Bookkeeping is an important function in any business, large or small. It involves recording all financial transactions made by a company and producing financial statements that summarize the company’s financial position. 

While bookkeeping may seem complex at first glance, it becomes much easier to understand when you break it down into basic concepts and terms. With a solid grasp of some key accounting and bookkeeping fundamentals, anyone can learn to keep accurate financial records.

In this comprehensive guide, we will cover everything you need to know as a beginner to understand basic bookkeeping and accounting principles. You’ll learn about:

– What bookkeeping is 

– Key accounting concepts like assets, liabilities, equity 

– Important principles like double-entry bookkeeping

– Common bookkeeping terminology 

– Different bookkeeping methods

– Accounting software options

Let’s get started!

What is Bookkeeping?

Bookkeeping refers to the process of recording all financial transactions made by a business. This includes sales, purchases, expenses, and any other money that comes in or out of the company.

The bookkeeper is responsible for tracking these transactions using an accounting system. This system can be manual, done on paper ledgers or journals, or digital, using accounting software.

Bookkeeping provides the data needed to prepare financial statements. This includes the income statement, balance sheet, cash flow statement, and statement of retained earnings. The financial reports give business owners, investors, and other stakeholders an understanding of the financial health and performance of the company.

While bookkeeping focuses on recording transactions, accounting involves summarizing the data and analyzing/reporting on the financial statements. Accountants may take the bookkeeping data and perform activities like preparing tax returns, auditing financial statements, forecasting profits, and detecting fraud.

In small businesses, the same person often performs both bookkeeping and accounting duties. But for larger companies, these are usually separate functions done by different teams or professionals.

Key Accounting Concepts 

To understand bookkeeping, you first need to get familiar with some key accounting concepts and principles. These fundamentals provide the foundation for recording financial transactions accurately.

Assets

Assets are economic resources owned by a company, which hold future value or benefit. Common examples include:

– Cash 

– Accounts Receivable 

– Inventory

– Equipment

– Vehicles

– Furniture

– Office supplies

Assets get recorded on the balance sheet. Current assets can convert to cash within 12 months, while long-term or fixed assets take longer to convert to cash. 

Liabilities

Liabilities are debts or obligations that a company owes. Common examples include:

– Accounts Payable – This is money owed to vendors/suppliers for purchases made on credit.

– Credit card debt – Money owed on business credit cards is a liability.

– Loans – Money borrowed from a bank or other lender.

– Mortgages – Loans taken to purchase property.

– Taxes owed – Business taxes that are due to the government.

Liabilities get recorded on the balance sheet and are settled over time by making payments of cash.

Equity

Equity represents the amount invested in the business by the owners, as well as cumulative business profits over time. Equity gets reported on the balance sheet and helps indicate the net worth of the company.

– Owner capital – This is the amount invested in the business by owners through purchasing stock. It increases with additional investments and decreases when money is withdrawn.

– Retained earnings – The cumulative profit earned over the lifetime of a business after distributing dividends. It gets reinvested in the company rather than paid out to shareholders.

Revenue 

Revenue represents income earned by making sales and providing services. Some examples include:

– Sales revenue – Money earned by selling products.

– Service revenue – Income from providing services to customers.

– Interest revenue – Interest earned on deposits in a bank account.

– Rental revenue – Money paid by tenants occupying your property.

Revenues increase equity on the balance sheet. On the income statement, they get reported at the top and subtracted by expenses to determine profit.

Expenses

Expenses represent costs incurred by the business. Some common examples:

– Wages – Salaries paid to employees

– Rent – Amount paid to occupy business properties

– Utilities – Electricity, gas, water, etc. 

– Supplies – Office and operating supplies used up in business activities

– Insurance – Premiums paid for business insurance policies

– Depreciation – The reduction in value of fixed assets like equipment over time

On the income statement, expenses get deducted from revenues to arrive at net profit or net loss for a period.

Important Accounting Principles

Now that we’ve covered the key accounting elements, let’s look at some concepts and principles that guide the bookkeeping process.

Double-Entry Bookkeeping 

This is a standard practice where every financial transaction gets recorded in two accounts. One account gets debited, and the other gets credited by an equal amount. 

For example, if you purchased inventory with cash:

– Debit Inventory (asset account) 

– Credit Cash (asset account)

The total debits must equal the total credits. This double-entry system helps maintain the accounting equation where assets = liabilities + equity.

Accrual vs. Cash Basis Accounting

There are two main methods for recording transactions – cash basis and accrual basis.

