So You Want to Do the Books - Basic Bookkeeping - Bookkeeping & Accounting All-in-One For Dummies (2015)

Bookkeeping & Accounting All-in-One For Dummies (2015)

Book I

Basic Bookkeeping


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In this book …

· Get to grips with the basic bookkeeping terminology.

· Take a look at the double entry rules of bookkeeping.

· Understand the Chart of Accounts to see how it impacts on the Profit and Loss and Balance Sheet.

· See how the different ledgers work together to make your accounting system work for your business.

Chapter 1

So You Want to Do the Books

In This Chapter

arrow Introducing bookkeeping and its basic purpose

arrow Maintaining a paper trail

arrow Managing daily business finances

arrow Making sure that everything’s accurate

For many small business owners, while they love working in their chosen field using the skills they know and love, they don’t always like to perform ‘bookkeeping’ duties. Most company owners prefer to employ the skills of a qualified bookkeeper. Some may, perhaps, prefer to give their bag-full of receipts to their accountant and simply hope that a useful set of accounts comes out of the end of the accounting sausage machine!

In this chapter we help to demystify the role of a bookkeeper. It may be that you’re just starting off in business and, as a result, can’t afford the services of a bookkeeper just yet! Think of this chapter as a checklist of jobs that need to be done.

Throughout the book, we introduce Have a Go sections, which are practical exercises aimed at helping you understand the bookkeeping principles we discuss. Feel free to draw all over these sections of the book; we want it to be as useful for you as possible.

Delving into Bookkeeping Basics

Like most businesspeople, you probably have great ideas for running your own business and just want to get started. You don’t want to be distracted by the small stuff, like keeping detailed records of every penny you spend; you just want to build a business with which you can make lots of money.

Well, slow down there - you’re not in a race! If you don’t carefully plan your bookkeeping system and figure out exactly how and what financial details you want to track, you’ve absolutely no way to measure the success (or failure, unfortunately) of your business efforts.

keyconcept Bookkeeping, when done properly, gives you an excellent measure of how well you’re doing and also provides lots of information throughout the year. This information allows you to test the financial success of your business strategies and make any necessary course corrections early in the year to ensure that you reach your year-end profit goals.

Looking at basic accounting methods

You can’t keep books unless you know how to go about doing so. The two basic accounting methods are cash-based accounting and accrual accounting. The key difference between the two methods is the point at which you record sales and purchases in your books. If you choose cash-based accounting, you only record transactions when cash changes hands. If you use accrual accounting, you record a transaction on its completion, even if cash doesn’t change hands.

For example, suppose that your business buys products to sell from a supplier but doesn’t actually pay for those products for 30 days. If you’re using cash-based accounting, you don’t record the purchase until you actually lay out the cash to the supplier. If you’re using accrual accounting, you record the purchase when you receive the products, and you also record the future debt in an account called Trade Creditors.

remember HM Revenue & Customs, who has an interest in every business in the UK, accept only the accrual accounting method. So, in reality you can’t use cash-based accounting. However, a special concession for smaller businesses allows them to use a form of cash-based accounting for value-added tax (VAT) purposes (which is covered in Book III, Chapter 1). In essence, you can complete your VAT return on a cash-based accounting method, which HM Revenue & Customs refers to as cash accounting.

We talk about the pros and cons of each type of accounting method in Book I, Chapter 2.

Understanding assets, capital and liabilities

Every business has three key financial parts that must be kept in balance: assets, capital and liabilities. Of course, for some of you these may be alien concepts, so maybe a quick accounting primer is in order.

example We use buying a house with a mortgage as an example. The house you’re buying is an asset; that is, something of value that you own. In the first year of the mortgage, you don’t own all of it, but by the end of the mortgage period (typically 25 years) you will. The mortgage is a liability, or a debt that you owe. As the years roll on and you reduce the mortgage (liability), your capital or ownership of the asset increases. That’s it in a nutshell.

· Assets include everything the business owns, such as cash, stock, buildings, equipment and vehicles.

· Capital includes the claims that owners have on the assets based on their portion of ownership in the business.

· Liabilities include everything the business owes to others, such as supplier bills, credit card balances and bank loans.

