financial position.  

Cash flow statement – Describes cash inflows and outflows over a timeframe. Allows assessing liquidity and cash needs.

Statement of equity – Details changes in equity accounts over time through earnings, dividends, investments, and withdrawals.

Bookkeepers need to supply correct figures, details, and reports from the books to facilitate compiling each financial statement. These statements are vital tools for monitoring company performance and making sound decisions.

Bookkeeping Software

One of the most important tools for effective bookkeeping is small business accounting software. Online solutions like QuickBooks Online and Xero allow you to:

– Organize financial records

– Track transactions seamlessly

– Sync data with bank accounts

– Manage invoicing and billing

– Pay vendors and employees

– Access reports and reconcile  

– Collaborate with an accountant

Cloud bookkeeping platforms make recording transactions, categorizing expenses, tracking sales, and other tasks much simpler and more efficient. The right software also enhances accuracy and transparency.

Be sure to select established, trusted providers and thoroughly evaluate available features when choosing bookkeeping software for your business. The upfront investment will pay dividends in easier, cleaner books and better financial oversight.

Hiring a Bookkeeper   

Many small business owners utilize an outside bookkeeping service or hire a part-time bookkeeper rather than managing the books themselves. This allows you to focus on your core business operations.

When hiring a bookkeeper, look for candidates who:

– Have 2+ years of professional bookkeeping experience

– Possess specific bookkeeping training and qualifications

– Are highly organized and detail-oriented

– Are skilled with major bookkeeping software programs

– Can maintain client confidentiality

– Have experience in your industry a plus

Define your specific needs like weekly/monthly hours, responsibilities, software knowledge, and reporting process in a bookkeeper job description. Thoroughly check references to confirm candidates’ expertise and reliability.

Developing a Bookkeeping System

As your company grows, you may choose to manage bookkeeping internally. If so, set up structured systems and protocols to promote consistency and organization. Your bookkeeping system should outline:  

– Who performs what tasks and when

– Standard procedures for recording transactions 

– Accounting software and tools used

– File storage and organization standards

– Reconciliation processes and schedules

– Financial reporting timetables

– Documentation and compliance practices  

Strong bookkeeping systems need clear procedures, orderly records, thoughtful safeguards, and quality controls. They evolve over time as the business grows and changes. Invest time upfront to implement systems that work smoothly and minimize errors.

Best Practices for Bookkeeping

Follow these bookkeeping best practices to keep your company’s books orderly, accurate, and audit-ready:

– Record transactions promptly – Don’t let details fall through cracks.

– Follow the matching principle – Match revenue and expenses to the same period. 

– Maintain detailed documentation – Retain receipts, contracts, invoices, and records.

– Perform reconciliations monthly – Compare books to third-party records.  

– Make bank deposits regularly – Don’t leave checks lying around.

– Require double authorization for payments – Have a second review for disbursements.

– Perform fixed asset inventories – Physically verify existence and condition.

– Develop financial controls and approval procedures – Limit access and require sign-offs.  

– Make data backups – Protect books from lost data or technology failures.

– Work with a qualified accountant – Have a pro prepare your financial statements.

Disciplined adherence to bookkeeping best practices prevents avoidable errors, preserves crucial documents, and establishes vital controls. This gives stakeholders confidence in the accuracy of your company’s books.

Conclusion

I hope this overview provides a helpful introduction to key accounting terms, bookkeeping concepts, and best practices for managing your business’s financial records. While bookkeeping may seem complex at first glance, grasping the basics helps demystify the process. Consistent, orderly recording of transactions is essential to understanding your company’s financial position. 

With the right foundational knowledge, bookkeeping tools, and disciplined processes, you can establish and maintain clean books. Accurate records allow you to monitor performance, make sound decisions, spot issues before they grow, and manage your business finances smoothly. Investing time in proper bookkeeping provides a long-term win for your business success and growth.