Bookkeeping is a process in which a company systematically collects, records, organizes, and tracks its financial data daily throughout the year.
Bookkeeping is important for businesses to ensure that every transaction, income, expense, and bill is accounted for throughout the year. It helps create effective financial strategies, file tax returns on time, and avoid errors and penalties.
In Mesopotamia, around 7,000 years ago, bookkeepers recorded financial data on clay tablets, while Babylonians used styli to record data on small clay slabs around 2600 BC. In 1494, Luca Pacioli introduced double-entry bookkeeping, which has since evolved into modern computerized systems.
What Is Bookkeeping?
Bookkeeping is the systematic process of tracking, recording, and organizing an organization’s financial transactions or records daily or regularly. It’s an important part of accounting that helps you make effective financial decisions and supports tasks such as budgeting, tax planning, and auditing.
In bookkeeping, source documents for business transactions and operations are prepared, such as sales orders, supplier invoices, payment receipts, customer purchase bills, payrolls, etc.
Modern bookkeeping uses electronic means such as spreadsheets and online bookkeeping software. Bookkeepers are individuals who perform bookkeeping in an organization.
How Bookkeeping Works
In bookkeeping, it’s essential to maintain each financial transaction properly and accurately. The bookkeeping process involves several systematic steps, including:
- Collecting transactions: First, you will need to collect accurate and up-to-date financial data and organize it. Consider all incoming and outgoing transactions from multiple sources, such as bank statements, payroll, receipts, invoices, etc. Ensure data is organized with details like amount, date, descriptions, account numbers, etc.
- Classifying records: Next, categorize your financial records based on their types and nature. Common categories include accounts payable, accounts receivable, rent, inventory, utilities, salaries, and more. This will help keep your records clean and is helpful in financial reporting.
- Recording data: Record transactions in a single-entry or double-entry accounting system. If you follow double-entry accounting, enter data as a credit and debit, ensuring they’re always balanced. Many organizations record their financial data in a journal, general ledger, or online bookkeeping or accounting software. This helps them track changes occurring in different accounts over a period.
- Trial balance: Organizations usually prepare a trial balance towards the end of an accounting cycle, like annually, quarterly, or monthly. A trial balance lists every account and their corresponding balances in credits and debits to check if they are in equilibrium and ensure bookkeeping accuracy.
- Closing entries: Bookkeeping teams make closing entries when an accounting cycle ends to reset all the temporary accounts to zero. These accounts could be dividends, expenses, revenue, etc. It enables them to refresh the books for the upcoming accounting cycle.
- Financial reporting: Bookkeeping teams report financial data to stakeholders like business owners, regulatory authorities, investors, etc. This also helps businesses analyze their financial position, make informed business decisions, and stay compliant with regulatory bodies.
Why Is Bookkeeping Important?
Bookkeeping is an important part of a business. Inadequate bookkeeping can lead to negative outcomes like budgeting issues, financial losses, operational delays, compliance risks, and other problems.
Here are some of the reasons underscoring the importance of bookkeeping for your business:
- Enabling you to keep up-to-date, accurate records for optimizing business operations.
- Setting realistic sales, revenue, and income standards and goals.
- Getting a broader view of your financial performance.
- Preparing for taxes with well-organized records.
- Take a sneak peek into your cash flow to optimize expenses.
- Planning for future endeavors based on current financial data.
Components of Bookkeeping
Regardless of business type, bookkeeping has some common components to help you understand your finances and make suitable strategies. These components are based on tasks and the location of bookkeeping.
Task-Based Components:
- Recording transactions: Record each financial transaction, such as payments received and made.
- Creating a ledger: Maintain a general ledger of all financial data.
- Documenting records: Document financial records like payroll details, credits, debts, etc.
- Tracking bank activities: Track each banking activity daily/regularly to ensure nothing is left unnoticed.
- Invoicing: Send bills/invoices to customers for purchased goods/services. You may use these invoicing software to automate the process.
- Processing payments: Process and timely payments for employees and suppliers/vendors.
