Bookkeeping is a process of recording all the financial transactions that have occurred in the course of the business. Bookkeeping is an integral part of every business that focuses on recording day to day business transactions in the books of account.
For example, keeping record of purchases, sales, receipts and payments on daily basis. Accurate bookkeeping practices insures the authenticity and appropriateness of the accounting process of a business. It helps in finding the profitability and growth of a business through financial reports. In this article, we will discuss essential information on bookkeeping.
Importance of bookkeeping
Importance of bookkeeping can help to gather essential information on bookkeeping. Bookkeeping is essential for legally running the business in the whole world. It helps to keep record of all the business transactions.
Bookkeeping enables a business to track its all the financial activities as well as also guides in knowing the business performance in terms of its profitability and growth. All the business decisions are guided by the business records.
A well maintained business records are crucial for making appropriate and timely financial decisions. Every business activity starting from its planning to its completion is based only on documented facts and figures. A business cannot take a single step without appropriate recordkeeping.
Methods of bookkeeping
In bookkeeping practices, mainly two methods are followed which are manual bookkeeping and computerized bookkeeping. Let’s discuss methods of bookkeeping to understand essential information on bookkeeping effectively.
- Manual book keeping:
In manual bookkeeping, all the business transactions are recorded manually by using different types of accounting books, physical registers, ledgers, small pads and other relevant methods. It is a most basic and conventional form of bookkeeping practice which is mostly followed by small businesses.
On the other hand, all the large organizations also use this method up to a certain extent in their operations. All the transactional evidence is mostly relied on manual bookkeeping in all types of businesses and firms. This method also has some limitations as well.
For example, it is a time consuming record keeping method. Manual record keeping comes with the high chances of errors as well as limited capacity of editing in records. Keeping manual records safe and retrieving them at the time of need is also a difficult task.
- Computerized bookkeeping:
Computerized bookkeeping is computer based record keeping which is used for recording, maintaining and retrieving business records. In this method, multiple options are available for keeping business records. For example, a business can utilize MS office or any other accounting software for maintaining records.
Computerized bookkeeping is a quick and efficient method where financial records are systematically accounted for in the form of excel spreadsheets and pdf form by utilizing a specially developed accounting software.
In this form of record keeping, there are very few chances of errors as well as it also gives a very precise output due to its automation capability. It enables a business to maintain financial records easily as well as it helps in producing account statements and other types of financial reports which can be used for analyzing business operations.
Types of book keeping
Essential information on bookkeeping can also provide insight into types of bookkeeping. Generally, there are two types of bookkeeping practice. One is single entry system and other is double entry system.
Single entry system:
A single entry system is a form of bookkeeping where all the business transactions effect only one account. In this system, a cashbook is prepared that shows the receipts and payments of cash transactions. In this system, all the calculations revolve around the cash and bank balances, stock position, amount payable and amount receivables.
All the transactions are recorded in physical registers. This system of bookkeeping comes with multiple drawbacks. This system can only support small businesses because it does not effectively analyze the financial position of the business.
Double entry system:
Double entry system is a method where every business transaction is recorded in at least two accounts in the form of debit and credit. The amount which are recorded on either side must be equal to the other side (debit amounts must be equal to the credit amounts).
For example, if a business sold goods on cash then cash is debited and sales are credited with the same amount. It is the most effective and efficient way of record keeping that enables a business to accurately record, maintain and retrieve financial transactions.
It is a standard method of record-keeping that is generally utilized by all modern-day businesses and organizations. There are mainly five accounts that are used in the double entry method of record keeping namely assets, liabilities, equity, expense and income.
Difference between bookkeeping and accounting:
Accounting and bookkeeping may initially appear to be similar but there are some distinctions in them. Bookkeeping is the initial practice for going to the accounting stage. It is a necessary step in accounting process. The primary goal of bookkeeping is to record and organize financial records.
On the other hand, accounting is the interpretation and display of that financial record or information in the form of financial statements. Bookkeeping system consists of invoicing, billing and receipts, recording and tracking business transactions and payroll maintenance.
Accounting process consists of making financial reports and statements, tax filings, budgeting, auditing and analyzing business performance.
Transaction based bookkeeping techniques:
There are mainly two techniques or methods of bookkeeping based on the nature of transactions. These are cash base bookkeeping/accounting and accrual base bookkeeping/accounting.
Cash based bookkeeping/accounting:
In this method, revenue and expenses are reported on the income statement only when cash is paid or received. This method is typically used by small businesses. Cash based bookkeeping is more simple and less expensive method. It is suitable for those small business owners who carry no inventory.
It gives a precise picture of cash in hand. This technique of bookkeeping also has disadvantages. For example, it is not suitable for large organizations. This form of record keeping is less accurate and its generalizability is weak. It does not support comparative analysis of the business as well as not helpful on long term basis.
