What is Bookkeeping (& How is it Different From Accounting?)
Ever found yourself lost in a sea of receipts, invoices, and financial statements? Felt like you're navigating the Bermuda Triangle rather than your business's finances?
Welcome aboard. You've just encountered bookkeeping - an essential yet often overlooked component of running any successful venture.
You might be thinking, "Isn't that just accounting?" To which I say... kind of, but not quite.
I've covered the A-Z of bookkeeping for you, from its humble beginnings to the modern tools revolutionizing it. This guide will cover the different systems and methods used today; all while drawing a clear line between bookkeeping and its close cousin - accounting.
Let's get into it.
So, What Is Bookkeeping?
Bookkeeping is the backbone of financial management for any business, big or small. It's a meticulous process where every financial transaction is recorded, categorized, and interpreted.
This essential task forms the basis for insightful financial statements, such as balance sheets and income statements. These documents provide a clear picture of a company's economic health to stakeholders. Those stakeholders, in turn, decide whether your business is ready for more funds or headed for bankruptcy... so it's best to keep them happy and keep your records straight.
A skilled bookkeeper can track everything from payable liabilities to accounts receivable with precision. They keep tabs on all money flowing in and out—making sure nothing slips through the cracks.
Does Your Small Business Need Bookkeeping?
Yes. Yes, it does.
For small businesses, good bookkeeping practices are crucial not just for survival but also for growth. Having an accurate record allows entrepreneurs and senior managers alike to make informed decisions about their operations.
If your books aren't balanced regularly, it could lead to over- or underestimating revenues, missing payment deadlines—or worse—running into trouble with tax authorities. If you've held up good bookkeeping processes during the year, your tax returns go from being a real pain in the behind to simply being another checkbox on your list.
Making Life Easier With Accounting Software
We live in a software world... so you can bet there's software for this. But the real question remains: Is it helpful?
From my perspective, yeah, I think it is. Unless you're obsessed with properly categorizing transactions for your business (a line that every accounting student, fresh out of school and desperate for a job, has probably used), modern accounting software can make it easy for you.
The software solutions available have simplified and systemized traditional bookkeeping methods—bringing ease and efficiency like never before. Automated tools help eliminate human error while giving you back the valuable time you would've had to spend on manual entries.
I've covered bookkeeping-specific tools further down in the article but, before we get there, we need to be clear on which tasks are considered bookkeeping, and which are flat-out accounting.
Differentiating Bookkeeping From Accounting
Bookkeeping and accounting are intertwined facets of managing your business' funds, yet they have separate purposes. Let's untangle them.
Bookkeeping tasks are all about the proper recording of a business' financial transactions. They involve keeping track of all financial records including daily sales and purchases, receipts, payments... essentially every penny that flows into and out of a business. Think of it as laying down the building blocks for a robust financial statement, while keeping your cash flow in check.
In contrast, the accounting process is more like constructing a building using those building blocks. It encompasses interpreting, classifying, analyzing, and summarizing financial data to generate financial reports such as income statements or balance sheets, which in turn help make strategic decisions.
If the building metaphor fell flat for you, here's another. Both bookkeepers and accountants work together to cook dinner: bookkeepers are responsible for gathering ingredients (recording all transactions), while accountants take those ingredients to whip up something delicious (creating meaningful reports).
To get things done smoothly, you need both people involved - meticulous bookkeepers to keep tabs on day-to-day finances and savvy accountants (or accounting systems) who can interpret this data for big-picture decision-making.
The Evolution Of Bookkeeping
Bookkeeping has been an essential part of financial operations for centuries, tracing its roots back to ancient civilizations. The need to record and track transactions gave birth to this practice.
In the early days, business owners and bookkeepers relied on simple tools like abacuses and physical ledgers. They recorded every transaction by hand. This method was time-consuming but necessary for maintaining accurate records.
The 19th century saw a major advancement in bookkeeping with the introduction of calculators, speeding up calculations and increasing accuracy. But before computers became widespread, bookkeeping wasn't significantly altered.
The introduction of spreadsheets and accounting software transformed the field dramatically. They automated tedious tasks, made systems easier to comprehend and keep, and further eliminated human error. Modern applications now integrate with business systems directly, tracking sales or expenses as they occur.
With digital solutions in play, small businesses experienced a total transformation in managing their finances - data is now within easy reach from any location, by anyone who needs it.
Types Of Bookkeeping Systems
The world of bookkeeping isn't one-size-fits-all. No single type of bookkeeping is suitable for all needs; each has its advantages and drawbacks.
