How to Keep Books for a Small Business: Bookkeeping & Accounting Basics
You need to work efficiently, in order to grow your business over time. Accounting tasks can be time consuming, but you can work more productively if you have a clearly defined process.
This article explains the accounting cycle, and the bookkeeping and accounting tasks that are required to complete the cycle. If you follow these steps in order, you’ll produce accurate financial statements in less time.
So, why should you use the accounting cycle in your business?
Why the accounting cycle is important
If you use the accounting cycle, you can generate accurate financial statements for your firm’s stakeholders. Stakeholders include investors, creditors, vendors, and regulators.
Investors want to know if your firm is increasing sales and generating a profit, while your creditors are focused the ability to repay company loans. When you follow the steps in the accounting cycle, you can produce accurate financial statements for your stakeholders.
A bookkeeper or an accountant must perform each of these steps:
Developing a chart of accounts
The chart of accounts is a list of each account needed to operate the business, and the account number. As your firm grows, you may add, subtract, or change the accounts to meet your needs, and the chart of accounts is used to post every accounting transaction.
Once you set up your chart of accounts, you use source documents to post transactions.
Posting activity using journal entries
Source documents are receipts, invoices and other documents that record business activity. Transactions are posted using journal entries, which post activity to accounts.
The general ledger is a list of every transaction posted to the accounting records during a month or year. General ledger lists every account name and number in the chart of accounts, along with each debit and credit entry for a particular account.
General ledger lists all of the accounting details for your business, and accountants refer to the general ledger frequently.
How double-entry accounting works
Businesses post accounting transactions using the concept of double-entry accounting. Double-entry accounting requires a business to follow these rules to post a journal entry:
- Debit entries: Debit entries are posted on the left side of each journal entry. Asset and expense accounts are increased with a debit entry, with some exceptions.
- Credit entries: Credit entries are posted on the right side of each journal entry. Liability and revenue accounts are increased with a credit entry, with some exceptions.
- Totals: The total dollar amount of debits must always equal credits. Accounting software requires each journal entry to post an equal dollar amount of debits and credits.
As an example, this journal entry is posted to record an asset purchase:
Debit inventory $5,000
Credit cash $5,000
(To record purchase of inventory for cash)
The journal entry includes the date, accounts, dollar amounts, and the debit and credit entries. An explanation is listed below the journal entry, so that the purpose of the entry can be quickly determined.
The general ledger detail for a particular account may include dozens of transactions in a given month. The next step is to create a trial balance.
Working with the trial balance
After all of the transactions are posted, companies generate a trail balance, which is a listing of each account and the account balance. A trial balance may require adjustments and corrections.
Generally Accepted Accounting Principles (GAAP) requires the accrual basis of accounting, so that the financial statements are clearly stated. An adjusting entry is an accounting transaction that is required to comply with the accrual basis method of accounting. Here are the final steps in the accounting cycle:
- Once the adjusting entries are posted, an updated trial balance is generated
- The adjusted trial balance is used to produce the financial statements
- Revenue and expense accounts in the income statements are adjusted to zero
- Net income, which is the ending balance in the income statement, is posted as an increase in equity on the balance sheet.
Starting the cycle again
At the beginning of a new month, you follow the same steps in order to generate the financial statements:
- Posts journal entries to general ledger
- Generate a trail balance
- Post adjusting entries
- Use the adjusted trial balance to create the financial statements.
The owner, a bookkeeper, or an accountant must perform each of the steps in the accounting cycle.
Delegating accounting work
Accounting work may be delegated between the owner, a bookkeeper, and an accountant. In smaller businesses, the owner does all of the accounting work.
Bookkeepers use source documents to post transactions, which is a task at the beginning of the accounting cycle. Accountants use their higher level of training to make decisions and judgment calls that bookkeepers don’t address.
The accountant uses the transactions prepared by a bookkeeper, along with payroll data and other records, to generate monthly financial statements, including the balance sheet and income statement. An accountant performs work toward the end of the accounting cycle.
Business owners use the financial statements to assess business performance, and to make informed business decisions. Well-managed firms use automation to complete many accounting tasks.
How FormPros can help
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Have you automated each step in your accounting process?
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