The formula for keeping your books in balance involves these three elements:

· Assets = Capital + Liabilities

Because this equation is so important, we talk a lot about how to keep your books in balance throughout this book. You can find an initial introduction to this concept in Book I, Chapter 2.

Introducing debits and credits

To keep the books, you need to revise your thinking about two common financial terms: debits and credits. Most non-bookkeepers and non-accountants think of debits as subtractions from their bank accounts. The opposite is true with credits - people usually see credits as additions to their accounts, in most cases in the form of refunds or corrections in favour of the account holders.

Well, forget all you think that you know about debits and credits. Debits and credits are totally different animals in the world of bookkeeping. Because keeping the books involves a method called double-entry bookkeeping, you have to make at least two entries - a debit and a credit - into your bookkeeping system for every transaction. Whether that debit or credit adds or subtracts from an account depends solely upon the type of account.

We know all this debit, credit and double-entry stuff sounds confusing, but we promise that this system is going to become much clearer as you work through this book. We start explaining this important concept in Book I, Chapter 2.

Charting your bookkeeping course

You can’t just enter transactions in the books willy-nilly. You need to know exactly where those transactions fit into the larger bookkeeping system. To know where everything goes, you use your Chart of Accounts, which is essentially a list of all the accounts that your business has and the types of transactions that go into each one. (We talk more about the Chart of Accounts in Book I, Chapter 3.)

Discovering different business types

Before you start up in business, you’re wise to sit down and have a think about the structure of your business.

For example, if you’re a window cleaner, and only ever see yourself doing your own rounds and not working with anyone else, then sole trader status would be more than adequate. However, if you’re planning to be much bigger and take on staff, then you need to read Book V, Chapter 1 to see how you should structure your business and what sort of advice you may need.

Planning and controlling your activities

Many businesses just start up and trade from day to day, without any real planning or control of the activities they undertake. Often, businesspeople become so busy that they’re fire-fighting continually and lack any real direction. We like using checklists, because they help to organise your bookkeeping activities in a methodical and orderly manner. This level of organisation means that you can pick up and put down the accounts from day to day or even week to week. You can always start from where you left off, quickly and easily, by simply adopting some of the hints and tips contained within Book II, Chapter 1.

Instituting internal controls

Every business owner needs to be concerned with keeping tight controls on business cash and how that cash is used. One way to institute this control is by placing internal restrictions on who can enter information into your books and who has the necessary access to use that information.

You also need to control carefully who has the ability to accept cash receipts and spend your business’s cash. Separating duties appropriately helps you to protect your business’s assets from error, theft and fraud. We talk more about controlling your cash and protecting your financial records in Book II, Chapter 1.

Keeping an accurate paper trail

Keeping the books is all about creating an accurate paper trail. A computerised accounting system would refer to this trail as the Audit Trail. You want to keep track of all your business’s financial transactions so that if a question comes up at a later date, you can turn to the books to figure out what went wrong. We’re big fans of using checklists, so you know exactly where you are in the monthly accounting cycle. We introduce our monthly checklist in Book II, Chapter 1.

All your business’s financial transactions are summarised in the Nominal Ledger, and journals keep track of the tiniest details of each transaction. Information can be gathered quickly by using a computerised accounting system, which gives you access to your financial information in many different report formats. Controlling who enters this financial information into your books and who can access it afterwards is smart business practice, and involves critical planning on your part. We address all these concepts in the following sections.

Defining and Maintaining a Ledger

jargonalert You may get confused by terms such as books, ledgers, journals and accounts. Most of these words evolved from traditional bookkeeping methods, where accounts were handwritten in huge leather-bound ledgers. These looked like books, hence the name bookkeeping - simply, keeping financial records in the books!

The books are also known as journals or ledgers (we told you it was a bit confusing!). You’d normally have one book for your sales, one for purchases and then a general one used for everything (often known as the General Ledger). Sometimes, businesses would also keep a separate cash book, which would record cash received and cash paid.