Single-Entry System
In a single-entry system, only one side of the financial transaction gets recorded. It's simple and best suited for small businesses or freelancers who have minimal transactions. If you're bigger than that, get ready for double-entry bookkeeping.
Double-Entry System
The double-entry bookkeeping system records both sides - debits and credits - of every transaction. This comprehensive approach gives a clearer picture but is more complex than single-entry bookkeeping.
Cash Basis System
A cash-based system logs revenues when received and expenses when paid. This straightforward method makes sense for smaller operations that don't have extensive payables or receivables.
Accrual Basis System
An accrual-based system records income when earned, not necessarily when payment is received, making it better suited for larger organizations that deal with delayed payments. This is the system that you'd eventually have to keep if your business grew so, it may be worthwhile to set a good foundation early.
Sometimes, it's easier to show the difference between cash and accrual basis using an example, so let's try.
If you "sell" a hat to someone but accept an IOU in place of immediate payment, these systems differ. In the accrual-based system, you record the transaction as happening at that point. In the cash-based system - you guessed it - you have to wait until the cash is in your hand to record it.
These varying systems underscore how vital selecting the right bookkeeping approach is in crafting an accurate financial portrait.
Exploring Modern Bookkeeping Tools
I told you we'd get here! Tools!
With the advent of technology, bookkeeping has been transformed from manual Excel entries to streamlined digital solutions. This change is primarily driven by a range of modern tools that automate and simplify the process.
There are no specific 'bookkeeping software' solutions, as it's typically more effective to have one system that can keep your books in line and interpret the results for you; in other words, a comprehensive accounting software.
The most popular among these are cloud-based accounting software like QuickBooks, which helps small businesses manage their financial transactions effectively. These platforms provide real-time updates on payable liabilities, generate income statements, and maintain balance sheets efficiently.
For instance, QuickBooks offers features such as invoicing, bill payment tracking, and payroll management. But there's more out there than QuickBooks.
- Xero: An intuitive tool preferred for its seamless integration with over 700 business apps.
- FreshBooks: Known for its time-tracking ability and user-friendly design, made with small businesses in mind.
- Zoho Books: Lauded for comprehensive automation capabilities, covering everything from bank feeds to recurring invoices.
Adopting these modern tools can significantly improve your efficiency in managing your company's finances, basically eliminating the potential for those pesky human errors. Remember though - every tool has different strengths so it’s important to pick one that best suits your specific needs.
I've covered the overall best accounting software in another article.
Professional Certifications In Bookkeeping
You don't need a CPA to keep your books in line but, if you're aiming to enhance your credibility and competence in bookkeeping, acquiring some professional certifications can be a smart move.
If you're a freelancer looking to enter into the bookkeeping-as-a-service world, gaining certifications will give you an edge over the competition, providing a tangible indication of your proficiency and expertise.
The Certified Bookkeeper (CB) program offered by the American Institute of Professional Bookkeepers is one option. This certification demonstrates mastery over essential work skills like adjusting entries, error correction, and payroll.
- The CB designation requires you to pass six exams while adhering to a code of ethics.
Another worthwhile option for small business operators could be the QuickBooks ProAdvisor Certification. It offers an understanding of how to use this accounting software for managing financial transactions effectively.
- QuickBooks ProAdvisor just requires you to pass a single exam covering its features.
Besides boosting career prospects, these certifications can give peace of mind to clients as they show your commitment to maintaining high standards in bookkeeping practices.
Recording Entries In Bookkeeping
The first step in recording entries is to document the financial transaction at the point of sale. This might be an invoice issued, a bill paid, or income received. Every penny counts.
Next, we move on to journals - the bookkeeper's diary, if you will. Wait, am I the only one saying that?
Okay, just me. Anyway.
Each journal entry notes down two sides of each financial transaction: a debit and a credit.
Debits, contrary to popular belief, aren't always bad. They just represent transactions that either increase assets or decrease liabilities on your balance sheet. Similarly, credits don’t mean more money but rather, reflect increases in liabilities or decreases in assets.
Your general ledger then takes all these journal entries and organizes them by account type; think bank accounts, receivables, payables, etc., making it easier for us humans (and software) to understand where the money’s coming from and what it's leaving for.
We finally arrive at the trial balance stage – this nifty tool helps ensure that our debits equal our credits (that's right folks - no cheating allowed). If there’s an imbalance here, it could spell trouble in the form of an audit.
Closing The Books
Bookkeeping is no longer a mysterious realm, right? You've now grasped what is bookkeeping - it's more than just numbers and accounts. It’s the backbone of your financial management.
If you want more content specifically created for financial professionals, subscribe to The CFO Club's newsletter and consider checking out the rest of our Accounting content today.