Company owners are often creative people who are interested in developing great products and services. However, it's imperative for a small business owner to always remain aware of the financial aspects of their business. In this article, we provide an overview of a few bookkeeping basics business owners should master to remain in control of their company's finances and steer their business in the right direction.
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What is bookkeeping?
Bookkeeping refers to the basic tasks you need to do to record and organize your company's financial transactions. The most obvious reason you need to do bookkeeping if you have a business is to ascertain whether you are making a profit or not. Having the ability to draw accurate reports also helps you gain a clearer understanding of the weaknesses and strengths of your business.
Although people often use the terms "accounting" and "bookkeeping" interchangeably, they are not the same. Bookkeeping involves collecting data, entering it into a system and then drawing basic reports. The bookkeeping tasks provide the basis for accounting processes, which are more analytical and involved.
Basic bookkeeping tasks include the following:
- Invoicing clients
- Recording supplier invoices
- Recording vendor payments
- Recording client payments
- Updating your payroll system
- Drawing financial reports
Related: Learn About Being a Bookkeeper
Why is it important to understand bookkeeping basics?
If you have a small business, you will likely invest in accounting software for your bookkeeping needs. Although these packages are very sophisticated and easy to use, you still need to input the information correctly and have to understand basic bookkeeping concepts to interpret the financial statements. As your company grows, you may want to hire a bookkeeper or an accountant to do your books for you. Even if this is the case, you still need to know how to interpret basic financial reports to gauge the financial health of your company.
This does not mean you have to become an expert in financial matters. As a business owner, your strengths may lie elsewhere, for instance, in creative and innovative product design or developing strong business relationships. However, to make a success of your business, you always need to remain cognizant of the financial side of things. As the main goal of a business is usually to make a profit, you need to have a clear financial picture of your business alongside a consideration of all the other important business aspects.
Related: 6 Essential Accounting Skills
Here is a list of important accounts, terms and financial statements of a bookkeeping system that all small business owners should familiarize themselves with:
1. Debits and credits
Generally, when a transaction involves cash coming into the business, this is a debit. Conversely, when money leaves the business, the system will credit the cash account. To put it simply, debits are positive numbers, while credits are negative numbers.
2. Stockholders' equity
Stockholders' equity is an account on a company's balance sheet that includes share capital and retained earnings.
Liabilities are the amounts that the company owes to its creditors and also form part of a company's balance sheet. Liabilities also include monies that a company has received for future services since the amounts received have not been earned yet.
The balance sheet also includes the assets of a company, which are the valuable resources that a company owns. Assets could include inventory, buildings, equipment, accounts receivable and stocks.
5. Accounts receivable
Accounts receivable is the account that records all outstanding client payments. If you render services or provide products without collecting the payment immediately, you will need to keep track of the monies that clients owe you. Accounts receivable assists you in sending accurate invoices to your clients, as long as you enter all the relevant data and keep the system up-to-date.
6. Accounts payable
As the term indicates, accounts payable helps you to keep track of accounts that your business needs to pay. Using accounts payable to monitor your payments will ensure you settle your accounts in good time and that you avoid mistakes, such as paying an account twice. Keeping a clean record with regards to payments is important if you want to build strong relationships with your suppliers and develop a good reputation for your business.
Your inventory is one of the most important aspects of your business, as it is basically how you make a profit. You should ensure the numbers reflected in the inventory section of your balance sheet accurately mirror the actual stock you hold by regularly doing an inventory count and adjusting the figures accordingly. It is also important that the system has the correct information in regards to inventory cost and selling prices.
8. Owner's equity
This account reflects how much money an owner has in a business when all liabilities are subtracted.
9. Retained earnings
This account keeps a record of all profits that an owner has reinvested in the business. This is a cumulative account, which means that it reflects all the retained earnings of a company since its inception, which is important information for prospective investors.
To run a successful business, you need to keep track of what you sell, as this directly influences how profitable a company is. It is important to enter all sales into the system so that you have a clear view of the profits you are making and so that the products also go off the inventory.
11. Payroll expenses
This account records the salaries and wages that you pay your staff as well as the costs of related payroll taxes, such as your matching contributions towards Medicare and Social Security. It is essential to keep this account accurate and up-to-date for tax and government reporting purposes.
12. Balance sheet
If you want an overall view of the financial health of your company, consult the balance sheet. This is a financial statement that shows the company's assets, liabilities and the shareholders' equity and provides details regarding the balance of income and expenditure over a certain period.
13. Income statement
This is another important financial statement that will give you a clear indication of your company's financial health. The income statement is also referred to as the profit and loss statement, as it focuses on the company's revenues and expenses during a given period.
14. Cash flow statement
The cash flow statement is also a very important financial statement, as it reflects a company's operating, investing and financing cash flow, which is a reflection of a company's liquidity and overall financial performance.