Bookkeeping For Dummies (UK Edition)
There are several steps to understanding bookkeeping and maintaining a good record of your business’s finances throughout the year. It’s advantageous to get your head around the trickier bits of keeping the books and to know the process in order to better check and control those incomings and outgoings.
The Flow of Credits and Debits in Double-Entry Bookkeeping
In double-entry bookkeeping you enter all transactions in the books twice: once as a debit and once as a credit. To keep your debits and credits straight follow this table which shows you how both impact on your various business accounts. Put a copy of this up by your desk to check back to for quick reference:
Building Blocks of a Bookkeeping System
The following elements make up the essential foundations of bookkeeping. Keep these business basics in mind when you set out to create a bookkeeping system:
Chart of Accounts: Lists all accounts in the books, and is the road map of a business's financial transactions
Sales Ledger: Lists all the customer accounts, showing sales invoices, credit notes and receipts for each customer.
Purchase Ledger: Is a list of all your supplier accounts, including purchase invoices, credit notes and payments made to suppliers.
Cash book: This is where you will record all the bank and cash payments and receipts for the business.
Nominal Ledger: The book that summarizes all of a business's account transactions
Key Steps to Keeping the Books
Bookkeeping involves following a set procedure of major stages. Take a look at these steps that detail the processes involved – from start to finish in the bookkeeping sequence:
Transactions: The purchases or sales of items start the process of bookkeeping, but there are other financial transactions such as nominal journals that will be posted too.
Reconciliations: Once all transactions are posted, you need to reconcile each of the bank accounts including credit cards.
Trial balance: A review of the Trial Balance will discover any anomalies or adjustments that exist or need to be made in the Nominal Ledger.
Adjusting journal entries: Once you have reviewed the Trial Balance, you may need to make correcting entries to the Nominal Ledger by posting journals. There may also be standard journals such as depreciation and stock journals that need to be completed.
Financial statements: Prepare the balance sheet and Profit and Loss Account using the corrected account balances.
Closing: Close the books for the revenue and expense accounts, and start the entire cycle again with zero balances in both accounts.
Tips for Controlling Your Business Cash
Here are some practical security guidelines when it comes to controlling your business’s cash. Follow these rules to ensure your business’s money handling and recording stays secure:
Separate cash handlers. Be sure that the person who accepts cash isn’t also recording the transaction.
Separate authorization responsibilities. Be sure that the person who authorizes a payment isn’t also signing the cheque or dispersing the cash.
Separate the duties of your bookkeeping function to ensure a good system of checks and balances. Don’t put too much trust in one person – unless it’s yourself.
Separate operational responsibility (actual day-to-day transactions) from record-keeping responsibility (entering transactions in the books).
Getting to Grips with Bookkeeping: The Current Ratio
The current ratio compares your current assets to your current liabilities, providing a quick glimpse of your business’s ability to pay its bills. The formula for calculating the current ratio is
Current assets ÷ Current liabilities = Current ratio
The following is an example of a current ratio calculation:
£5,200 ÷ £2,200 = 2.36 (current ratio)
Lenders usually look for current ratios of 1.2 to 2, so any bank would consider a current ratio of 2.36 a good sign. A current ratio under 1 is considered a danger sign because that indicates the business doesn’t have enough cash to pay its current bills. However, some business sectors have traditionally lower acceptable current ratio values, so find out about these before you leap to a judgement.
Stricter Bookkeeping Methods: The Acid Test Ratio
Many lenders prefer the acid test ratio when deciding whether to give you a loan because of the test’s strictness. Stock isn’t included in calculating the ratio.
To calculate the acid test ratio you must do a two-step process:
Determine your quick assets. Cash + Debtors (Accounts Receivable) + Marketable securities = Quick assets
Calculate your quick ratio. Quick assets ÷ Current liabilities = Quick ratio
The following is an example of an acid test ratio calculation:
£2,000 + £1,000 + £1,000 = £4,000 (quick assets)
£4,000 ÷ £2,200 = 1.8 (acid test ratio)
Lenders consider a business with an acid test ratio around 1 to be in good condition. An acid test ratio less than 1 indicates that the business may have some difficulty settling its day-to-day liabilities.