Introduction:
Let’s be honest, none of us started a business to do bookkeeping. But without it, most businesses don’t last very long. In this blog, we will go over the bookkeeping basics for small businesses. We will discuss what bookkeeping is, why it’s important, and how to do it in a few simple steps. By the end of this blog, you will have a clear understanding of the bookkeeping process and how it can help you make better financial decisions for your business.
What is Bookkeeping and Why is it Important?
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The textbook definition of bookkeeping is the systematic routine method of retrieving financial information, categorizing that information, and putting it into an accounting system. This information is then used by decision makers to make better financial decisions in the future.
A simpler definition of bookkeeping is the recording of past financial data so that you can make future business decisions. Bookkeeping helps you keep track of your business’s financial transactions, such as sales, expenses, and other financial activities. It provides you with a clear picture of your business’s financial health and helps you make informed decisions to grow your business.
The Bookkeeping Process
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The bookkeeping process can be broken down into six simple steps. By following these steps, you can effectively manage your business’s financial records and make better financial decisions.
- Step 1: Gather Source Documents
The first step in the bookkeeping process is to gather source documents. Source documents are original records for a transaction, such as invoices, sales orders, or receipts. These documents contain important information, such as the date of the transaction, the buyer and seller, the amount, and the product or service provided.
While most people don’t keep physical copies of their source documents, they rely on bank statements to tell the story. However, it’s important to note that cash transactions are not recognizable using bank statements alone. If you have a cash transaction, you must retain the physical receipt or recall the purpose of the transaction to correctly classify it.
It’s good practice to use a debit card or a credit card for all payments, as this makes it easier to classify transactions using bank statements.
- Step 2: Categorize Your Transactions
The second step in the bookkeeping process is to categorize your transactions. This involves classifying your transactions into specific categories, such as assets, liabilities, equity, revenue, and expenses.
Assets are what your business owns, such as cash, inventory, or equipment. Liabilities are what your business owes, such as loans or accounts payable. Equity represents the ownership interest in your business. Revenue is the income your business generates from selling products or services. Expenses are the costs incurred to operate your business.
By categorizing your transactions, you can easily track and analyze your income and expenses, which is essential for making financial decisions.
- Step 3: Reconcile Your Transactions
The third step in the bookkeeping process is to reconcile your transactions. Reconciliation is the process of matching your bank statements with your accounting software to ensure that every transaction is accounted for.
Reconciling your transactions helps catch any errors or discrepancies. It ensures that your financial records are accurate and up to date. It’s important to start with the beginning balance on your bank statement and check each transaction to ensure that it matches with what’s in your accounting software.
- Step 4: Prepare Financial Statements
The fourth step in the bookkeeping process is to prepare financial statements. Financial statements provide a summary of your business’s financial activities and are essential for understanding your business’s financial health.
There are three main financial statements that should be prepared: the balance sheet, the income statement, and the cash flow statement.
The balance sheet shows your business’s assets, liabilities, and equity. It provides a snapshot of your business’s financial position and helps you gauge its liquidity and sustainability.
The income statement, also known as the profit and loss statement, shows your business’s revenue and expenses. It tells you how profitable your business is at any given period.
The cash flow statement tracks the cash coming in and out of your business. It shows how transactions from the balance sheet affect your cash account. By analyzing the cash flow statement, you can understand how your business is managing its cash flow.
- Step 5: Read Your Financial Statements
After preparing your financial statements, it’s important to read and understand them. Many businesses fail or succeed based on their financial statements, so it’s crucial to review them and take advantage of the insights they provide.
By reading your financial statements, you can gain valuable insights into your business’s financial performance. You can identify areas where you can cut costs, improve profitability, or make strategic investments.
To read your financial statements, you need to understand their structure. For example, the balance sheet lists assets first, followed by liabilities and equity. Assets are ordered based on liquidity, with cash being the first item listed. The income statement lists revenue first, followed by expenses, and calculates net income.
By understanding the structure of financial statements, you can easily interpret the information they provide and use it to make informed decisions for your business.
- Step 6: Make Decisions Based on the Data
The final step in the bookkeeping process is to make decisions based on the data you have gathered. The purpose of bookkeeping is to help you make better, more profitable decisions for your business.
The balance sheet can be used to gauge the liquidity and sustainability of your business. For example, if your balance sheet shows a large amount of accounts receivable, you might decide to shorten the collection period to have more cash on hand.
The income statement tells you the operating performance of your business. By analyzing your revenue and expenses, you can identify areas for improvement and make necessary adjustments to increase profitability.
The cash flow statement shows how much cash you have on hand. If your operating cash flow decreases, you might need to reassess your operating expenses or pricing strategies to maintain a healthy cash flow.
By utilizing the data from your financial statements, you can make informed decisions that will help your business thrive and grow.
Conclusion
Bookkeeping may not be the most exciting part of running a business, but it is essential for its success. By following the simple six-step bookkeeping process outlined in this blog, you can effectively manage your business’s financial records and make better financial decisions.
Remember, bookkeeping is the recording of past financial data to make future business decisions. It helps you track your income and expenses, reconcile your transactions, and prepare accurate financial statements. By reading and understanding your financial statements, you can gain valuable insights into your business’s financial health and make informed decisions to increase profitability and sustainability.
So, if you haven’t already, start implementing the bookkeeping basics for your small business and watch your business thrive.
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