Accrual based bookkeeping/accounting:
In this method, revenue or expenses are accounted for when they are earned or incurred. In other words, money is accounted for before it is actually received or paid in the form of revenue or expenses. This method is more accurate for viewing the financial status of a company.
It is supportive to all types of organizations. Under this method, revenues and expenses are recorded by using balance sheet accounts like accounts payable, accounts receivable, prepaid assets and accrued incomes and expenses. It provides a better insight of profitability due to the clear overview of incomes and expenses.
Stages of Bookkeeping
Bookkeeping is starting point of accounting process. The cycle of bookkeeping and accounting for recording business information is explained below:
- Transaction identification: Bookkeeping cycle of business starts from identifying all the financial transactions that appear from the trading activities of the business. These transactions include all purchases, sales, receipts and payments of the business in a specified time frame.
- Recording transactions into general ledger: After identifying the transactions, these are recorded into general entry books in the form of general entries where effected accounts are debited or credited. In other words, it is a complete record of transactions over a period of time that document all the changes in assets, liabilities, expenses and equity.
- Posting general entries into ledgers accounts: In this process, separate ledger accounts for all the general entries are made by considering the effected accounts or segments of any business. These ledgers are named according to the specific transactional activity. For example, two ledger accounts are made for cash purchase scenario with the names of cash ledger and purchases ledger where cash account credited and purchase account is debited.
- Extracting trial balance: A trial balance is a financial report which shows the closing balances of all the accounts at the end of a specified accounting period. These balances are then recorded in the trial balance on its debit or credit side. Purpose of making trial balance is to ensure the accuracy of bookkeeping system. TIf both the sides of any ledger are equal then trial balance is considered to be balanced.
- Doing adjusting entries: Adjusting journal entries are used to correct mistakes that are made in the previous accounting period. These are basically used to record any unrecognized income or expenses.
- Making adjusted trial balance: Adjusted trial balance is extracted by entering the adjusting entries into trial balance account. This shows accurate financial position after the end of an accounting period and it can be used for making financial statements.
- Preparing financial statements: Preparing financial statements is the last step in bookkeeping process. These financial statements include income statement, cash flow statement and balance sheet. Income statement is prepared by using information from the expenses and incomes. After preparing income statement, a balance sheet is prepared which includes assets, liabilities, net profit and owner’s equity.
Bookkeeping Cycle of a business
Conclusion
To Summarize the essential information on booking, Bookkeeping practice is mandatory for any type of business activity. With improved bookkeeping capability, a business can enhance its profits and growth. In today’s world, more focus is towards computerized bookkeeping which offers multiple benefits over manual record keeping.
Various accounting software are available in the market which facilitates the record keeping process of a business. Computerized accounting improves efficiency and effectiveness in record keeping process by decreasing record keeping costs and increasing its performance.
Keeping records through double entry system and using accrual based accounting are more sophisticated and better approaches of bookkeeping.
FAQs:
What is bookkeeping, and why is it somehow useful for business?
Bookkeeping is the activity of keeping record of all financial transactions a business organizes. It is important because it is the real picture of financial activities of the business which can be considered in the assessment of the performance, profitability, and growth. Fundamentally it constitutes the basic structure for profitable financial management and making of quality managerial decisions within a business.
What is the internal system of bookkeeping and how does it differ?
There are primarily two methods of bookkeeping: manually and computers operating. Manual bookkeeping is the process of writing down the transactions by hand using many loose registers and ledgers but computerized bookkeeping relies on the accounting software to maintain and so retrieve records efficiently. Meanwhile automatic bookkeeping promise automatization, accuracies and report generation easiness.
In which types of bookkeeping system does my business fits in and how do summarize this?
The most important bookkeeping systems are the single entry system and the double entry system. Single entry is the type of system where you record transactions that relate to one account only for each entry in a journal and then post to the ledger. Small businesses usually go for this method. In contrast to this, double entry records each transaction with at least two accounts affected. It enables providing more complete and truthful financial picture. The factor to be considered is how big and complex your operations are.
In what way is bookkeeping different from accounting?
While bookkeeping is about recording and organizing these financial transactions, accounting takes financial data, analyzes them, and produces financial statements. Bookkeeping is a starting point in the accounting process as it incorporates transactional recording, while accounting covers the broad range of activities including financial reporting, budgeting, and audit.
In what stages does the bookkeeping process involve and what does its cycle contribute to the maintaining of the business records?
The bookkeeping cycle consists of a number of steps including entry identification, recording the transaction, posting to ledgers, extraction of trial balance, adjusting entries, preparation of the adjusted trial balance, and creation of financial statements. Data aggregation, at each phase, promotes the accuracy, completeness and maintenance of financial records enabling quality decision-making and compliance with regulations.
