Hello you freaks who decided to start your journey towards financial freedom, I want to present to you a brief explanation in simple words about bookkeeping basics, so you can understand what you are doing, what your bookkeeper is doing or simply to not mess your books.
I always loved the quote from the 2011 movie Margin Call: “explain it to me as if I was a 5 year old, or a golden retriever”. That’s why I’ll do my best to avoid the accounting (boring) jargon and I’ll do my best to explain concepts in a simple manner.
Let’s start, shall we?
Purpose of accounting and bookkeeping: The objective is to make informed financial decisions. That’s it. It’s not to calculate taxes or provide financial statements or comply with regulations. Those are extras but the main focus why bookkeeping is important is to help make informed decisions about the financial health of the entity.
Chart of accounts: This is just the categories and subcategories of accounts where you’ll classify every transaction and this in turn will affect where it shows up in your financial reports.
Most accounting software already come with a standard chart of accounts that looks like this:
- Assets: Cash, bank accounts, people who owe you money (accounts receivable), inventory, computers, desks, office, and any other type of property or equipment.
- Liabilities: People who you owe money to (accounts payable), upcoming rent, upcoming payroll and benefits, loans and financing.
- Capital: Earnings, partner’s equity and losses.
- Revenue: Any money you made from selling goods and services, and from appreciation or sale of any type of assets.
- Expenses: Payroll paid, benefits paid, business expenses, interest paid, trips, gasoline, software, and any type of expense related to the operations of the business.
This chart of accounts is generally acceptable, and you’ll only have to add the categories for accounts specific to your niche.
Pro-tip: Liabilities are things that you know you’ll have to pay (in some cases just that you may or may not have to pay) but you haven’t paid yet. Once they are paid, you cancel the liability by debiting it and credit the expense.
Recording transactions: Recording transactions is the heart of bookkeeping. You’ll need to enter all financial activities, like sales, purchases, expenses, and payments, into your system. Accuracy is critical here, as it directly impacts your financial reports
Bank reconciliation: Bank reconciliation is a must-do process. It involves comparing your recorded transactions with your bank statements to ensure they match. This helps catch errors, identify missing transactions, and maintain accurate financial records.
Almost always the balances won’t match, due to transactions not cleared within the month, checks in transit, transfers in transit, plus any mistakes done when recording or not recording a transactions, such as an expense not entered into the accounting software or double recording a bank match.
Financial statements: Financial statements are the end result of your bookkeeping efforts. The three main statements are the Income Statement, Balance Sheet, and Cash Flow Statement. These reports summarize your business’s financial performance, assets, liabilities, and cash flow.
Financial statement analysis: To make the most of your bookkeeping data, schedule regular reviews and analysis. This will help you spot trends, identify areas of improvement, and make informed decisions for the future of your business.
The financial statements by themselves won’t tell you much. But when you compare them to historical data and as a percentage of your revenue or total costs, you can start to see a clear picture of where you at right now and you can create budgets and forecast.
Conclusion: And that’s it for today. Remember to hire a professional the moment you can afford it. Accurate financial records are the heart of a healthy entity, doesn’t matter if you’re a large corporation of a small local business. Don’t do it yourself or have your wife do it.