Understanding Small Business Bookkeeping & Accounting

To an untrained eye, bookkeeping and accounting may appear same, but they are two different functions and extremely crucial for businesses.

Bookkeeping focuses on identifying, measuring, and recording financial transactions.

Accounting refers to summarizing, interpreting, and communicating financial information. Before we learn more, let’s understand the basics first.

The basic definition looks confusing. To understand them, first, you should know four aspects of the business that defines the purpose of maintaining bookkeeping practices.

Related: An Introduction to Accounting Basics

Related: An Ultimate Guide to Small Business Accounting Tips

Bookkeeping & Accounting Basics

1. Money In (Sales)

Basically, there are two ways a business to generate sales.

  • Cash Sales
  • Credit Sales

The difference lies in the time a customer makes payment for the purchased product or the given service. For instance, a customer purchases a product from you and makes the payment at the same moment, it might be through cash, or credit or debit card.

Under credit sale, you have made the sale or given the service and the customer pay for that only after some days, based on your business credit terms.

Let’s say you make 10-15 sales every day, most of them being credit sale. In such scenarios, it is required you have a good booking system to maintain each and every sale and record how much each customer owes you.

2. Money Out (Expenses)

The business expenses are categorized as follows,

  • Recurring
  • Non-recurring

Expenditures that are fixed are referred to as recurring expenses. Rent, utilities, these are something businesses have to make every month.

Non-recurring expenses can be unexpected and may differ each month. They are also referred as one-time expenses and may include accounts payable, major repair costs, or inventory up gradation.

When it is about accounts payable or other major expenses, it is necessary organization has a proper booking system to keep track of all, so while preparing financial statements things would be much clear.

3. Purchase/Inventory Cycle

Whether you sell products or make inventory purchases, it is necessary you keep track of cost and the number of quantities involved.

Having a good system in place will help here. Between countless sales and purchases, it will be easier to keep track of the inventory cycle and the cash involved.

4. Liabilities

Liabilities are the money owed by businesses.

Liabilities should not be confused with expenses. The business expenses will stop once an organization stops operating. But liability is an outstanding balance that has to be paid off even if the organization goes out of business.

Develop the Chart of Accounts (COA)

For each type of asset, liability, equity, revenue, and expense, an account is a unique record. By using a chart of accounts, you can efficiently create a list of every such account.

Basically, a COA contains the account’s name, description names, and identification codes. The sole purpose of creating COA is to give the company a quick view of its financial health – it’s a lot easier to analyze the segregated revenue, assets, liabilities, and expenditures.

The COA differs for each business. For instance, a service-based business need not have an inventory account.

Five Main Account Types are as follows,

  1. Assets – They are the tangible and intangible items owned by the company. (patents, buildings, cash, computer systems, business equipment, etc)
  1. Liabilities – It’s the company’s debt obligations. What your company owes currently or may owe in the future.
  1. Owner’s Equity – It’s the total assets owned by the business person. It also details the ownership of other shareholders if any.
  1. Income or Revenue – The income generated from the sale of goods and services. Also, the interests and dividends earned from marketable securities.
  1. Expenses – Both recurring and non-recurring expenditures incurred by the company. (office supplies, advertising, utilities)

How to Create an Efficient Chart of Accounts?

1. Set up Only that is Required

Don’t set accounts more than you can handle. Set up accounts that you only need. Once you start managing transactions things will get frustrating if you have a long list. So keep it relevant. You will run the report in a very less time.

2. Keep Generic Names

Do not keep your account name specific to customer or vendor name. Rather, use the type of item you purchased as the name. (e.g: office supplies)

3. Using the Correct Account Type

Basically, there are three types of financial statements – Profit & Loss (P&L), Balance Sheet, and Statement of Cash Flows.

So, the account type you are going to choose determines the financial statement the account appears on.

Under any circumstances, if you set up an account and use the incorrect account type, it will result in inaccurate financial statements.

An Overview of Three Key Financial Statements

1. Profit & Loss Statement (P&L)

The P&L statement is also referred as ‘income and expense statement’, ‘statement of operations’, ‘income statement’, ‘statement of profit & loss’, and ‘statement of financial results.’

This financial statement gives you an overview of bottom line net profit or net loss. You will get summarized data on the revenues, costs, and expenses incurred during a specific time period (fiscal quarter or year).

Investors or stockholders will thereby learn whether the company they are investing in is capable of generating profit or not, just by analyzing the P&L statement.

2. Balance Sheet

Balance sheet offers information on the assets, liabilities, and the owner’s equity for that business.

It’s important to understand the net worth of your business and what you owe to others, and a balance sheet helpful in that.

The balance sheet is based on this formula,

3. Statement of Cash Flows

Also referred to as cash flow statement, statement of cash flows provides information about the amount of cash or cash equivalents entering and leaving a company for a defined time.

The cash flow statement can be defined by three different models.

  • Operating Activities
    • Here the information reflects the cash generated from the sale of business’s products and services on a daily basis.
  • Investing Activities
    • The purchase of fixed assets and the purchase or sale of securities issued by other entities constitutes investing activities. In other words, you will have a report on the sale or purchase of long-term investments.
  • Financing
    • The sale of company shares, repurchase of shares, and dividend payments constitute financing activities. Whatever the changes that materialize in the long-term liabilities and stockholders’ equity in the balance sheet is reported here.

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