Table of Content
- Section 1: The basics of financial accounting: A Quick Read
- Section 2: Steps involved in a successful bookkeeping process
- Section 3: The difference between bookkeeping and accounting
- Section 4: The similarities that exist in bookkeeping and accounting
- Section 5: Emerging trends influencing bookkeeping and accounting
- Section 6: 20 important accounting and bookkeeping terms to know in 2020
The basics of financial accounting: A Quick Read
Before we understand bookkeeping and accounting in the present-day context, it is important to know the basics of “financial” accounting, which refers to recording of information about financial transactions and money. A transaction is a business event with a monetary impact. This could include selling goods to customers or buying something from vendors. such as selling goods to a customer or buying supplies from a supplier. In financial accounting terms, a transaction is what triggers the recording of information about the money involved in such an event. The information is recorded in accounts, which is a detailed record about a specific item. This could include office expenditure, accounts receivable, or payable. Some of the most common accounting terms are as follows.
The current balance of money held by a business. This is usually in the checking or savings accounts.
Sales on credit which the customers must pay for at a later date.
Items held in stock for eventual sale to customers.
Assets purchased with long-term use in mind that cannot easily be liquidated.
Liabilities that are payable to suppliers, but which have not been paid yet.
There are liabilities for which the business has not yet been billed but will have to eventually pay for.
The cash loaned to the business by another party.
This refers to the ownership interest in the business. It is the founding capital and any subsequent profits retained in the business.
Sales made to customers (both on credit and in cash).
This refers to the expenses incurred in running a business and includes salaries, rent, utilities, and office supplies.
This refers to the tax paid on any profits earned in the business.
Lists assets, liabilities, and equity of the business as of the report date.
Lists revenues, expenses, and profit or loss of the business for a specific period.
Statement of cash flows
Lists cash inflows and outflows generated by the business during a specific period. It can be formatted through the direct or indirect method.
Thus, financial accounting refers to recording of business transactions in accounts, which are summarized in the general ledger. This in turn helps in creating financial statements.
Steps involved in a successful bookkeeping process
For anyone to run a business, it is important to be somewhat familiar with the process and art of bookkeeping. A basic understanding of this process can help you in revolutionizing your business. The right bookkeeping tools will help you feel more confident about running your business and profit from it as well. However, at the outset, we will help you understand what bookkeeping is before going into other details.
Bookkeeping refers to the process of recording and organizing financial transactions of your business. A bookkeeper is the person who is responsible for this work. Bookkeeping is a way for businesses to understand if they are making profits, tackle any challenges at an early stage and avert crisis. Bookkeeping also helps businesses in identifying potential expansion areas and gives a clear overview of your financial health.
A bookkeeper thus records transactions, sends invoices, makes payments, manages accounts, and prepares financial statements. Although bookkeeping and accounting are similar, the former lays the foundation for the accounting process. Accounting on the other hand focuses more on data analysis collected in the process of bookkeeping.
Understand business accounts
The five basic types of business accounts include assets, liabilities, revenue or income, expense or expenditure, and equity. Bookkeeping helps record transactions in the appropriate categories.
Setting up business accounts
In earlier days, account charts were recorded in general ledgers. However, nowadays there exist several bookkeeping software that help with this. There are three ways to create a general ledger in a software:
- Desktop accounting bookkeeping software, and
- Cloud-based accounting software like Giddh
Although the spreadsheet is the cheapest, it comes with several issues such as errors creeping in and so on. A desktop bookkeeping software on the other hand has a high up-front fee. Cloud-based bookkeeping software is the most cost-effective and secure alternative that is available for a very nominal monthly subscription fee.
Recording all financial transactions
Now that you have a set of financial accounts and a bookkeeping system in place, it is important to record what you are doing with your money. Each debit and credit transaction must be recorded in the right account otherwise the account balances will mismatch leading to non-closure of books.
Balancing the books
This is the last step where the account debits and credits are tallied. This usually happens at the end of a quarter or year. Essentially, when the account types are combined, the adjusted balances should meet the equation:
Assets = Liabilities + Equity
Preparing financial reports
Once the books are balanced, it is important to summarize the flow of money in each account. This will give a clear picture of the business’ financial health. This will help in making the correct decisions about the future of your business. Some of the common financial reports created in bookkeeping include balance sheet, profit and loss statement (which breaks down revenues, costs, and expenses over a period of time), and cash flow statement.
A bookkeeping software can help in preparing these financial reports and is the lifeline for small business owners who need to make quick financial decisions.
Sticking to a schedule
Once a week, it is imperative to make a record of financial transactions. This includes incoming invoices, bill payments, sales, and purchases. Close your books regularly at least every quarter.
Storing records securely
When you engage in proper record-keeping, it not only makes processes easier but also keeps the business compliant with the law.
Do not DIY
Unless you are a businessperson trained in accounting principles, bookkeeping can be a tough nut to crack. Either you can hire a bookkeeper or make use of good bookkeeping and accounting softwares to help you.
The difference between bookkeeping and accounting
Despite being the integral aspects of a business, both bookkeeping and accounting are different from each other. Bookkeeping is an integral part of accounting. The latter, however, is broader and includes a design of accounting systems. This is used in bookkeeping for preparing financial statements, audits, cost studies, income-tax statements, etc. This also helps facilitate the interpretation of accounting information for both internal and external users and helps in decision making. In bookkeeping, one needs to follow basic accounting concepts and conventions. On the other hand, bookkeeping is clerical and done by junior employees. However, many businesses have not started using bookkeeping software rather than doing it all manually. Accounting depends on bookkeeping since it contains a proper record of all financial transactions.
