Bookkeeping Basics

Despite the importance of bookkeeping, small businesses often neglect it because of the time and effort it takes to set up and tend to a bookkeeping system. Most business owners would rather be out generating sales than sitting in the office making journal entries or entering debits and credits in their general ledgers.

But bookkeeping is one thing you can't afford to ignore. To understand why, it helps to comprehend what bookkeeping is and how it affects your business.

Bookkeeping is the recording of a business's financial transactions. It's the first step of the accounting process, which also includes classifying, reporting and analyzing financial data.

Bookkeepers are responsible for organizing and tracking receipts, canceled checks and other records generated by financial transactions. Bookkeepers chronologically record all transactions — cash disbursements, cash receipts, sales and purchases, and others — in a journal and post the journal entries to a general ledger of accounts, which accountants use to prepare monthly financial statements.

Although bookkeeping doesn't contribute directly to your profits, there are several good reasons to maintain balanced books:

• Lenders and investors want to see accurate and complete books for a business before granting loans or raising capital for it. If you rely on outside financing, this is the most important reason to invest time and money in bookkeeping.
• Bookkeeping generates the information you need to manage your company. For example, up-to-date general ledger information shows which customers are past due on their accounts or have outstanding balances on lines of credit. Financial reports help you assess whether or not gross profits and expenses are in line with your budget and projected net profits. In other words, these reports help you anticipate and avoid cash-flow problems.
• In order to know how much you owe the IRS, you need an accurate picture of your company's income. In addition, keeping receipts and canceled checks will back up whatever deductions and tax credits your company takes. Without good record keeping, you leave yourself exposed to fines and penalties if you get audited.

Bookkeeping Options

Many businesses hire an accountant or a bookkeeper to maintain their books. But if you can't afford to or don't want to hire an accountant, you can learn the basics by taking a bookkeeping class at a community college or small business center in your area.

One of the first decisions to make is whether to use a manual or computerized bookkeeping system. Generally only the smallest companies use manual systems and make entries to ledger pads. Most companies use desktop accounting software, such as Intuit's QuickBooks or Peachtree Software's Peachtree Accounting. These programs make it easy to set up accounts, post entries and generate financial statements.

Online accounting solutions are another option. Internet-based accounting solutions allow multiple users to access company records from any computer with an Internet connection. When you use an online application, you contract with another company to keep your financial data on its secure servers. You access your records online by entering a password, and the service provider is responsible for providing the software, security and data storage.

If you have a Web store, consider a Web-based bookkeeping solution that will help you combine online and offline transaction reporting. Many online bookkeeping applications allow e-commerce transactions to flow seamlessly into online general ledgers, saving you from downloading them or rekeying transactions into a desktop system.

A key function of bookkeeping is cash flow management, and several of the popular accounting programs support that analysis as well. Our plain-English guide to cash flow management tools explains the numbers you should watch in doing cash flow management, and it also tells you how to choose a program that can help you analyze your cash flow.

For another perspective on the process of selecting and implementing a bookkeeping method, see our Setting UP a Bookkeeping System Step-by-Step Guide.