- Organizing data: Classify and organize financial data for timely audits and taxes.
Location-Based Components:
- Journals: It’s like a business diary that you use to jot down financial data daily to track cash flow. In general, small businesses and startups use journals.
- General ledgers: Ledgers track money and determine financial stability by dividing your finances into assets and liabilities.
- Charts of accounts: These are lists of properly organized income, revenue, assets, liabilities, expenses, etc., divided into different categories. Finding relevant financial data becomes easier with this list.
- Financial statements: Financial reports/statements are created to help you analyze all your profits, losses, financial health, etc., to make informed business decisions.
- A trial balance: Before generating a financial report, you must perform a preliminary check to verify the correctness of your (debits + credits). This check is referred to as a trial balance.
Methods of bookkeeping
Methods of bookkeeping include:
1. Single-Entry Bookkeeping
In single-entry bookkeeping, each transaction will have only one entry in your cash book or ledger, maintained daily or weekly, to track revenue and expenses. It records payments, sales, purchases, cash receipts, etc. It best suits small businesses, startups, and solopreneurs with minimal inventory, assets, and business transactions. Single bookkeeping doesn’t require bookkeepers to have a formal training or degree.
2. Double-Entry Bookkeeping
In double-entry bookkeeping, each transaction should be recorded as credits and debits in at least two accounts. Credits must always balance debits to ensure your books are balanced, indicating accuracy in financial recording.
Example: A business has sold a good for $100. So, $100 will be debited from their cash account, while $100 will be credited to your sales account.
Double-entry bookkeeping is best for larger companies with many inventory and tangible assets. It involves frequent selling or buying on credit.
3. Cash-Based or Accrual-Based
In cash-based bookkeeping, businesses record revenue in books upon receiving cash from an entity (like customers). Similarly, they record expenses in books upon paying cash to another entity (vendors, suppliers, etc.). It depends on cash exchanges only and not credit transactions, thus making it more suitable for startups and small businesses.
In accrual-based bookkeeping, a business records revenue in books upon earning it. Similarly, they record expenses in books once billed. Cash exchange is not required to record a transaction. Businesses can record their purchases and sales on credit. This method is more suitable for larger businesses with frequent credit transactions.
Do Small Businesses Need Bookkeepers?
Yes, small businesses need bookkeepers to accurately record, track, and maintain their financial transactions, even if the number of transactions is smaller than larger businesses.
Maintaining financial records can become difficult and overwhelming without a bookkeeper, leading to missed payments, unbalanced books, errors, etc.
If you are a small business with growing transactions and have a good budget, consider hiring a bookkeeper. They will record and organize daily transactions and prepare reports for taxes and compliance. Since local tax laws and regulations keep changing, professional bookkeepers ensure you meet their requirements.
However, self-employed individuals, solopreneurs, freelancers, or small businesses with less than 10 employees need not necessarily hire a bookkeeper in-house. Instead, they can hire a bookkeeper or a private accounting firm to handle their financial records and file taxes.
How to Become a Bookkeeper
Becoming a bookkeeper is a good career option if you have a way with numbers. Many companies don’t even require formal education or certification to hire bookkeepers. Thus, many are self-taught, acquiring skills and expertise while working professionally in a company or finance firm or handling clients contractually. But with increasing competition in every industry, taking up courses, training, online classes, etc., helps increase your chances of getting hired.
Here’s how to get started with bookkeeping as a career.
- Bookkeeping Course: Get a bookkeeping course from a platform like Coursera or Udemy and familiarize yourself with basic concepts, collect and organize data, and balance books.
- Obtain a diploma/degree: Some employers require candidates to have a formal bookkeeping education, like a diploma or degree in accounting, business administration, finance, etc. Check out these accounting courses.
- Build Essential Skills: Build skills like data entry, payrolls, invoicing, financial statements, etc., since a degree alone won’t cut it anymore.
