Business

What Is Bookkeeping and Why Is It Necessary?

Well Balanced Bookkeeping is an essential business process that helps you stay organized, prepare for tax season, and make informed decisions. It’s also an essential step in preventing financial errors and discovering discrepancies between statements and records.

Bookkeeping

The first step in bookkeeping is preparing source documents such as receipts and invoices for purchases and sales, deposit slips, cheques, and bank statements. These are recorded in journals, physical books of first entry, or spreadsheets.

Recording transactions in bookkeeping involves ensuring that all business and financial activities are documented. This is done by identifying each transaction, its financial impact and the date it occurred. Once this information is collected, it can be recorded in a journal and later posted to the business’s general ledger. Bookkeepers use double-entry accounting to document each transaction, a system in which at least two accounts are affected by every debit and credit entry. The purpose of the general ledger is to provide an accurate, real-time snapshot of a business’s financial standing.

To keep track of the information, books are arranged in a chart of accounts that lists every account within the company, including assets, liabilities and equity. Each account is categorized by a unique code and records how much money has been credited or debited to the account. The information recorded is then used to prepare financial statements, which are useful for analyzing the company’s performance and making informed decisions.

In addition to recording each transaction, a bookkeeper must determine which accounts the transaction will affect and make sure that it is recorded correctly. For example, if your business receives a check from a customer, you must record this as revenue in the sales and income tax accounts. If you use a cash basis for accounting, then you will only record the revenue when the customer actually pays the invoice.

The other important step in the process is reconciling each account on a regular basis to ensure that everything is accurate and up-to-date. This includes reviewing and comparing the data to supporting paperwork, such as receipts and canceled checks. It also means ensuring that the numbers match when preparing reports and filing taxes.

Keeping up with your bookkeeping throughout the year can help you discover errors before they become problems at tax time. Moreover, it can help you set goals for your business that are based on factual information. However, if you are not comfortable performing this task yourself, it is best to hire an expert. You can find one by asking other business owners for recommendations or searching online.

Reconciling Transactions

Reconciling is the process of comparing a company’s internal accounting records with external documents such as bank statements and credit card receipts. This verification ensures that the total sum of money entering and leaving a business matches the amount recorded in an account, thereby maintaining consistency between the two documents. Reconciliation also helps find and correct data entry errors, guard against fraudulent charges and resolve other discrepancies or issues. Small businesses generally reconcile their accounts on a monthly basis, but larger companies may choose to do it on a daily or weekly basis, depending on the number of transactions and the size of the accounts.

Start the reconciliation by reviewing your source documents. Compare the bank statement to your business records and make notes of any deposits, withdrawals and payments that don’t match up. Then, examine each ledger of income and expense items for the month – these could be cash books, general ledgers, rolling accumulated depreciation schedules or sub-ledgers (excel spreadsheets). Make sure the total balances in these documents agree with one another and that all entries have been posted to the appropriate ledgers.

Then, look for any special bank charges or credits that aren’t recorded in your books, such as interest earned or banking service fees. Record these items in your financial statements and compute the new expected general ledger cash balance. Compare the expected cash balance to the ending bank balance and enter it on your reconciliation.

Sometimes, mistakes are just human: You debit your cash book when you finish a project and promise the client a cheque is on its way, but it never arrives. In this case, you can often get your money back from the bank if you catch it quickly enough, and your reconciliation will tell you that there was a discrepancy between your records and the bank.

But other times, the discrepancy might be more serious – your bank statement might show you’ve paid an invoice but it wasn’t posted to your account in your books, or your bank might have accidentally credited you with someone else’s money. Either way, this type of discrepancy can be hard to explain and should be investigated as soon as possible to protect your financial integrity.

Preparing Financial Statements

Bookkeeping is the process of compiling financial details into official statements that are ready to be shared with stakeholders. These statements are used to report on a business’s performance, cash flow and financial health. They are also necessary for preparing taxes, securing loans and attracting investors.

Preparing these reports requires a thorough review of every entry, reconciling the data and ensuring that everything adds up correctly. The resulting statements are used by businesses to make decisions and by accountants to file taxes. Depending on the size of a company, these statements may be created monthly or at the end of the year.

One of the most important steps in preparing a financial statement is selecting the basis for which the company will record its sales and expenses. Companies can choose between two basic accounting methods: the cash basis and the accrual basis. The cash basis records sales (money inflow) and purchases (money outflows) at the time that they actually occur. This method makes it easy to compare results from different periods because the numbers are based on real-time activity. The accrual basis records revenue and expenses in the books when they are incurred, regardless of whether the cash has been received or not. This method is preferred because it provides a more accurate reflection of the actual financial position of the company and is required by regulatory bodies.

Once the basis for reporting has been determined, a chart of accounts is created to organize all of the financial accounts within the general ledger. This system enables bookkeepers to easily find the accounts they need to record transactions and then make a corresponding entry in the appropriate account. The chart of accounts also includes a coding system for each type of asset, liability, equity or expense to help bookkeepers quickly locate the right account when recording a new transaction.

Bookkeepers must also verify source documents, including sales invoices and receipts, before entering them into the system. This ensures that only valid transactions are recorded and prevents fraud. This step can be accelerated using automated accounting software that allows bookkeepers to scan in or snap photos of the source document and use OCR technology to automatically extract the relevant information. This technology eliminates the need for manual data entry and helps speed up the bookkeeping process.

Filing Taxes

While accounting and bookkeeping are separate disciplines, they do share some overlap. Both work with raw data and require a solid understanding of financial concepts. However, accountants typically have more formal training in analyzing data and correcting errors. They also have more advanced skills for preparing reports and interpreting data, making them the ideal candidate for senior-level positions at larger companies. It’s not uncommon for a bookkeeper to transition into an accounting role as their career progresses.

A business’s success depends on its ability to collect and manage money. A skilled bookkeeper can efficiently collect, record, save and spend cash to maximize profits and minimize the risk of financial disasters.

Whether your company has a full-time bookkeeper or utilizes a combination of in-house staff and outsourced services, an experienced bookkeeper can provide valuable insights to help you improve cash flow and profitability. They can identify areas in which your business can cut costs, ensure that debtors pay you on time and prevent fraud by highlighting suspicious transactions. Additionally, they can help you prepare for tax season by streamlining processes and identifying any discrepancies between financial statements and recorded data.

An accurate and up-to-date bookkeeping system can be the key to a stress-free and successful tax season. However, many small businesses and self-employed professionals fall behind on their records during the year, leading to a chaotic and stressful filing process. Bookkeepers can provide assistance with this process by reconciling records, reducing errors and ensuring that all tax deductions have been claimed.