The Five Pillars of Bookkeeping
Although the concept of bookkeeping is fairly simple, the actual practice can get a bit complex. For the purpose of simplicity, we have broken things down into five “pillars.” As long as you understand these basics, you’ll have what you need to set up your own system. Then, you’ll be well on your way toward all of the benefits afforded by accurate bookkeeping.
1. Create Separate Accounts
This is essential. Simply put, every bookkeeper needs to establish separate accounts for business and personal finances. If you commingle your personal funds with your business funds, this will create a nightmare situation for your bookkeeping. Not to mention, it can also cause serious liability — you don’t want to end up personally responsible for business debts.
2. Choose Between Single or Double Entry
Bookkeepers use one of two methods: single-entry or double-entry. The right option for you will depend on the nature of your business.
In general, a single-entry system is best for a simpler business. Here, each transaction is recorded only once, either as a debit or credit. In a double-entry system, however, each transaction is recorded twice — as both a debit and a credit. This way, the ledger should always add up to zero. For instance, in a double-entry system, the sale of an item would be marked as a credit for the sale, but then a debit to your inventory.
Obviously, the double-entry method is more complicated. But, in the long run, it will result in more accurate books.
3. Choose Between Cash or Accrual
You will also need to decide whether to have a cash accounting system or accrual accounting system. In cash accounting, you only record a transaction once cash has been received (or spent). In the accrual system, transactions are recorded when they are billed, rather than when cash actually changes hands. This way, at the end of the tax year, you’ve recorded all income that you earned during that year, even if you haven’t collected it yet.
Again, as with the single- or double-entry system, choosing between these two accounting methods depends on the nature of your business. Generally, the cash method is ideal for small businesses without inventory, while the accrual method is best for businesses with inventory and large corporations.
4. Create Transaction Categories
Organized books are healthy books. Creating categories for your transactions will enable you to track your income and expenses more carefully and will be a lifesaver if you’re ever audited. Categories should start with the five main account types: assets, liabilities, equity, revenue, and expenses. From there, you can break each into subcategories based on your business.
This more precise tracking will provide countless advantages; for instance, it will make taking certain deductions easier, because you will have a clearer sense of the precise nature of your expenses.
5. Organize and Check Your Records
Remember, organization is the key to good bookkeeping. And that applies both to the contents of the books and the books themselves. In addition to having line items carefully broken down into proper categories, you need to establish a good system (either physical or cloud-based) for storing your records, receipts, and other documents that may be relevant come tax time.
Keep your time organized as well — since it’s one of the more tedious tasks, bookkeeping has a way of continually getting pushed to tomorrow’s to-do list. So, to make sure you don’t fall behind, set a regular day and time for tending to your books.
