Managing your finances and tracking your expenses are just some of the major challenges that you’ll encounter once you decide to start your own business. Preparing financial statements may seem too complicated for some, and might even cause problems later on, that’s why it’s important to learn the basics of bookkeeping. Getting professional help from accountants and finance experts will also benefit you and your business.
Definition of Bookkeeping
Bookkeeping is defined as the practice of recording and tracking the financial transactions of a business. Some business owners may think bookkeeping and accounting are just the same, but they actually have different definitions.
Bookkeeping focuses more on recording and organizing financial data. Accounting, on the other hand, refers to the interpretation and presentation of said financial data to business owners and investors. In simple definition, bookkeeping is the process of summarizing your financial activities into reports so you can easily understand the status of your business.
The financial transactions of most small businesses usually revolve around sales, purchases of inventory, and monthly expenses. Small business owners often prepare two financial reports: the income statement, which covers all sales and losses; and balance sheet, which tracks assets, liability, and equity.
Importance of Bookkeeping
Bookkeeping can help you accurately record financial transactions, track profit and growth, and separate business from personal assets.
Some people may think it’s just okay to put both business and personal finances in only one account but experts say it would be best to create separate accounts for each. It’s also important to note that separating business finances from personal finances will make it easier for you to easily assess your business cash flow.
Aside from getting accurate and organized financial information and data, bookkeeping is also important for filing taxes.
Before we go to the process of bookkeeping, let us first determine the different types of books that business owners typically use:
- Sales Book: covers everything related to sales
- Purchases Book: covers everything related to your purchases
- Cash Receipts Book: covers all the cash you receive
- Cash Disbursement Book: covers all cash outflow
Some businesses opt to have all these books so they can easily track their financial transactions. However, if you find several books difficult to manage, you can just create one book for all your records and just organize them accordingly.
Let us now discuss the process of bookkeeping. Here are the general bookkeeping guidelines that you need to follow:
Analyze Financial Transactions
By definition, a financial transaction is an agreement between a buyer and seller to exchange goods, services, or assets for payment. There are four types of financial transactions that usually occur in a business: sales, purchases, receipts, and payments.
In analyzing financial transactions, you must determine what was acquired and what was given up. For example, you are selling school supplies and a customer bought five pencils for PHP50.00. Analyzing this transaction from a business perspective, the buyer acquired five pencils from the store, while the seller gave up five pencils from his inventory.
After determining and analyzing what was acquired and what was given up, you can now record the financial transaction that took place. In recording transactions, you must have a clear understanding of what assets, liabilities, and equity are.
- Asset: may generate cash flow, reduce expenses or improve sales; can be classified as current, fixed, financial, or intangible
- Liability: can also mean legal or regulatory risk obligation; can be classified as short-term financial obligations that are due within one year or a normal operating cycle; or long-term financial obligations that are listed on the balance sheet and not due for more than a year
- Equity: attributable to the owners of a business; value that needs to be determined when preparing financial statements
Note: You must use the ASSET = (LIABILITY + EQUITY) formula in the balance sheet.
It is also important to know the difference between debit and credit when recording financial transactions. Debit increases the value of asset, expense, and loss accounts, while credit increases the value of liability, equity, revenue, and gain accounts. Debits and credits must be equal to keep your book/s balanced.
Post Entries to General Ledger
A ledger is defined as an account or record used to keep track of entries for balance-sheet and income-statement transactions. It serves as a master file for all the financial transactions of your business.
Posting entries to a general ledger will allow you to see your revenues and expenses real-time. It can help you monitor your spending, identify unusual transactions, compile a trial balance, and create financial statements.
Adjust Entries and Prepare Trial Balance
Before creating your financial statements, you need to adjust the entries to update all account balances. Adjusting entries is done to ensure that your income and expenses are matched with the correct bookkeeping periods.
Meanwhile, a trial balance refers to the list of credit and debit entries from your general ledger. It includes associated account names and numbers, dates of the bookkeeping period, credits and debits to each account from transactions during the bookkeeping period, and the total sum of all credit and debit balances.
Prepare Your Financial Statements
Investopedia defined financial statements as written records that show the financial activities and financial performance of a business.
A comprehensive financial statement usually includes the following elements:
- Assets, Liabilities, and Equity
- Investments by Owners
- Distribution to Owners
- Revenues and Expenses
- Gains and Losses
- Income Statement
In preparing your financial statements, you can use tools and software such as Excel and Google Sheet.
Close the Books
The number one reason for “closing the books” is to get accurate reports. Most businesses usually close their books annually because they need to file income tax returns every year. However, some businesses also opt to close their books in a monthly period.
Having accurate reports are very important in operating your business so make sure to follow these bookkeeping guidelines. Remember that if the work gets too much, you can always ask the assistance of an accountant or bookkeeper.
Various bookkeeping resources are also available online. You can also join communities on Facebook, like Small Business Network (SBN) Philippines, that can help you connect with financial experts and fellow entrepreneurs.