Cash basis means income and expenses get recorded when cash actually changes hands. Accrual basis records revenue when earned and expenses when incurred, even if no cash payment has been made yet.

Accrual accounting gives a more accurate picture of financial position and is required for external financial reporting. However, smaller businesses may opt for cash basis taxes.

Debits and Credits

These are the fundamental terms used in double-entry bookkeeping. 

– Debits – Debit accounts record increases in asset and expense accounts. “Debit” basically means “the receiver.” Assets, expenses, and dividends get debited when they increase.

– Credits – Credit accounts record increases in liability, equity, and revenue accounts. “Credit” basically means “the giver.” Liability, equity, and revenue accounts get credited when they increase.

The acronym “DEAD CLIC” can help you remember:

– Debit – Increase Assets, Expenses, Dividends 

– Credit – Increase Liabilities, Equity, Revenue

Key Bookkeeping Terminology

Now let’s go over some important terms related to bookkeeping activities and records.

Chart of Accounts 

This is a list of all the accounts or “general ledgers” that a company uses to record transactions. The Chart of Accounts forms the foundation of the accounting system. It typically includes:

– Assets – Example accounts: Cash, Accounts Receivable, Inventory, Equipment 

– Liabilities – Example accounts: Accounts Payable, Credit Card Debt, Loans 

– Equity – Example accounts: Common Stock, Retained Earnings

– Revenue – Example accounts: Sales Revenue, Service Revenue, Interest Revenue

– Expenses – Example accounts: Salary Expense, Rent Expense, Utilities Expense

The Chart of Accounts is numbered and organized into categories or subheadings for easy reference.

General Ledger

The General Ledger contains all accounts from the Chart of Accounts. Transactions get posted to the respective accounts in the General Ledger. Balances from each general ledger account get used to prepare the financial statements.

Journals

Journals provide a chronological record of transactions. Common journals include:

– Sales journal – Records sales made on credit

– Cash receipts journal – Records cash received from customers 

– Cash disbursements journal – Records cash paid out

– General journal – Records miscellaneous transactions

Trial Balance

A trial balance is a listing of all general ledger accounts and their balances at a point in time. It helps ensure the total debits equal total credits in the system. If debits and credits match, the trial balance indicates transactions were posted correctly.

Bookkeeping Methods

There are two main methods used for bookkeeping:

Single Entry Bookkeeping  

This is a simplified method that primarily records cash transactions. With single entry, only one entry gets made per transaction – either a debit or credit. This approach does not use double-entry accounting.

Single entry bookkeeping only tracks income, expenses, and cash. So balances for accounts like accounts receivable, accounts payable, and inventory get omitted. It does not allow preparation of accurate financial statements.

This approach works for very small, cash-based businesses with minimal transactions. But it lacks the control and accuracy of double entry bookkeeping.

Double Entry Bookkeeping

As explained earlier, double entry records both debits and credits for each transaction. This provides a checks and balances system to prevent errors and detect fraud.

Double entry bookkeeping is the standard practice used by businesses and required for accurate financial reporting. Transactions get recorded into journals first, then posted to the General Ledger under the appropriate account.

The extra time required to record transactions twice provides long-term benefits by generating financial statements with credible, verifiable information.

Accounting Software

In the past, bookkeeping was done by hand in paper books or ledgers. Today, most businesses use accounting software to automate the process. Some popular options include:

– QuickBooks – The most widely used small business accounting platform. User-friendly with lots of how-to guides and support available.

– Xero – Cloud-based software focused on small business. Mobile enabled and integrates with many ecommerce platforms. 

– Sage – Offers a range of cloud solutions scaled for small to enterprise level companies. More customizable than QuickBooks.

– Wave – Free software with income and expense tracking, invoicing, payroll, and more. Ideal for very small businesses.

– Zoho Books – Affordable and easy to use. Integrates with other Zoho business apps.

Accounting systems allow easycategorization of transactions for reporting. They automate tasks like sending invoices, tracking sales taxes, reconciling accounts, and generating financial statements.

Conclusion

Mastering the fundamentals of bookkeeping and accounting is an important skillset for small business owners and entrepreneurs. 

While it may seem complex at first, the basic concepts are straightforward once you understand key terms and principles like double-entry bookkeeping, debits and credits, and accrual accounting.

Recording transactions accurately is crucial for producing financial statements that provide insights into the performance and profitability of a business. 

With accounting software, the bookkeeping process is much smoother than manual methods. The right system helps automate routine tasks so business owners can focus on analysis and strategy.

I hope this overview has provided a helpful introduction to bookkeeping basics. Let me know if you have any other questions as you set up your accounting process!