For small businesses entering the realm of complex financing, the art of double-entry bookkeeping is a lifesaver. Managing their finances and keeping an eye on the balance sheet can be daunting. However, following simple accounting principles can help them manage their tasks effectively.
Double-entry Bookkeeping or double-bookkeeping is a concept that can ensure every business’s financial health. To have complete control over Bookkeeping, it is essential for business managers to understand the underlying concepts involved and manage their accounts and financial results.
Conversely, Businesses enter their day-to-day financial information in a journal during the bookkeeping process, and the accountant then uses this information to create daily, weekly, monthly, or even yearly reports. The task seems easy, but managing it daily with multiple transactions makes it complex.
The term’ bookkeeping’ refers to a business’s record-keeping process. The bookkeeper’s duty is to manage and review sources like invoices, transactions, receipts, and bank statements. The primary purpose of the bookkeeper is to manage and link every entry to the source data. Moreover, proper documentation is necessary for more complex transactions to avoid any future discrepancies.
Single Bookkeeping works for small businesses with simpler transactions where you usually add and subtract from a balanced account. In single Bookkeeping, you manage the cash outflow and inflow from the bank account in a single account, as there is only one side to a transaction.
In Bookkeeping, we effectively use accrual accounting when debiting and crediting two or more accounts.
As the name suggests, in double-entry bookkeeping, we record every financial transaction and data into two accounts in the general ledger.
Double-entry Bookkeeping works on the principle of duality, meaning every transaction has a dual effect on the business.
Taking out a loan increases the debt level and the balance in the business’s bank account (otherwise known as assets). In contrast, after every sale, inventory decreases, but the bank account increases.
Understanding the accounting equations and terms involved in Double-entry Bookkeeping is vital to understanding the process better.
The fundamental financial reports that manage the business’s information are the balance sheet and the income statement.
The balance sheet: Assets (things owned) – Liabilities (things owed) = Value of the business
The income statement: Revenue (money in) – Expenses (money out) = Profitability
The focus is balancing credit and debit entries in both accounts and journals. Hence, there must be an equal debit entry against every credit entry. For example, if you record an expense, you also record its effect on a business banking account or the amount you owe to a credit card.
In the case of a loan, you enter the effect of the transaction on your bank account and your due loan balance. The purpose is to minimize errors and keep the balance sheet perfectly balanced.
In simpler words, in Double-entry Bookkeeping, the increase in an account with a debit should result in a decrease in the opposite account with credit. The simplest accounting equation to understand the Double-entry Bookkeeping is:
Assets – Liabilities = Equity
Imagine this: If you sell the firm’s assets for cash and pay off the remaining balances and long-term debts, then the remaining money is your firm’s equity.
After recording and balancing the transaction in journals, the information is to be recorded in the ledger. The purpose of a ledger is to organize the transaction into various categories, like revenue, expenses, liabilities, assets, equity, etc. The ledger gives a clear, balanced view of each account.
For instance, if you have made CAD 1000 in credit sales, and the processor sends CAD 993 to your bank, CAD 7 is charged as a processing fee. The following is the step-by-step procedure for Double-entry Bookkeeping.
Accounts Receivable is the money that your client owes you. In Double-entry Bookkeeping, when you send an invoice to your client to pay, you enter the sale as the credit to your revenue and then as a debit to your account receivable.
After the payment, you record a credit to your account receivable to reduce the Value of your asset while entering a debit into your bank account to increase the Value of your asset.
Accounts Payable is the money that your business owes to other people. It is otherwise known as a liability.
When an expense is delayed, it is recorded as a debit, and the amount due is recorded as a credit in the amount payable journal(s).
After the bill is paid, you record a debit to your account payable, which reduces the amount of liability, and a credit to your bank account, which reduces the Value of the e asset.
Moreover, if the bill is paid through the line of credit, there will also be a debit, but it would increase the liability account.
To set up Double-entry Bookkeeping, the first step is understanding how your accounts are used and creating a separate journal for each. There should be separate financial accounts for every aspect, such as revenue, assets, liabilities, equity, etc. The accounts increase with the growth of the business.
However tricky double-bookkeeping might sound, once businesses understand its intricacies, they are like knights in shining armour. If you want to understand your business financials accurately, the best way is to implement double-bookkeeping in your business today!