Essential Bookkeeping Skills
Effective bookkeeping requires technical and interpersonal skills to ensure accurate financial management and reporting. Here are some essential bookkeeping skills:
Interpersonal Skills
- Effective communication, both verbal and written, to confidently present information to superiors, discuss work, and clarify details
- Attention to detail to detect errors and address them
- Organizing skills prioritize tasks and work on them
- Critical thinking to overcome bookkeeping challenges by interpreting records, trends, and patterns
- Time management to efficiently manage daily transactions and meet goals on time.
Technical Skills
- Basic mathematics to share reports and communicate data with stakeholders
- Data entry into books, via both digital and physical means,
- Invoicing and billing to list items, charges, quantities, etc. in a transaction and
- Accounts payable and account receivable to understand all the details of accounts, order processes, and apply accounting principles
- Debits/credits to understand how debit and credit work, which account to credit/debit, and when
- Preparing financial statements like balance sheets, income statements, etc., is desirable.
- Knowledge of how payroll works to ensure employees get paid on time accurately. Learn more about payroll accounting.
- Bank reconciliation skills to compare bank statements with company records to ensure each transaction is correct, preventing fraud
- Knowledge of accounting software to automate tasks and be able to work efficiently
How to Find a Bookkeeper
To find a bookkeeper, seek recommendations from your peers, social groups, and platforms like LinkedIn. You can also search for bookkeeping services online and inquire about services.
As bookkeeping is a serious business aspect, be careful with who you work with. Check reviews and feedback online to understand the service provider’s reputation in the market before making your decisions.
Once you find a trustworthy bookkeeper to work with you in-office or remotely, create a solid contract or employment details to ensure the work goes according to your expectations. Next, start delegating your bookkeeping tasks to take the burden off your shoulders.
Bookkeeping vs. Accounting
Accounting and bookkeeping are different terms, although they appear to be similar.
- Focus: Bookkeeping is simply recording, tracking, and organizing financial records. However, accounting expands on this functionality; it analyzes financial data to make better business decisions.
- Bookkeeper/accountant: A competent employee with skills like problem-solving, attention to detail, math, basic accounting concepts, etc., can handle bookkeeping tasks. On the other hand, accountants need to possess advanced accounting skills, analytical skills, and other required soft skills.
- Financial position: Bookkeeping doesn’t determine a company’s financial position, but accounting does by analyzing and understanding financial reports.
- Software/tools: Bookkeeping can be done using bookkeeping software, a ledger, journal, or trial balance, while accounting can be done using accounting software to manage cash flow and profit/loss statements, balance sheets, etc., efficiently.
What Are the Differences Between Accrual and Cash Basis of Accounting
Here are the differences between accrual and cash basis of accounting:
- Focus: In accrual-based accounting, transactions are recorded when they occur, whether cash is received/paid or not. In cash-based, transactions are recorded only when cash is received/paid.
- Best for: Accrual-based accounting is best for larger businesses with many credit transactions. Cash-based accounting is best for startups and small businesses with budget limitations and fewer credit transactions.
- Details: Accrual-based accounting offers more detailed, realistic information on all the expenses and income in a given period than cash-based accounting.
- Taxes: In accrual-based accounting, companies pay taxes on money received and outstanding amounts. In cash-based accounting, companies pay taxes only on received money.
Bookkeeping Best Practices
Consider the following bookkeeping best practices to manage your finances effectively:
- Consider a phased approach: Doing everything at once could overwhelm your team. Take one step at a time when implementing bookkeeping or shifting from manual to digital bookkeeping.
- Keep your general ledger current: Consider keeping your general ledger up-to-date and accurate. It will help you make financial strategies that benefit your business.
- Plan for taxes throughout the year: Seek your accountant’s help maintaining financial records, tracking income and expenses, and organizing all financial data properly throughout the year. This will help when filing taxes, reduce last-minute rushes and errors, and avoid penalties.
- Keep your personal and business finances separate: This helps avoid confusion between personal and business income and expenses, benefiting small and large business owners. It ensures no personal purchases are made from business funds, preventing cash flow problems. Consider opening separate credit cards and a bank account for your business transactions.