What is Bookkeeping?
What is Bookkeeping?
Part 5 of a 10 Part Series
5 Minute Read
Accounting for Small Business 101
This 10 part guide will provide you with the most basic fundamentals of accounting for your business. Whether you’re a budding entrepreneur with your first start-up or a stay-at-home mom selling knit hats on Instagram, lay the groundwork. Here’s how.
Part 5: What is Bookkeeping?
If you’ve been following along with this series, you already know the simple answer. Bookkeeping is the recording of financial transactions. Or put even more simply, bookkeeping is tracking money coming in and going out.
Since this data is so crucial to the world of accounting, it’s important to know the details of what bookkeeping is. This post will make it easy to understand what bookkeeping is. It’s valuable info whether you’re doing your own bookkeeping or have hired a bookkeeper.
Bookkeeping is Tracking Data
Data is the foundation of accounting. These numbers tell a story about the growth and life of your business. The data will give us insights into the past, present, and future. You’ll be able to see the results of decisions you made in the past. You can get an understanding of how secure you currently are. And you can even make predictions about where your business will be a month, a year, or a decade from now.
And it all starts with the simple, steady task of keeping track of data. If math isn’t your bag, think of data entry not as a chore, but as a scientific study. A scientist testing an experiment in a lab will take careful notes each day to monitor their results. You’re the guy in the lab coat scribbling down the core temperature of your test subject.
How to Do Bookkeeping
To track money, you’ll want to have an organized data entry system that you update on a regular basis. You can go super old-school and manually write down transactions in a ledger. Or you can join the rest of us in the 21st century and use bookkeeping software. Quickbooks is the most well-known. But there are some other great options out there like Xero, Freshbooks, and Wave.
Stick to a regular schedule of bookkeeping so you don’t get overwhelmed. This could be once a month, or even once a week. It helps to have your memory fresh in case there are some confusing transactions. Most of your transactions import automatically into your bookkeeping software. You may need to make some manual entries if you use paper invoices or cash transactions.
Of course another great way to do bookkeeping is to outsource it to someone else. Whenever possible, hire a bookkeeper that you trust to free up your time for other tasks. I know of a great accounting group that could help you out… 😏
There are two methods for bookkeeping data entry: cash basis and accrual basis. The concepts can be confusing if you’re not a numbers person. So let’s break these down.
Cash Basis Tracking
Cash basis is probably the method you’re most familiar with. It’s how you track transactions for your household budget. With cash basis accounting, you record when money changes hands.
For example, let’s talk about personal finances. If you receive a bill in January, but don’t pay it until February, you would put that expense in your February budget. If you worked overtime in January but that pay is in your February paycheck, you would record that pay as February income.
Cash accounting is simple and used by many small businesses. But the downside is that it doesn’t give the most accurate picture of your business’s financial health.
For instance, let’s say you paid $1,000 of bills this month. You also did a ton of work and sent thousands of dollars of invoices out, but none of your clients paid this month. So you don't track any revenue. With cash accounting, it will look like this month was a total dud. When in fact, it was profitable!
Accrual Basis Tracking
Accrual basis is the gold standard method for accounting. It's used in bookkeeping software. It’s a double-entry system of debits and credits. You record revenue and expenses when they are incurred. This means your bookkeeping records won’t always match your bank statements.
If you’re new to bookkeeping, you may need to reframe your brain for this. You are not tracking the movement of money when it exchanges hands (or bank accounts). You’re tracking the movement of the monetary value of products and services.
You track revenue (money coming in) as soon as the service is rendered, or the product is sold. That’s regardless of whether you receive the payment right away. And you track expenses (money going out) as soon as the expense is incurred. Regardless of whether you pay the bill right away.
Examples of Accrual Basis Tracking
It's July. You’re a web designer, and you just finished a website for Josh's Custom Tees, so you send them an invoice for $3,000. The due date for payment is in August. You do not receive payment from your client this month. But you record the invoice amount of $3,000 as revenue for July. That's because your work in July earned $3,000 for your business.
In July, Josh received an order for $500 worth of custom t-shirts for Lynn's Cafe. He sends the customer an invoice that says they have 30 days after they receive the shirts to pay. The shirts aren’t delivered until August, and the customer ends up paying in September. Josh recorded the $500 as revenue for July, because that is when he sold the shirts.
Lynn ordered custom t-shirts for the baristas at her cafe in July. She don’t receive the shirts until August, and she paid the bill in September. But she recorded the $500 as an expense for August, since that’s when she received the shirts.
The Best Bookkeeping Method
Accrual basis accounting gives the most accurate picture of your finances. A month with high sales and low expenses is profitable, and you’ll see that in your income statement.
Accrual basis accounting is also helpful for the long-term view of your finances. Since you're tracking the value of services and products when they are exchanged, you can get some valuable insights. You can find out if marketing expenses were worth it based on sales. You can decide how to budget for the future based on current profits or loss. And you can see trends like slow sales months that happen every year.
Accrual basis accounting is the standard for the accounting industry. It's even legally required for publicly traded companies. So if you are a tiny business or startup, get into accrual accounting and it’ll make life easier as you grow.