The process of bookkeeping involves identifying and recording financial transactions and preparing ledger accounts and trial balance. Accounting, on the other hand, involves recording, classifying, and summarizing financial transactions in a proper manner. Accounting is therefore a broader concept than bookkeeping. Accounting helps understand the financial position of a business and enables preparation of various types of reports.
The similarities that exist in bookkeeping and accounting
Accounting involves recording, interpreting, classifying, analysing, reporting and summarizing financial data. Bookkeeping, on the other hand, helps in recording financial transactions. This is the foundation of accounting. Bookkeeping is all about recording details to be used in accounting. The process of bookkeeping helps record the financial transactions in chronological order. Accountants on the other hand, analyse financial transactions through statements and business reports. These follow accounting principles, standards and requirements. This financial data analysed by accountants helps in assessing the financial condition of the business and its performance – thereby letting the leadership make informed decisions.
To an untrained eye, bookkeeping and accounting can appear to be similar. Some similarities among the two processes are as follows. Financial data is the basis for both bookkeeping and accounting. One needs basic accounting knowledge to be able to work in either of the professions.
Emerging trends influencing bookkeeping and accounting
There is a sea change in the way bookkeeping and accounting are done today especially with the arrival of bookkeeping and accounting software. Some emerging trends in this field are as follows.
Merger of bookkeeping and accounting
The thin line between the processes is vanishing due to the advent of accounting and bookkeeping software. Some bits of accounting are slowly being absorbed into the process of bookkeeping. Bookkeeping software, on the other hand, is now capable of generating financial statements as well.
Bookkeeping may become obsolete
Although many businesses may still need a bookkeeper, this process will cease to be limited to just data entry, balancing bank ledgers, and reconciling bank statements. These functions will start becoming obsolete in the years ahead, with most tasks being ably handled by bookkeeping software.
Extension of services
With the emergence of newer technologies, bookkeepers and accountants need to explore emerging software options. This change is imperative since even clients demand it. These changes will also be a way of presenting value-added services such as payroll processing, credit card reconciliation, etc. with the help of the latest software.
Arrival of smartphones
Businesses are increasingly shifting operations online. With increased smartphone penetration, business owners want to be able to access data from anywhere on different devices at their convenience. Given this, accounting and bookkeeping professionals are making sure that the reports generated are available online for them.
With the arrival of new technologies and services, one can see consulting and advising corporations taking full advantage of them. The advancement in analytical tools will only make bookkeeping and tax preparation services more efficient and significantly cheaper in the years to come.
20 important accounting and bookkeeping terms to know in 2020
Amount owed by a business to its suppliers or vendors for goods and services purchased on credit.
Amount owed to a business from its customers or clients for goods or services provided on credit.
Amount owed by a business to its suppliers or employees that relate to the current period but which it has not yet been invoiced. Also called accrued expenses.
One of the three main financial statements prepared by a business. The balance sheet displays everything that is owned and owed by the company that has a measurable financial value.
The value of assets, liabilities, and equity recorded on the balance sheet of a business. Book value may differ from replacement cost or market value.
The process of planning and projecting revenue, expenses, and capital expenditures for future fiscal periods.
The tangible operating assets of a business. These assets generally provide the business with operating capacity as opposed to being held for resale. They have a relatively long life.
Cash basis accounting
The method of accounting in which financial transactions are recognized in the period in which cash is transfered, not necessarily the period to which the event relates. Generally accepted accounting principles usually do not allow cash basis accounting.
One of the three main financial statements of a business. In most general terms, it shows why there is an increase or decrease in cash during the year. These increases and decreases are summarized into operating, financial, and investing activities.
Chart of accounts
The set of accounts used by a business that make up its general ledger. These accounts are standard to that organization, and all transactions must be recorded using these standard accounts unless a change is granted by management.
Cooking the books
A term for the process of making the financial results look good. Although there are many acceptable choices that can be made with respect to accounting policies, some of which make the books look better, “cooking the books” generally involves fraudulent methods of recording nonexistent transactions or transactions with values different from what is being recorded.
Cost of goods sold
The purchase or manufacturing costs of the goods that were sold during a particular period. The costs related to the goods not yet sold are accounted for in inventory on the balance sheet.
Debits and Credits
Accounting terms representing the increases and decreases in ledger accounts. Debits represent increases to assets and expenses, and decreases to liabilities, revenue, and equity accounts. Credits represent increases to liability, revenue, and equity accounts, and decreases to assets and expenses.
The amounts owed by a business to outside persons or businesses. It is sometimes more narrowly defined as to exclude accounts payable and only include loans that have fixed interest rates and repayment schedules.
The main summary of financial reports produced by a business’s accounting and bookkeeping system. The three main financial statements are the business sheet, the income statement, and the cash-flow statement.
Generally Accepted Accounting Principles (GAAP)
The collection of standards and practices required to be used by businesses to record and present the results of their financial activities and their records of what they own and what they owe. GAAP can be different between industries and between countries.
This is one of the three major financial statements of a business. The income statement shows operating activity over an operating period from revenue, expenses, and extraordinary gains and losses.
A term used to describe a business that does not have enough assets to meet its debt obligations in the short term. Insolvency must be corrected quickly, or it could lead to bankruptcy.
A method of accounting for inventory by which all purchases throughout the operating cycle are posted to the cost of goods sold. Inventory is physically counted at the end of the period, and the adjustment for goods sold is made at that point. With this method, inventory is correct only at the end of the period.
A method of accounting for inventory by which goods are recorded as being removed from inventory as they are sold. With this method, inventory is always theoretically correct and is checked against a physical count at the end of the period.