Accounting is the process of recording the day-to-day financial transactions of a business in an organized accounting system. It can also refer to the accounting method used by a company. Bookkeeping is an integral part of the accounting process for several reasons. Keeping up-to-date records of transactions produces accurate financial statements and helps to evaluate a company’s performance. Detailed records are also helpful in the event of a tax audit.
This guide discusses the various accounting methods, how to record journal entries, and basic financial statements.
Accounting Method
Before you start keeping records, you need to decide which method you will use. When choosing, consider the volume of daily transactions and the revenue generated by your business. A complex accounting method designed for companies may cause you unnecessary hassle if you are a small or medium-sized business. Conversely, a less robust accounting method is not suitable for large companies.
So let’s categorize the accounting methods to find the right one for your business.
1. Single-Party Accounting
Single-part accounting is a simple method where all transactions on the books are made only once. These transactions are usually recorded in a cash book to keep track of income and expenses. No formal accounting knowledge is required to work in the line item system. The general ledger method of accounting is suitable for small sole proprietors and individual entrepreneurs who do not sell on credit, have few fixed assets, and have a small amount of inventory.
2. Double-entry accounting method
Double-entry bookkeeping is more reliable. In a double-entry accounting system, the total amount on the credit side must always equal the total amount on the debit side. At this point, your accounts are “balanced.”
Double-entry accounting is helpful if your business is a large utility or if you buy and sell on credit. Businesses usually choose a double-entry accounting system because there is less room for error. Each transaction is recorded in two overlapping but opposing accounts, so it is a “double-check” of funds.
3. Cash basis or accrual basis
The next step is to decide whether you want to keep a cash or accrual basis. This decision depends on when your business records its income and expenses.
- Under the cash method, accountants add income when money comes for the business and expenses when companies make payments. This means that purchases or sales on credit are not recorded in the account until the money is transferred or received.
- Under the accrual accounting method, revenues are recorded when received. Similarly, expenses are recorded when incurred, generally simultaneously as the related revenue. There is no requirement for deposit or withdrawal of cash and you can record sales and purchases immediately to credit.
You can use cash and accrual accounting methods in single or double-entry accounting. However, the basis for cash accounting is generally found in single-entry accounting, and transactions are recorded as separate items representing cash receipts or cash disbursements. Accrual accounting is the best accounting method in a double-entry accounting system.
How do you record entries in bookkeeping?
Preparing financial statements, such as balance sheets, income statements, and cash flow statements can help you understand your business and evaluate its performance. To ensure that these reports accurately reflect your business, you must keep proper records of your transactions. Maintaining these records up to date will also help you reconcile your accounts.
Recording transactions begins with original documents, such as purchase orders, sales invoices, bills, and cash register tapes. Once you have gathered these documents, you can record transactions using journals, ledgers, and trial balances. A tiny business may only need a cash register. The information collected can be collated and converted into financial statements.
Records
A cash register is an electronic machine for calculating and recording transactions. Cash registers are typically used to record the movement of money in a store. The cashier collects the money from the sale and returns the balance to the customer. The funds received and the balance returned are recorded once at the cash register as a cash account. The cash register also stores transaction receipts, which can be quickly documented in the sales ledger.
Cash registers are standard in businesses of all sizes. However, because they use a unique cash accounting system, they are not usually the primary accounting method of recording business transactions. This makes them suitable for tiny businesses, but they are straightforward to use for corporations.
Journal
- This journal book is known as the beginning balance sheet book. This is where the first transactions of the business are recorded in chronological order. The journal can be in physical form (in the form of a book or diary) or digital format (in the form of a spreadsheet or accounting software).
- It contains the date, account receivable or payable, and amount of each transaction. Although you don’t usually check the journal balances at the end of the fiscal year, each journal entry affects the general ledger.
- As we will learn, the public ledger must be balanced, so it is a good idea to keep accurate journal entries. This chart is helpful for double-entry accounting.