Nowadays, most people use computers to do their accounts (anything to make our busy lives easier). The most simplistic set of accounts can be done on a spreadsheet, although we don’t recommend it because mistakes can easily be made and you’ll struggle to find an efficient way to make sure that the books balance.

tip In this book we demonstrate the use of ledgers using Sage 50 Accounts. However, it’s worth pointing out at this stage that if your budget is low and you’re a micro business (for example, a one-man band), you may find Sage One useful. Sage One is a new online accounting service developed by Sage that’s simple and easy to use. Refer to Sage One For Dummies by Jane Kelly to find out more.

remember Most computerised accounting systems use the term ledger, so you usually find the following:

· Sales Ledger: A ledger that holds all the individual customer accounts and their balances. This ledger is sometimes known as the Customer Ledger or the Debtors Ledger.

· Purchase Ledger: A ledger that holds all the individual supplier accounts and their balances. This ledger is sometimes known as the Suppliers Ledger or Creditors Ledger.

· Nominal Ledger: A ledger that includes balances and activities for all the Nominal accounts used to run the business. We discuss Nominal accounts in Book I, Chapter 4. This ledger is also known as the General Ledger.

· Cashbook, or Bank: In Sage, in particular, you can have numerous Bank current accounts and Petty Cash accounts all under the general ‘Bank’ heading. Any cash received or paid is recorded in this part of the accounting system.

· Accounts: Simply a collective term for all the ledgers.

The pinnacle of your bookkeeping system is the Nominal Ledger. In this ledger, you keep a summary of all your accounts and the financial activities that took place involving those accounts throughout the year.

The sum of each Nominal Ledger account can be used to develop your financial reports on a monthly, quarterly or annual basis. You can also use these account summaries to develop internal reports that help you to make key business decisions. We talk more about developing Profit and Loss statements and Balance Sheets in Book I, Chapter 3, when we introduce the Chart of Accounts.

We explain more about developing and maintaining the Nominal Ledger in Book I, Chapter 4. We also discuss the importance of journals and talk about the accounts commonly journalised in Book I, Chapter 4.

Using Bookkeeping Tools to Manage Daily Finances

After you set up your business’s books and put in place your internal controls, you’re ready to use the systems you’ve established to manage the day-to-day operations of your business. A well-designed bookkeeping system quickly makes the job of managing your business’s finances much easier.

Tracking sales

Everyone wants to know how well sales are doing. If you keep your books up-to-date and accurate, you can easily get those numbers on a daily basis. You can also watch sales trends as often as you think necessary: daily, weekly or monthly.

Use the information collected by your bookkeeping system to monitor sales, review discounts offered to customers and track the return of products. All three elements are critical to monitoring the success of the sales of your products.

tip If you find that you need to offer discounts more frequently in order to increase sales, you may need to review your pricing, and you definitely need to do market research to determine the cause of this sales weakness. The cause may be the new activities of an aggressive competitor, or simply a slowdown in your particular market. Either way, you need to understand the problem and work out how to maintain your profit objectives in spite of any obstacles.

When sales tracking reveals an increase in the number of your products being returned, you need to find the reason for the increase. Perhaps the quality of the product you’re selling is declining, and you need to find a new supplier. Whatever the reason, an increased number of product returns is usually a sign of a problem that needs to be researched and corrected.

We talk more about how to use the bookkeeping system for tracking sales, discounts and returns in Book II, Chapter 2.

Keeping stock

If your business keeps stock on hand or in warehouses, tracking the costs of the products you plan to sell is critical for managing your profit potential. When you see stock costs escalating, you may need to adjust your own prices in order to maintain your profit margin. You certainly don’t want to wait until the end of the year to find out how much your stock cost you.

You also must keep careful watch on how much stock you have on hand and how much was sold. Stock can get damaged, discarded or stolen, meaning that your physical stock counts may differ from the counts you have in your books. Do a physical count periodically - at least monthly for most businesses and possibly daily for active retail stores.

In addition to watching for signs of theft or poor handling of stock, make sure that you’ve enough stock on hand to satisfy your customers’ needs. We explain how to use your bookkeeping system to manage stock in Book II, Chapter 3.

remember If you run a service-based business, you can count yourself lucky because stock isn’t as significant a cost in your business. You’re predominantly selling time and using stocks of materials as a part of your service. However, you can’t ignore your material costs, so the same lessons on stock control apply to you.

Running Tests for Accuracy

Tracking your transactions is a waste of time if you don’t periodically test to be sure that you’ve entered those transactions accurately. The old adage ‘Garbage in, garbage out’ is particularly true for bookkeeping: if the numbers you put into your bookkeeping system are garbage, the reports you develop from those numbers are also garbage.

