What are the types of bookkeeping?
Bookkeeping is the backbone of the small business financial system. The process involves organising and storing accounting and financial documents like financial statements, ledgers, income tax records, journals, and much more.
If we go by a typical definition then, ‘it involves systematic recording and organising of financial transactions in an organisation.’
Maintaining financial transactions or the payroll may sound simple enough, but it is not. Small or big, every business should have a professional maintaining the task. These backend operations need more attention than your core business interests. The following section will give you a better insight into the importance of bookkeeping for a successful business.
Traditional bookkeeping was performed using one of two systems. Accountants and bookkeepers used the systems to manually calculate company books and present financial statements per federal regulations. The two main systems still exist in today’s digital era, but it’s much easier to perform bookkeeping tasks for your company on the computer than by hand. Many business owners opt to do their own bookkeeping or outsource the duty to off-site accounting professionals.
What is Bookkeeping?
Bookkeeping involves the recording, on a daily basis, of a company’s financial transactions. With proper bookkeeping, companies are able to track all information on its books to make key operating, investing, and financing decisions.
Bookkeepers are individuals who manage all financial data for companies. Without bookkeepers, companies would not be aware of their current financial position, as well as the transactions that occur within the company.
Accurate bookkeeping is also crucial to external users, which includes investors, financial institutions, or the government – people or organisations that need access to reliable information to make better investments or lending decisions. Simply put, the entire economy relies on accurate and reliable bookkeeping for both internal and external users.
Double-entry bookkeeping systems are used for businesses that routinely have more complex transactions. Companies that collect income through accounts receivable and receive merchandise and inventory on credit are better-suited for this method. This system posts single transactions as an income or expense item then create a second entry to trace the transaction to a corresponding account. For example, if you receive income from a customer, the revenue is posted as income and also traced to the customer’s account. In the event you are audited or need to know where income and expense payments generated, you’ll have a paper trail to find the information quickly. This system uses debits and credits, which is the accountant’s language of increases and decreases to each account affected by your transactions.
History of The Double Entry System
Benedetto Cotrugli first mentioned the double-entry system in his book “Of Trading and the Perfect Trader.” Cotrugli’s book was able to elaborate on some of the fundamental principles that are used in modern-day bookkeeping.
In 1494, Luca Pacioli, famously known as “the Father of Modern Day Accounting,” expounded Cotrugli’s work to create the basic blueprint of the bookkeeping system used today.
Advantages and Disadvantages of the Double Entry Method
The double-entry method, though preferred, is not a perfect system. There are instances that the single entry is preferred more than them. Listed below are some of the advantages and disadvantages of the double-entry method:
- It allows the company to create and understand financial statements more efficiently.
- The business is able to keep a record of every transaction that happens and the effect of it on every element.
- It uses the trial balance, which makes the accuracy of the books easier to monitor.
- It makes the comparison of one period to another easier.
- The matching principle allows a company to determine the correct profit and loss of the company with higher detail.
- It is harder to understand for beginners.
- The cost to maintain is higher for a double-entry system than a single one.
- More time is spent to record each transaction.
The single-entry bookkeeping system is used for businesses that have minimal or uncomplicated transactions. This system records cash sales and business expenses that are paid when incurred. This system is not traditionally used for businesses that have accounts receivable, accounts payable or many capital transactions. Bookkeeping entries under this system don’t match transactions to corresponding accounts, which can make tracing revenues and expenses more difficult. In essence, the single-entry system consists of a cash sales journal, a cash disbursements journal and your bank statements. An entry is made to the sales journal when revenue is received, and an entry is made to the disbursement journal when an expense is paid. Your journal entries should reconcile with your bank account transactions.
History of the Single Entry System
The single entry system dates back as far as accounting itself. Scientists have traced its origins way back in the ancient civilisations. Because of this, not much is known about the origin of it. However, it was the oldest method of accounting used by traders as early as 2000 BC. (5)
Advantages and Disadvantages of the Double Entry Method
As the “prototype” of modern-day accounting, the single entry lacks many features that can be offered by its modern counterpart. Nevertheless, it still has some advantages which make it a better choice for some smaller businesses.
- Easier to understand and apply for those without a background in accountancy.
