“Are your books balanced?” your accountant asks.
“Mmhmm……” you nod unconvincingly, secretly unsure if that shoebox of receipts constitutes “balanced” books.
“Great. If you send me your income statement I can get started on your taxes.” You nod very slowly. You have no idea what he’s talking about.
If that’s you, keep reading. We’ll lay out the basics of what bookkeeping is and why it’s critical to your business. And we’ll point to some resources on how to get started doing your own bookkeeping.
A simple definition of bookkeeping
If you look up bookkeeping in the dictionary, it’s defined as the job of keeping an exact record of the money that has been spent or received by a business.
To put it in even simpler terms, bookkeeping keeps track of your finances. As a business owner, it’s difficult to deny the value in seeing a financial snapshot of money going in and money coming out each day, week, and month. Bookkeeping makes this picture crystal clear.
Breaking down the elements of bookkeeping
Let’s start with the master document—the general ledger. This ledger summarizes the financial information of your business by recording what you earn and spend, and is made up of sub-ledgers like accounts payable (money you owe), accounts receivable (money owed to you), and inventory.
All of your financial statements are based on the information gathered in your general ledger, and your accountant will rely on it when doing your taxes.
Income and expenses
Bookkeeping records your income from sales of a product, service, or both—you’ll need to document any activity that generates revenue for your business.
Let’s say your business collects cash as payment for goods or services sold, or a customer swipes their credit card to make an electronic payment. Gathering information from receipts, like the amount of cash and sales tax collected, and the type and quantity of products sold, is part of bookkeeping.
Bookkeeping is also how you record expenses incurred by your business, like employee salaries, rent, insurance, office supplies, and cost of goods sold—which is the total cost associated with making or acquiring inventory.
Debits and credits
In the double-entry accounting method, you maintain a ledger that tracks both debits and credits. Every time a transaction takes place an equal amount of money moves from your debit (payments made) to your credit (value of goods owned or sold) or vice versa. Each business transaction needs to be entered into the general ledger twice—once as a debit, once as a credit.
These values have to equal each other, which determines the profit or loss during a certain period of time. Proper bookkeeping makes this happen. When the debits and credits are in agreement, you can proudly say you’ve just “balanced the books.”
Further reading: Debits and Credits: A Simple, Visual Guide
If the transactions in your bank account don’t match the transactions recorded in your business’s books (which happens often, don’t worry), you’ll need to do some reconciliation.
Reconciling your bank statement means comparing it with your bookkeeping records for the same period of time, noting each discrepancy, and recording those discrepancies.
To learn more about how to actually do this yourself, check out The Art of Bank Reconciliation.
Part of bookkeeping is tracking the money that’s owed to you by customers for products or services sold—this falls under accounts receivable. This involves following up on overdue invoices, and deciding which unpaid invoices should finally be categorized as bad debt.
Accounts payable is essentially keeping track of the money your business owes. A good bookkeeper will keep tabs on who needs to be paid by when, and will make sure no one gets paid twice.
Accounts payable includes money owed to suppliers, vendors, employers, and even the government (for sales tax, income tax, payroll deductions, etc.).
After a bookkeeper receives (and verifies) an invoice, they’ll make sure the proper amount is paid, and then record the payment as a business expense in the relevant ledger.
Computers, cameras, production equipment—these fixed assets won’t last forever. Bookkeeping practices will calculate a portion of the tangible asset’s cost that depreciates, and record it as an expense. For more on depreciable assets, read this from the IRS or CRA, depending on your country.
Bookkeeping is only as valuable as the information it gives you. That comes in the form of financial statements. The big four are:
- Income statement (or Profit & Loss): shows your revenue and your expenses over a specified time period, and is the best view of your bottom line
- Balance sheet: a snapshot of your financial health at any given point in time
- Cash flow statement: a record of the cash and cash-like hard equivalents entering and leaving your company
- Statement of changes in equity (or a statement of total recognized gains and losses): shows how your share capital, reserves, and retained earnings have changed in a reporting period
Now that you know what bookkeeping is…
You’re probably wondering why bookkeeping matters. All of these puzzle pieces—ledgers, reconciliations, financials statements—fit together to give you the whole picture of your financial situation.
Bookkeeping takes time. But it’s worth it to know exactly where your business stands financially. It’s how businesses like yours see what their cash flow looks like, save on deductions during tax time, and stay organized throughout the year.
When it’s saving you time and money, bookkeeping becomes worth a little effort up front. Here’s why it’s so important.
Your financial health—and business relationships—depend on bookkeeping
Bookkeeping is how you take control of your finances. If you don’t have a clear picture of your income and expenses, you won’t know if you’re making or losing money—and cash flow is the best possible pulse check of your business.
You need cash to stay afloat and run a successful business. You might be able to glance at your bank balance and see your bottom line, but your financial story is more than that. Are invoice payments delayed? Are shipping costs too high? Is a major expense payable this month? Are sales up or down?
Without knowing, you could fall behind on payments or fulfilling orders, ruin relationships with suppliers, and disappoint your customers. With a bookkeeping process, you can see the full story of your financial situation.
Bookkeeping helps you prepare financial statements
Without bookkeeping, you wouldn’t be able to produce financial statements. These statements gather important data and provide insights into how your business is doing.
The most valuable financial statements to get acquainted with are your income statement and balance sheet. Do you want to know your most profitable month? How about how much inventory you have on hand? These statements equip you with the financial information you need to run your business like a well-oiled machine.
Bookkeeping makes business planning easier
After your financial statements are prepared, you can use that information to plan for the future of your business. With a look at your income statement and balance sheet, you can compare previous years to your current year, see the areas of your business that are making the most profit, and plan for your busiest/slowest months.
With all this information now at your fingertips thanks to bookkeeping, you have the ability to make better financial decisions and plan effectively for the future of your business.
Bookkeeping saves on accounting costs and helps you catch valuable tax deductions
Messy books can cost you on your tax return.
When your business has all the necessary documents and information on hand, filing your tax return becomes less of a burden. You’re not rushing to play catch up by looking for bills or remembering if that expense was business or personal. When everything is recorded, taxes are less complicated.
Also, keeping your books in order lowers your accounting fees come tax time. Instead of paying your accountant a premium to rifle through your shoebox of receipts, put in a little bit of legwork ahead of time (or pay a bookkeeper a lower rate to do it). When it’s time to file taxes, your accountant can instead focus their efforts on saving you money by finding every possible tax deduction.
Clean books = easier audit
Getting audited isn’t fun. But it’s way less painful if your books are up to date.
Bookkeeping makes it easy and fast to retrieve information about your income and expenses. Having it all in one place can help you avoid expensive penalties or late fees.
Bookkeeping keeps you organized (and lowers your stress level)
You’re here to run a business, and keeping your finances organized is key to a healthy, successful business. You’re more prepared to handle financial planning, reporting, taxes, and a potential audit. Are you best friends with bookkeeping yet?
Time to get a handle on those books
Now that you know what bookkeeping is and why it matters to your business, you might be raring to tackle the actual work. If so, our beginner’s guide to bookkeeping is a great place to start.
There are plenty of options out there for bookkeeping, but if DIY just isn’t for you, your best option is to hire a bookkeeper. Our bookkeepers here at Bench can do your books for you— but you should find the right bookkeeping solution for your business.