What Is Bookkeeping and What Does a Bookkeeper Do?
This article is part of a larger series on Bookkeeping.
Bookkeeping is the process of recording transactions of the business in the company books. Traditionally, bookkeepers record journal entries for each transaction and then post each of these journal entries to the appropriate account in the general ledger. They’re also often responsible for sending invoices to customers and paying bills from vendors. Get your books in order by checking our guide on the best small business accounting software.
Small Business Bookkeeping Defined
Small business owners like you should have a bookkeeping system to keep transactions organized, track cash flows, assess business performance, and gather data for tax compliance. Without a proper bookkeeping system in place, there’s a chance that you’re losing money without you knowing, and it’ll be more challenging to pull out data when preparing your tax returns.
Setting up a bookkeeping system doesn’t mean that you need a bookkeeper right away. If you’re up to do the task as the owner, you can do-it-yourself (DIY) bookkeeping by using accounting software programs that are easy to use—even for nonaccountants. But as your business grows, hiring a dedicated bookkeeper or outsourcing one can lift some burden off your shoulders.
With the rising popularity of small business accounting software like QuickBooks Online, bookkeeping has become easier and more straightforward. Your banking transactions can be imported directly from your bank account and, after you assign each transaction to an account, the software does the rest. It will also record transactions automatically anytime an invoice is created or a bill paid. Entering transactions is like filling up a form and, once you save it, the accounting software posts it to the accounts affected automatically.
Double-entry vs Single-entry Bookkeeping
Double-entry bookkeeping tracks your assets and liabilities and your revenue and expenses whereas a single-entry bookkeeping system tracks only revenue and expenses. A double-entry system works by following the principle that every transaction affects at least two accounts. For example, if you pay an electric bill with your credit card, a double-entry system will record both the utility expense and the credit card liability whereas a single-entry bookkeeping system will record only the utility expense without regard to how it was paid.
The easiest way to distinguish a single-entry system from a double-entry system is that a double-entry system will always be able to print a balance sheet, whereas a single-entry system will not.
The advantage of a double-entry bookkeeping system is completeness. By tracking all of the assets and liabilities, you are guaranteed to pick up all the revenue and expenses incurred by the company. A double-entry system does not rely on receipts to record transactions but rather bank and credit card statements. By performing a reconciliation between your books and bank statements, you are guaranteed to pick up all the activity.
We highly recommend all businesses use a double-entry accounting system as they have become easy to use even for nonaccountants. These accounting software products simplify the bookkeeping process by using easy to understand interfaces and forms. If you want to learn more about accounting platforms, we evaluated the best small business accounting software that we think are suitable for DIY business owners.
A bookkeeper is in charge of extracting data from source documents and entering them into the company’s records. With the use of small business accounting software, they can extract data easily from physical documents through the use of optical character recognition or attach data using receipt scanning features. This software also speeds up the data entry process by providing autofill features, search features within drop-down menus, multiple data entry interfaces, automatic transfers of bank transactions, and many more.
Invoice Customers (Accounts Receivable)
Accounts receivable (A/R) management involves issuing invoices, tracking unpaid invoices, and receiving customer payments. Invoices are requests for payment for a product or service provided. As a best practice, always send invoices within 48 hours after completion of the work. You must also send payment reminders to customers as a way of tracking unpaid invoices and consider giving early payment discounts to speed up collections.
Additionally, you should state the payment term on the invoice so that your customers know the due date, discount period, and discount rate. When setting payment terms, try to base them on the payment terms of your competitors so that you don’t lose customers. When customers don’t pay their invoices, try to reach out to them via call or email first. Then, if they don’t respond to you, try sending collection letters to formalize the demand for payment. Our list of the best invoicing software can help find the best software that can help you manage, send, and organize invoices.
Track & Pay Bills (Accounts Payable)
Accounts payable (A/P) management focuses on managing, approving, tracking, and scheduling vendor billings for payment. When you receive invoices from vendors, you should immediately enter them into your A/P software so that they can be tracked easily. Note that it’s not good cash management to pay bills before they’re due unless the vendor offers an early payment discount.
Every month, generate an A/P aging report to monitor all your outstanding bills. Pay the most attention to bills from your most important vendors, especially if they’re approaching 90 days past due. Ideally, you can pay all the bills on time, but if cash flow is slow, it’s important to recognize that not all vendors are of equal importance to your company. Manage bills, track vendors, and send payments efficiently by checking our guide on the best accounts payable software.
Cash management is the process of managing cash receipts, disbursements, and reserves. Managing cash effectively and efficiently lies in your ability to understand how cash moves in and out of your business.
Cash receipts from customers include both physical cash and checks. You should keep cash and checks in a safe place to protect them from theft or loss. In a small business setup, you can use lock boxes, cash registers, and vaults as a place to store cash. You’ll also want to deposit cash and checks on a daily basis to reduce the risk of theft or loss.
When managing cash payments, you should have an active role in reviewing, approving, and signing checks. You should also establish a petty cash fund for small and incidental expenses as it speeds up the reimbursement process for expenses that are too small for a check. As much as possible, pay vendors on time to avoid late payment penalties. If you don’t have enough cash, try utilizing a line of credit to borrow quick cash.
Ultimately, all bank-related transactions should be reconciled. Due to the timing difference between when a check is written and when it clears the bank, the bank and book balances of cash seldom agree. Preparing a bank reconciliation statement can help explain the differences between the bank statement balance and cash register balance.