- No skilled or trained professional is needed to be hired, making it cheaper to implement for businesses.
- The single entry method is; hence errors are easier to neglect.
- It does not reflect the true profit and loss of the business.
- Fraud can be done with ease as there are no counterbalancing accounts to compare to.
Many small-business owners use bookkeeping software to keep track of financial activities. Programs such as Quickbooks and Sage — formerly Peachtree — use the double-entry bookkeeping system, but you won’t necessarily need to be well versed in the method to use the software. These programs are relatively user-friendly and prompt you to enter information to complete and post your transactions. Various versions of the software exist, ranging from basic to professional capacities, and you can purchase the software in desktop, online or cloud versions.
Because bookkeeping systems are often difficult to understand and operate for the typical bookkeeper, the market has put out hundreds of computerised bookkeeping systems. These structures use the single-entry or double-entry methods and make it simple for you to enter transactions accordingly.
There’s bookkeeping software designed for both small and large businesses. Small businesses can simply keep track of all accounts and transactions with easy-to-use interfaces. There’s no need for customised services, as a basic accounting software system is enough.
Large businesses will likely need the assistance of a bookkeeper, but the computerised software can make it easier to stay on the same page. They will also likely need a customised system that will match their unique needs as no business is the same.
The best part about computerised systems is automation. It can efficiently record receivables and payables based on real-time transactions. It speeds up all transaction processes and improves accuracy.
It is expensive, and you may need assistance at the beginning to set it up. It’s also not foolproof, as many would believe it to be. Financial data can be stolen or manipulated, impacting the business’s bottom line. Still, it’s an efficient option for any business in need of flexible, affordable services.
If the whole idea of single-entry and double-entry bookkeeping methods makes you queasy, you might benefit from virtual bookkeeping services. A virtual bookkeeper eliminates the need for expensive CPA fees or an in-house bookkeeping employee. Most virtual bookkeepers accept your sales invoices, expense receipts and payroll ledgers electronically. The bookkeeper posts your transactions to appropriate journals and ledgers, and emails you a copy of your reports. Virtual bookkeepers are typically CPAs or degreed accountants who tend to have lower fees than private CPA firms.
Essentially, a virtual bookkeeper is an online agent who handles your books. Virtual bookkeeping services are common for those who see both the single-entry and double-entry systems as complex and difficult to manage.
A virtual bookkeeper is a great alternative to an in-house bookkeeper or accountant because of the expense; they cost a fraction of what an on-site employee would cost a small business, but they’re just as effective.
Virtual bookkeepers will handle any accounting-related items you wish, but they’re most commonly used for invoices, payroll ledgers, and expense receipts. They’ll apply the single or double-entry system of bookkeeping for you.
Typically, virtual bookkeepers will request the use of a certain type of accounting software. For example, they might request that you purchase QuickBooks so that you can keep track of all your receipts and transactions there. They will have access to your account and track, organise, and reconcile your accounts for you. This makes it easier for everyone.
If that system doesn’t work, you can devise another option with your virtual bookkeeper. They’ll work with your unique needs to develop an accounting system that removes the burden from you while putting all your files in perfect order.
The most notable advantage of using a virtual bookkeeper is the cost savings, but there are others. It’s extremely flexible—your bookkeeper can work whenever it’s convenient. You’ll also have access to knowledge regarding federal regulations and the latest tools. Plus, these bookkeepers often offer other account-related services, such as tax preparation.
There is some risk with data security, since you may be sharing sensitive information over the internet. There is some vulnerability to these accounts and chances for miscommunication. However, if you’re diligently seeking secure communication and share all requested information with your bookkeeper, it can be an excellent method for managing your books.
Why Is Bookkeeping Important?
Proper bookkeeping gives companies a reliable measure of their performance. It also provides information on general strategic decisions and a benchmark for its revenue and income goals. In short, once a business is up and running, spending extra time and money on maintaining proper records is critical.
Many small companies don’t hire full-time accountants to work for them because of the cost. Instead, small companies generally hire a bookkeeper or outsource the job to a professional firm. One important thing to note here is that many people who intend to start a new business sometimes overlook the importance of matters such as keeping records of every penny spent.
