Bookkeeping is a part of the process of accounting which records the transactions made by a business. It is essential to every business as it is the first process of accounting. Therefore, every individual involved in a business should know about the basics of bookkeeping and its importance, which we has been elaborated in the following article.
This article discusses the following topics:
- About Bookkeeping
- Elements of Bookkeeping
- Importance of Bookkeeping
Bookkeeping is concerned with the processes regarding the systematic and organized recording and classification of the financial transactions made by a business. It classifies financial data of a business and records it in an orderly manner as the first step of accounting. Bookkeeping acts as a key process in preparing financial statements and source documents for other operations being carried out in the business.
Bookkeeping is basically the maintenance of books of accounts in the form of records. There are two main ways of bookkeeping: the single entry system and the double entry system. These days, majority of the businesses follow the double entry system of bookkeeping as it removes any scope of contradictory entries being made. Methods other than these are also considered acceptable as bookkeeping methods.
Bookkeeping mainly aims at maintaining an accurate and complete record of all the financial transactions made by a business. It aims to do so by arranging these transactions in a systematic and orderly fashion which can be easily read by any individual. Bookkeeping ensures that the effects of the financial transactions made by a business are reflected in the books of accounts.
Bookkeeping also aims to determine the overall effect of all the financial transactions on the financial statement of the business. It eventually ascertains the financial position of a business and the effect of its transactions on its final accounts such as the Balance Sheet and the Profit and Loss Account.
Elements of Bookkeeping
The basic elements of bookkeeping are:
- General Ledger: The general ledger is the summary of the financial data of a business. It records the total expenditure and income of the business. General ledgers have sub-ledgers which include sections such as accounts payable, accounts receivable, and inventory. The financial statements of a business are based on the data recorded in the general ledger which is further used by an accountant to file the business’ taxes.
- Income and Expenditure: The income and expenses of the business are recorded in the process of bookkeeping. The details of the payment slips generated to customers whenever a sale is made are recorded as income. The receipts of payments made by the business like rent, payroll, office supplies, cost of production, insurance, etc. will be recorded as the expenses made by the business.
- Debit and Credit: The double entry system of bookkeeping involves maintaining a ledger which makes two entries for every transaction made. Every business transaction is recorded twice in the general ledger, once as debit (value paid) and once as credit (value saved).The debit and credit entries should however be equal to each other so that they are balanced out in the ledger.
- Bank Reconciliations: Sometimes it may so happen that the transactions of the bank account do not match with the ones recorded in the ledger. This will require the business to reconcile its books of accounts with the bank statement. The transactions in both the records will be compared and analyzed for a given period of time. All discrepancies will be noted and recorded, which will help in creating a more accurate record of financial transactions made by the business.
- Accounts Receivable: Accounts receivable records those accounts which owe some amount to the business. This may include any entity which has purchased goods and services from the business on credit and is still due to pay the amount. Accounts receivable helps in recording such data so that a follow up can be made on the overdue and unpaid invoices. This will help in categorizing which accounts can finally be considered as bad debt for the business. Once this amount is received, the account is cleared and the transaction is recorded as an income in the ledger.
- Accounts Payable: Accounts payable records those accounts to which the business owes an amount of money. It records and tracks the payments which are due to other entities on part of the business and when the said payments are due. This helps ensure that payment is not made to the same account twice and that it is made on time. Accounts payable may include amount owed by the business to its employers, suppliers, vendors, and the government (in the form of tax and deductions). Once this amount is paid, the account is cleared and the transaction is recorded as an expense in the ledger.
- Depreciation: Depreciation is the value of an asset which is lost with the passage of time. Fixed assets owned by the business such as cameras, computers, manufacturing equipment, furniture, etc. depreciate in value with time. This depreciated value will be calculated and recorded as an expense in the books of accounts.
- Financial Statements: Bookkeeping helps in the creation of financial statements of the business for a particular period of time. There are four main financial statements of a business: the Balance Sheet, the Income Statement, the Cash flow Statement, and the Profit and Loss Statement. These statements help outsiders to analyze the financial position of a business and help them in making investment related and other decisions accordingly.
Importance of Bookkeeping
Bookkeeping is extremely important to the accounting process of a business. It helps in determining the financial position of the business. Other reasons which signify the importance of bookkeeping are:
- The financial health of a business depends on bookkeeping: Bookkeeping helps the business in controlling its finances. The business should have a clear idea about its income and expenditure so that no decision is made which takes the business towards losses. Maintaining a healthy balance of income and expenses will improve the financial health of the business and help in strengthening its business relations. Accurate bookkeeping enables the business to have ample knowledge of its earnings and expenditure to make well-informed decisions over time.
- Financial statements are prepared with the help of bookkeeping: The first step to accounting is recording the transactions. Bookkeeping helps in recording all business transactions in an organized and accurate manner. Accountants then refer to these books of account to prepare the financial statements of a business. These financial statements help the business in making decisions accordingly and also help outsiders like investors to make investment decisions for the business.
- Business planning is made easier with bookkeeping: When financial statements are prepared accurately, its information will help the business in planning its future accordingly. Comparisons can be made with the previous years’ financial statements and informed financial decisions and effective planning can be made and done for the future of the business.
- Accounting costs can be saved with the help of bookkeeping: Bookkeeping makes filing taxes easier for a business as all the required information is at hand in an organized manner. This avoids overpayment or underpayment of tax and ensures that tax is paid on time. Furthermore, accurate bookkeeping helps lower the accounting costs. The hassle of appointing an expensive accountant can be eliminated and tax can be paid accurately by hiring a less expensive bookkeeper. The accountant can then focus more on saving money by finding possible ways of tax deductions.
- Organized bookkeeping enables easier audit: Since all the data will be systematically organized, the accountants will not take much time in carrying out the audit for the business. Also, any scope of fraud will be eliminated.
Bookkeeping, thus, keeps the finances of a business organized. When the financial data of the business is maintained in an organized manner, a considerable amount of stress will be reduced. This will help in keeping the business financially healthy and propel it towards a successful growth.