Track Inventory & COGS
Tracking and managing inventory involves keeping enough inventory on hand, tracking its per-unit cost, and accounting for cost of goods sold (COGS). Once goods have been received, the bookkeeper should record the inventory purchase along with the invoice due to the vendor. Be sure to enter both the cost of inventory as well as the number of units purchased.
If your software doesn’t allow you to enter both the cost and units of inventory purchased, you’ll need to track the COGS manually. We recommend QuickBooks Online if inventory is a major component of your business as it’ll calculate your COGS automatically.
You should account for all the costs, such as freight, insurance, and taxes to ensure an accurate inventory per-unit cost. In the course of selling goods to customers, your business should adopt a cost flow assumption such as first-in, first-out (FIFO), last-in, first-out (LIFO), or average cost method. These cost flow assumptions determine the ending balance of inventory and the COGS reported in the income statement. By knowing the correct amount of COGS, you can determine the gross profit and evaluate if it’s enough to cover operating expenses.
Manage Fixed Assets
Fixed asset accounting involves recording the cost of fixed assets, accounting for depreciation, and recording its disposal. In recording fixed asset costs, you must capitalize the purchase price of the fixed asset and all directly attributable costs necessary to bring the fixed asset to its intended use, such as taxes, freight, and insurance. Subsequently, you may incur costs related to the repair or maintenance of the fixed asset. You should know when to capitalize or expense these costs.
Depreciating fixed assets is the second component of fixed asset accounting. You need to use depreciation methods like the straight line method, double-declining balance method, units of production method, and sum-of-the-years-digits. For simplicity, many businesses use MACRS depreciation, which is required for their tax return.
Who Should Do Your Small Business Bookkeeping?
Business owners who are hands-on in managing the business can handle bookkeeping. In this setup, you see the inflows and outflows of resources as you enter transactions in your accounting system.
But since bookkeeping requires hours of data entry and management, you may want to delegate the task to somebody else and focus on essential business processes that add value to the company’s products. There are two options to consider in hiring a dedicated bookkeeper:
- Hire an internal bookkeeper: You should consider this option if you need a readily available bookkeeping expert at your disposal and you have enough activity to keep them busy. They can look closely at your business’ finance, accounts, and practices as part of the job description. If the bookkeeper is a certified public accountant (CPA), they can also handle your tax compliance and provide management advice in terms of cost management and control. However, hiring a bookkeeper entails salaries and benefits that you need to shoulder.
- Outsource bookkeeping to an online or local bookkeeper: If your business isn’t large enough to justify an internal bookkeeper, outsourcing can be a more affordable option as you don’t have to shoulder employment costs like benefits and insurance. The only downside is that an outsourced bookkeeper won’t be readily available in case you need something done. We’ve evaluated the best online bookkeeping services that can help you find a bookkeeper with expertise in catch-up bookkeeping, payroll, and tax filing.
While good accounting software will make bookkeeping easier without an extensive knowledge of bookkeeping, understanding the basics will help—especially when something goes wrong in your software and you need to problem solve.
To get you started learning in your quest for bookkeeping knowledge, here’s a list of commonly used bookkeeping terms:
- Accounting equation: It’s a fundamental formula in accounting showing that a company’s total assets are the sum of its total liabilities and equity.
- Accrual vs cash accounting: Accrual basis of accounting recognizes income and expenses in the period in which they earned or incurred. On the contrary, the cash basis of accounting recognizes income and expenses only when cash is received or paid.
- Profit and loss (P&L) statement: Also known as the income statement, the P&L statement is a report that shows the business’s revenues, expenses, and net income. It’s also the report used to evaluate company performance.
- Balance sheet: It’s a year-end statement that shows the ending balances of assets, liabilities, and equity for a given period. It’s called a “balance sheet” because total assets reported must be equal to the total liabilities and equity.
- Cash flow statement: It’s a financial statement that shows the actual cash inflows and outflows in operating, investing, and financing activities of the business.
- Journal entry: It’s the primary mode of recording transactions. A journal entry should be equal to at least one debit and credit entry.
- Assets: These are resources owned and controlled by the business for the purpose of generating revenues.
- Liabilities: These are financial, such as A/P, salaries, loans, and nonfinancial, such as warranties, unearned revenues, or obligations that make a company liable to pay cash, deliver goods or perform services in the future.
- Owner’s equity: It’s the residual amount of assets in excess of liabilities. Equity is a combination of contributed capital and net income retained in the business.
- Revenues: These are the total amounts earned as a result of providing goods and services to customers at a marked-up price.
- Expenses: These are the total amounts incurred that can be directly or indirectly traced to revenue-generating activities. Direct expenses include the costs of goods or services sold while indirect expenses pertain to general and administrative costs in conducting business such as professional fees, rent, and utility bills.
- Chart of accounts: It’s a complete listing of all accounts in the general ledger. Each account has a unique numbering system that describes its classification, category, and function.
Bookkeeping vs Accounting
Bookkeeping is only the first two steps in the accounting process. It includes making invoices, entering bills, reconciling bank accounts, receiving and sending payments, and managing customer and vendor accounts.
Meanwhile, accounting is the process of analyzing, recording, summarizing, and reporting the financial information of a business for its owners. It includes analyzing financial statements and other output of the accounting system to help make business decisions.
Bookkeeping is an important function of a business. Even if you do it yourself, the information you get from bookkeeping can help in assessing the business’s performance, usage of resources, and ability to deliver the best products to customers. With the help of small business accounting software, you can do the bookkeeping yourself or let a professional bookkeeper handle the books while you focus on more important business processes and aspects.