Bookkeeping Basics You Should Know
Bookkeeping is the process of recording your business’s financial transactions. As a small or medium-sized business owner, you can hire a bookkeeper or do the bookkeeping by yourself.
Whichever way you opt, it is important to have a bookkeeping system for reliable measurement of your business’s performance.
There are several things to consider when setting up your small business’s bookkeeping. I’d recommend working with a professional bookkeeper or accountant to help with this setup.
Single vs Double Entry Accounting Method
First, decide whether you will be using a single or double-entry method. The single-entry bookkeeping method is a one-sided accounting system where you record only one entry for every incoming or outgoing transaction. This system is best for a small business with few transactions.
In a double-entry bookkeeping method, an entry for any transaction has the opposite and corresponding entry in a different account. For instance, when you buy stocks for your small business and pay by cash, your inventory will increase, but your cash will reduce. This transaction’s double-entry process will touch both the cash and inventory accounts when recording the transaction.
Cash vs Accrual Basis
You also need to decide whether your bookkeeping system is on a cash or accrual basis. The cash accounting system involves recording revenue or income when you receive the money or make a payment. On the other hand, the accrual basis involves recording the transaction whether or not the money is received or paid.
For example, if you purchase an item worth Ksh. 50,000 and pay for it, the transaction is recorded through the cash method. If you pay for the item the following month, you use the accrual method and record the transaction as a liability in the accounts payable account.
The accrual accounting basis is best if you will be buying or selling your products or services on credit. You can start with a cash-based system and switch to the accrual system as your business grows.
Accounting Software or Spreadsheets
Next is choosing whether to use accounting software or spreadsheets for your bookkeeping. Some small business owners keep manual records in journals or books.; either works because at least you can track your revenues and expenses. However, I advocate for accounting software where you just feed the data, and it generates financial reports for you.
Do not forget to set a chart of accounts for your business, especially when using accounting software. This is a list of all accounts your business uses to classify transactions and organize finances. You can tailor a chart of accounts to suit your business’s needs.
Bookkeeping Accounts to Know
A chart of accounts has several accounts, which are important to understand to ensure proper bookkeeping.
Types of Account | Increasing the Balance | Decreasing the Balance |
Assets | Debit | Credit |
Liabilities | Credit | Debit |
Expenses | Debit | Credit |
Income or Revenue | Credit | Debit |
Equity | Credit | Debit |
When using a double-entry system, you need to understand the types of accounts, what credits or debits are, and the effects on each account.
Assets
Assets are resources that the business owns or controls for the production of economic value. In a business, assets include:
- Cash – can be cash in hand or at the bank
- Inventory
- Equipment
- Accounts receivable (AR) – money owed by customers if you are selling on credit
- Real estate
- Furniture
Liabilities
Liabilities are anything your business owes to third parties, like banks and suppliers. These include:
- Accounts Payable (AP) – money you owe your suppliers when you buy materials, goods, or services on credit and banks when you borrow money
- Interest Payable – this is interest from any business loans or interest accrued from nonpayments.
- Unearned revenue – money you receive when your business is yet to deliver the product or provide the service
- Income taxes payable – tax owed from the income your business makes
- Accrued expenses – these are outstanding expenses from the previous accounting period.
Expenses
A business expense is any cost your business incurs in the course of its operation. Some business expenses to expect are:
- Utility expenses
- Marketing and advertising expenses
- Insurance expenses
- Payroll expenses – employee salaries and wages
- Office expenses
Income
Also referred to as revenue is the money that your business earns from selling services or products. Examples of income are:
- Sales income – income from the sale of goods or services
- Interest income – interest earned from investments like fixed deposit accounts
- Rental income – income earned from real estate investments
Equity
This is the value of ownership or financial interest in the business by an owner/s. Business equity includes:
- Retained earnings (RE) – the remaining net income after the business has paid its dividends
- Owner’s capital
- Dividends
Bookkeeping Practices to Follow
- Keep all your records neat and organized for easy retrieval. It will save you time when looking for records, especially during audits.
- Do not leave your bookkeeping until the last minute. Keep all records up to date to reduce mistakes and ensure you always have access to the business performance records like the income statement and the balance sheet.
- Ensure you keep all the documents, like receipts and invoices, for compliance. You can use a paperless system or the traditional filing method. Sometime down the line, you might need to prove the transaction to the revenue authority or another party if the transaction is disputed. Keep your records as long as possible.
- Always separate personal and business finances, not just for compliance issues for easy tracking and sorting.
- Try to save some money for tax payments, especially the annual income taxes and other unforeseen expenses. Although some business expenses are tax-deductible and will reduce your tax liability, it is hard to know the final amount. You do not want to be caught off guard by a large tax bill, and your business account does not have enough money to cater to this.
- Know all the tax and statutory payment deadlines, like PAYE, VAT, WHT, NSSF, and NHIF, among others, to avoid accumulating penalties.
- Always keep your books balanced and prepare financial reports. And remember that assets = liabilities + equity.
