Understanding basic bookkeeping when you’re first starting your business will help you keep up-to-date and organized books to help you make well-informed decisions about your company and develop strategies that play to your business’s strengths.
When you start your business, you’ll have to decide if you’re going to use a cash based accounting system or the accrual method.
In a cash based accounting system, you count income when you receive the cash, and you count expenses when you pay them.
Using the accrual method, you count income and expenses when they happen, not when you actually receive or pay cash. This is when your accounts receivable and accounts payable records come into play – to keep track of what has not yet been received or paid. If you keep inventory or handle transactions on credit, the accrual method is necessary.
You’ll also have to decide whether you’ll use single-entry or double-entry bookkeeping.
Using single-entry bookkeeping, you record transactions as you pay bills and make deposits. This method only works for the smallest companies with a low volume of transactions.
Using double-entry bookkeeping, you’ll make at least two entries for every transaction – you’ll record a debit to one account and a credit to another account.
The purpose of this is so that when your financial statements and reports are run, your assets equal your liabilities and your owners’ equity.
Assets are the things your company owns and have monetary value. They include cash, accounts receivable, inventory, land, buildings, and equipment.
Liabilities are the things your company owes to other people or businesses. They include accounts payable, accrued wages, and long-term debt.
Owners’ equity, or net worth, keeps track of how much money each owner has in the company.
Retained earnings are the business’s profits that have been reinvested in the business, instead of being paid to the owners.
Accounts receivable track money due to the business from customers. If you decide to allow customers to purchase goods or services on credit, rather than collecting payment immediately, make sure to establish the terms of payment. It’s important to keep your accounts receivable records updated so you send timely and accurate invoices.
Accounts payable track money your business owes to other businesses and people. By keeping updated records, you’ll ensure that everything is paid on time.
Sales records track the business’s income from products or services sold.
Revenue is the income your business receives from selling your products or services.
Your purchases records track raw materials or finished goods bought by the company for your products or services. Keeping track of your purchases is essential to determining the cost of goods sold.
Payroll expenses are the biggest costs for many businesses. You’ll need to keep an accurate record of your payroll expenses to make sure you’re meeting your tax obligations and other government reporting obligations.
Your expense records track money your business spends to run the business but is not specifically related to the products or services you sell. Expenses include salaries and wages.