Checking the cash and bank

The first step in testing your books includes proving that your cash transactions are accurately recorded. This process involves checking a number of different transactions and elements, including the cash taken in on a daily basis by your staff and the accuracy of your bank account(s). We talk about all the necessary steps you can take to prove that your cash is correct in Book II, Chapter 4.

Testing your balance

After you prove that your cash is right (see Book II, Chapter 4), you can check that you’ve recorded everything else in your books just as precisely. Review the accounts for any glaring errors and then test whether or not they’re in balance by doing a Trial Balance. You can find out more about Trial Balances in Book III, Chapter 3.

Understanding your VAT

For those of you who are VAT registered, you know that you need to submit a regular VAT return, usually on a quarterly basis. In Book III, Chapter 1 we talk about how you can easily do this return using a computerised accounting system.

Doing bookkeeping corrections

After you’ve entered your normal day-to-day transactions, you find you need to make additional adjustments, such as accruals, prepayments and depreciation. In Book III, Chapter 3, we explain some of these adjustments required, as you close your books at the end of an accounting period.

Preparing financial reports

Most businesses prepare at least two key financial reports: the Balance Sheet and the Profit and Loss statement. These reports can be shown to business outsiders, including the financial institutions from which the business borrows money and the business’s investors.

remember The Balance Sheet is a snapshot of your business’s financial health as of a particular date, and ideally it shows that your business’s assets are equal to the value of your liabilities and your capital. The Balance Sheet is so-called because of its balanced formula:

· Assets = Capital + Liabilities

The Profit and Loss statement summarises your business’s financial transactions for a particular time period, such as a month, quarter or year. This financial statement starts with your sales, subtracts the costs of goods sold and then subtracts any expenses incurred in operating the business. The bottom line of the Profit and Loss statement shows how much profit your business made during the accounting period. If you haven’t done well, the Profit and Loss statement shows how much you’ve lost.

We explain how to prepare a Balance Sheet in Book IV, Chapter 4, and we talk more about developing a Profit and Loss statement in Book IV, Chapter 1.

Computers now play an important part in creating your reports. Provided that you’ve set up your nominal codes correctly, you can easily prepare reports at the click of a button! Having said all this, you need to understand the bookkeeping rules of double entry, which we explain in Book I, Chapter 2. So, when you need to make an adjustment to your accounts, you’ll have the necessary confidence to complete journals by applying the rules of double-entry bookkeeping.

Throughout the book, we demonstrate using Sage software and you’ll be pleased to know that the majority of double-entry bookkeeping is done automatically for you. For example, when you create a sales invoice on the system, Sage debits the Debtors Control account and credit the individual Sales account with the net value of the invoice. It also posts the VAT element (assuming that you’re VAT registered) to the VAT Control account.

Handling payroll

Payroll can be a huge nightmare for many businesses. It requires you to comply with loads of government and tax regulations and complete a lot of paperwork. You also have to worry about collecting and paying over such things as Pay As You Earn (PAYE) and National Insurance. And if you pay employee benefits, you’ve yet another layer of record-keeping to deal with.

We talk more about managing payroll and government requirements, particularly with the introduction of the recent RTI (Real Time Information) system, in Book III, Chapter 2.

Working with your accountant

The majority of the tasks that we discuss in the first three books can be carried out by a bookkeeper, but some tasks perhaps require the skills of an accountant. We cover the areas in which an accountant can help you and your business (as well as work with your bookkeeper) in Books V and VI.

Most bookkeepers are adept at preparing a Profit and Loss statement and a Balance Sheet, but they may not get involved with the choice of accounting methods that a business uses, such as stock valuation and calculating the cost of goods sold. We cover these areas in Book V, Chapter 1. We also look at costing methods (particularly for manufacturing businesses) in Book V, Chapter 4, and budgets in Book V, Chapter 5. The last book discusses how the business may need external accountants and the kind of role that they may play.

Having said all this, the business relies first and foremost on a good-quality bookkeeper to maintain its financial records. The bookkeeper may well be the business owner to start with. If that’s you then buckle up: we’re going on a bookkeeping journey!