Running a small business is hard enough – trust us, we’ve been there. You have taken perhaps the biggest step of your life and set up a business, but now there are costs coming from every angle. No matter how small your business is, the books (your financial records) must be kept in check.
What is bookkeeping and how do I do it?
In short, bookkeeping is making sure that you record all of your financial transactions so that you pay the correct amount of tax at the end of the year.
Here’s a glossary of common terms used in bookkeeping:
Accounting period – A period of time over which financial information is tracked. This is usually done monthly, quarterly and annually.
Accounts payable (payable by the business) – The account where all of a company’s outstanding bills are tracked.
Accounts receivable (payable to the business) – The account which tracks payments to be collected by the company. This might be credit the company has issued or outstanding invoices to be paid by clients.
Assets – All the things a company owns which are required to do business. Common examples are properties, tools, vehicles, and of course, cash.
Balance sheet – This is a financial statement which provides an overview of the financial position of a business at a moment in time. “Balance” refers to the equilibrium between assets (which the company owns) and liabilities and equity which make claims against these assets. These things must be in balance.
Capital – The resources supplied by the business owners – e.g. money
Costs of goods sold (COGS) – This is a straight-forward account of the costs involved in producing or buying the goods and services sold by a business.
Depreciation – All held assets depreciate (go down) in value over time and this depreciation must be accounted for. In some instances, assets will appreciate (go up) in value.
Drawing Account – Will track the cash paid to owners in a small business whereas incorporated companies will pay dividends to shareholders.
Equity – The money invested in a company by the owners. In small businesses, the owner’s equity tends to be shown in a “capital account”. In larger, incorporated businesses, owner’s equity is visible in shares of the stocks.
Expenses – The business running costs – not associated with the sale of goods or services.
General Ledger – This is a summary of all accounts and should be considered the “master document” in bookkeeping.
Income statement – Ultimately, this calculates net Profit or Loss – beginning with Revenue earned, then subtracting the Costs of Goods Sold (COGS) and Expenses.
Interest – We’ve all heard of this one before. Interest is the cost of borrowing money, usually expressed as a percentage of the borrowed sum.
Inventory – The account which tracks all of the products which businesses intend to sell.
Journals – Bookkeepers keep their daily records in journals – categorized chronologically. The most active accounts have their own journals.
Ledger account – Informally known as a “T-account” due to it’s appearance, having debits on the left and credits on the right of a “T” separating the columns. A ledger account is a ledger of debits and credits for one specific account. For example, asset accounts like cash and inventory will have their own ledgers accounts.
Liabilities – All the debts a company is due to pay out – loans, mortgages, bills etc.
Payroll – How companies pay their employees. This is a cornerstone of the bookkeeper’s work. Payroll records will include information on pensions, taxes and such.
Retained Earnings – An important equity account, tracks all company profits that have been reinvested in the business.
Revenue – Simply put, revenue is all money collected by selling goods and services. There are other ways businesses collect revenue but these differ greatly case by case.
Source documents – Source documents are the original financial records which make up the paper trail of transactions to support your bookkeeping.
Trial balance – This is the test balancing of the books before making financial reports and closing the books for that accounting period.
There’s more to bookkeeping than just the terms and these only scratch the surface of the jargon used in accounting. Let’s try and keep things light by moving on to look at the basic principles of bookkeeping in practice.
Unfortunately, there is not a one-size-fits-all approach to bookkeeping. You need to decide whether to adopt the single-entry or double-entry system. But fear not, here is a brief description of both to help you choose.
This is the slightly more complicated way of bookkeeping, but the upside is that it reduces mistakes and allows you to keep a detailed account of everything that happens. At the most basic level, double-entry bookkeeping makes two entries for every transaction.
Here’s a simple breakdown of the steps:
- If you have an increase in assets, you need to write in the debit account
- If you have a decrease in assets, mark the credit account
- If you have an increase in liability or capital, you have to mark the credit account
- A decrease in either of liability or credit means an entry into the debit account
Double-entry bookkeeping uses a double ledger account for every entry in a system – for every transaction, a debit will have a corresponding credit and vice versa.
It’s based on the fundamental accounting equation: assets = equity + liabilities.
In other words, every time something happens in your company, two of the three fields mentioned above will be affected – i.e. if capital goes up, assets may go up; if liabilities go up, assets may also go up.
In layman’s terms, this means that you need to make two entries in your bookkeeping book for every transaction that occurs meaning the total debits must equal the total credits.
This is easier to understand in practice so download our double-entry template to gain a better understanding. Just remember this: for double-entry bookkeeping you debit the receiver and credit the giver.
This is a much simpler form of bookkeeping and is used by smaller firms to simply record what goes in and out. It involves a daily or monthly summary of the incoming and outgoings of a business without detailed information about equipment, capital and inventory – which are marked informally as notes.
You do not need a double ledger to track the whereabouts of every transaction.
However, this allows those who are not familiar with bookkeeping to keep abreast of their transactions while continuing to run their business.
A word of warning: single-entry bookkeeping can lead to errors and therefore bigger issues down the line if not done properly. We recommend you get acquainted with the double entry system by practicing in our template.