Improved Finance Management & Analysis
If you keep a detailed report on customer invoices, it is easier to follow up and remind late-paying customers. With positive cash flow, you will efficiently manage day-to-day business operations and will not experience negative working capital gap.
Meet Tax Obligations
Annually, every business has to meet tax obligations. Your accountant at the end of the year should easily find information in your company report. The report, as prepared by your bookkeeper, should be inclusive of net profit, income, expenses, assets, liabilities, and tax. Only then your accountant can arrange for tax payments and file the company tax return forms with accuracy.
Designing Budget & Business Planning Becomes Easier
With proper insight into your financial stability, you can plan your business accordingly. Also, you will get a clear idea of whether you should invest in growing your business or just focus on improving the depleting cash flow.
Safe in the Event of Auditing
No business wishes to get audited. But unfortunately, if you do get audited, your proper bookkeeping methods will help you get with the things in less time. Also, by providing proper records, you will avoid penalties and/or sanctions.
Bookkeepers can serve a wide range of functions, from standard data entry to advising on business strategy. They come from all walks of life too.
Here are some of the types of bookkeepers that keep businesses running today:
Unofficial ‘kitchen table’ bookkeeper
This might be the small business owner, their spouse, partner or family member. Or it may be someone with another role in the business which ends up working on the accounts by default. They’re doing the basic tasks of data entry, bank reconciliation, invoicing, payments, and filing the paperwork for the accountant. They’re probably self-taught.
This is a one-person bookkeeping firm. They may have started out as a kitchen table bookkeeper and loved it, or maybe they left a big firm. Now they’ve set up a business and taken on a few clients of their own through referrals from friends, colleagues and other people who’ve heard they’re bookkeeping. They’re likely to have some training and certification.
Just as there are accounting firms, so there are bookkeeping firms. They often sell off-the-shelf service packages ranging from basic bookkeeping, all the way up to strategic advice.
Department in the accountancy firm
Some accounting firms have a bookkeeping department that keeps your accounts up to date and produces monthly reports. These people may also be called accounting technicians.
These bookkeepers work in a business doing the full spectrum of bookkeeping duties. They often report directly to the owner (or management), and they may work with an external accountant to deliver all of the business’s accounting needs.
Virtual bookkeepers deliver their service remotely by using online accounting software and meeting mostly via video conference. Doing business this way allows them to keep their prices down. They might be a sole trader, inside a practice, or be based offshore as an outsourced service.
Bookkeepers are generally good with people. They like breaking down concepts such as finance and tax so that any business owner can understand them. They’re also interesting characters. Meet some of them in our series of accountant and bookkeeper stories.
The Accrual vs Cash Basis of Accounting
In order to properly implement bookkeeping, companies need first to choose which basis of accounting they will follow. Companies can choose between two basic accounting methods: the cash basis of accounting or the accrual basis of accounting. The difference between these types of accounting is based on when the company records a sale (money inflow) or purchase (money outflow) in the books.
Methods of Bookkeeping
After learning the two types of bookkeeping system, let’s now discuss the two methods of bookkeeping which are: manual and computerised.
Manual bookkeeping is the paper-based and traditional way of bookkeeping. Business transactions are recorded manually by hand using manual or paper book of accounts, such as journals books, ledger books and worksheets.
This method of bookkeeping is still widely used, especially by small businesses with less complex transactions. Many opt to manual bookkeeping because it is cheaper and easier to maintain. However, the recording process is more tedious than computerised bookkeeping.
Computerised bookkeeping is a new and innovative way of recording business transactions. With the use of accounting and bookkeeping software, the bookkeeping process has been made easier, faster and more convenient.
Keep in mind that principles and concepts of traditional bookkeeping process are still implemented and followed in computerised bookkeeping. It only eliminated the tedious tasks involved in manual bookkeeping, thus, it made recording and reporting of business transaction a lot faster and easier.
Some small businesses do not use computerised bookkeeping because it is more expensive than the manual system, and because they don’t want to go through the technical training involved in computerised bookkeeping. However, most businesses use computerised because of convenience, reliability and efficiency.
To wrap things up, the choice between the single entry system and the double-entry system lies with the owner of the business. No matter which method you use, remember to consult a professional to avoid making any errors that may adversely affect your business.