When you first start a small business, you will hear the terms bookkeeping and accounting used almost interchangeably. There is a difference in bookkeeping and accounting in your business firm. Small businesses may have both bookkeeping and accounting functions, and they are synergistic.
Bookkeeping is the practice of recording your business transactions in your general ledger, the book or software program that contains all the financial transactions for your firm since its inception.
Accounting is the practice of analyzing the information in the ledgers and developing insights into your business's financial decisions.
Bookkeeping is the process of the daily record-keeping of all a company's financial transactions. Bookkeepers record the sales, expenses, cash and bank transactions of the business in a general ledger.
One of the important habits you should develop when you start a business is recording transactions in your general ledger. The ledger and its accuracy are central to your company's finances.
Recording these transactions is referred to as posting. A bookkeeper may also generate invoices and/or complete payroll. The complexity of the bookkeeping process depends on the size of your business and the number of transactions conducted daily, weekly, and monthly.
The following nine accounts should be set up and tracked by all but the smallest businesses to provide adequate financial information for the company's accountant for financial statements and taxes:
1. Cash: The Cash ledger often has two parts which are Cash Receipts and Cash Payments, which are also used to complete the Cash Budget.
2. Accounts Receivable: If your company allows credit accounts, then it has accounts receivable. This information is used to generate invoices and send out bills to your credit customers.
3. Inventory: If you sell products instead of services, you have inventory that you must track.
4. Accounts Payable: If you buy items such as office supplies for your business and you use credit, you will have Accounts Payable. This account is also called trade credit, and it is what you owe your suppliers. There is a cost associated with trade credit.
5. Loans Payable: If you have borrowed money to make larger purchases, you must be able to track your due dates and payments.
6. Sales: You must be able to track your sales, whether credit or cash.
7. Payroll Expenses: The cost of paying your employees.
8. Purchases: This includes finished goods or raw material. It is used in the Cash Budget and in calculating the firm’s Cost of Good’s Sold on the Income Statement.
9. Owner’s Draw: This is the amount the small business owner takes from the firm.
The two methods of bookkeeping are single-entry and double-entry. Most businesses use the double-entry bookkeeping system in which every entry to an account requires a corresponding and opposite entry to a different account.
For instance, a $10 cash sale would require posting two entries: a debit entry of $10 to an account called "Cash" and a $10 credit entry to an account called "Revenue."
The key attributes of a good bookkeeper are being a stickler for accuracy and completeness. Because even the most thorough bookkeeper can make mistakes, a bookkeeper usually works under the direction of an accountant unless the business is very small. Some studies have found that an external accountant may be best. If the business is very small, bookkeeping may be very much like keeping your checkbook.
Accounting has been called the language of business. It is the process of measuring, processing, and communicating financial information. Accounting provides the business owner with information about the company's resources, finances, and the results the business achieves through its use.
The function of accounting is to prepare a record of the company's financial affairs. Accounting includes the interpretation of the numbers prepared by the bookkeeper to determine the financial health of the business.
It also includes the presentation of the financial health of a company, which involves preparing financial statements, and indicators that can be derived from them. Furthermore, a function of accounting is the preparation of tax and other required financial materials.
There are two different methods of accounting. One is based on the cash you have, and the cash you have received. The other is accrual basis accounting. If you have an inventory or a possibility of being audited, you are required to use accrual basis accounting under the Generally Accepted Accounting Principles (GAAP), established by the Financial Accounting Standards Board (FASB).
Cash-based accounting is much simpler than accrual basis accounting. In cash-based accounting, you record revenue when you receive it, and record payments when they are made. This method is usually limited to small businesses in the service industry that has no inventory.
The accrual basis accounting method is based on when revenues are earned, rather than received. This can be thought of as value being transferred between accounts. If you purchase a point of sale terminal, you transfer value from your cash account to your equipment account.
Credit is recorded to the cash account, and debit is recorded to the equipment account. A chart of accounts can help you decide when to credit or debit accounts.
The accounting function can also be outsourced to a private entity. In some small businesses, the bookkeeping and accounting functions are both outsourced. If you outsource your bookkeeping and accounting, you'll still want to be familiar with them both to understand the reports you'll receive.