General Ledger
The general ledger is a collection of ledgers or accounts. It is also called a second general ledger. Transactions recorded in the general ledger are assigned to individual accounts and then transferred to the public ledger. These items are organized by account in the following order: assets, liabilities, equity, income, and expenses. The general ledger can be a physical or electronic spreadsheet like the journal book.
The ledger includes a chart of accounts, which is a list of the names and numbers of all the accounts contained in the catalog. The schedules are generally set up in the order of declassified entries.
Unlike the journal book, the general ledger must have a balance at year-end in order to be audited by an auditor. If the total debits exceed the total credits, it is called a debit balance, and if the full credits exceed the total debits, it is a credit balance. The ledger is essential for double-entry bookkeeping, where each transaction changes at least two sub-accounts in the catalog.
Trial Balance
Trial balances are prepared from abstract and summary entries in the general ledger. The trial balance is used to ensure that the accounts are in harmony. The reports are presented in the following order. Assets, Liabilities, Equity, Revenues, and Expenses show the account’s ending balance.
Accountants usually prepare trial balances to check the condition of the business and the balance of the accounts. They can then reconcile them with the books and journals. An imbalance between debits and credits can easily be detected on a trial balance. However, it is not always error-free. Calculation errors or erroneous entries can cause the balance sheet to be displayed incorrectly. It is better to detect the mistakes early and correct them in the general ledger than wait for the balance sheet at year-end.
Financial Statements
The next and perhaps most important step in accounting is the preparation of financial statements. These reports are produced by consolidating information from daily entries, and they show how your business has changed over time and identify areas that need improvement. There are three financial reports that managers need to know about: the cash flow statement, the balance sheet, and the income statement.
Cash Flow Statement
- As the name implies, the cash flow statement shows cash flow. It is a financial statement that shows its cash inflows and outflows.
- It allows you (and your investors) to see how your business manages its debts and expenses.
- These numbers can help you determine if you have enough cash to support your business and generate profits.
Balance Sheet
The balance sheet reflects the assets, liabilities, and equity of a business at a given time. In simple terms, it shows what the company owns, what it owes, and how much the shareholders have invested. However, a balance sheet is only a snapshot of a company’s financial situation at a given time, and an accountant must compare it to balance sheets from other periods. Detailed balance sheet ratios, such as the current ratio, current asset turnover, inventory turnover, and debt ratio, provide insight into the liquidity and financial structure of the company.
Income Statement
The income statement, also known as the profit and loss statement, focuses on the revenues and expenses incurred by a company during a given period. A typical income statement consists of two parts. The top half is revenue, and the bottom half is expenses. This report covers a specific period, such as the last quarter of a fiscal year. It shows how its net income has translated into net profit or loss. The income statement does not show revenues and expenses.
Bank Reconciliations
Bank reconciliation is matching bank account transactions to those in the accounting records. Moreover, bank reconciliations are an essential part of accounting because they are the final step in finding discrepancies in the books after all balances have recorded. Bank reconciliations ensure that all funds are in control correctly.
Why is it mandatory?
- Bank reconciliations are mandatory because they
- Ensures the finances of your business.
- It keeps a close eye on the flow of funds
- It helps identify fraud and banking errors
3 Types of Bookkeeping Systems Suitable for Small Businesses
Stay on top of your bookkeeping
Proper accounting can make your business a success. It is the foundation of the accounting process, and without it, it is almost impossible to develop a strategy to improve the fundamentals of your business. Accounting is essential, but adopting the wrong system for your business can lead to problems. Some companies still use manual accounting methods with physical calendars and paper agendas. However, thanks to advances in technology, even small and medium-sized businesses can now benefit from digitization. This is where a cloud-based accounting solution like Tax king service can help.
- Tax king service helps businesses record their finances accurately. It provides faster and easier solutions for cash management, accounts payable, accounts receivable, bank reconciliations, and financial reporting.
- In addition, built-in automation helps you manage routine accounting tasks, allowing you to focus more on your business.
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Author Bio
Villie Walters Ramirez is a 32-year-old bookkeeper nyc at a tax king who enjoys accounting and bookkeeping. She has a post-graduate degree in accounting, and she has a severe phobia of cats. She enjoys traveling A lot.
