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.
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.
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 three 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
Journals: The place in the books where transactions are first entered
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.
Journal entries: Enter transactions into the books through journals.
Posting: Post journal entries to the Nominal Ledger.
Trial balance: Test accounts in the Nominal Ledger to see if they’re in balance.
Worksheet: Enter on a worksheet any account adjustments needed after the trial balance.
Adjusting journal entries: Post adjustments from the worksheet to affected accounts in the Nominal Ledger.
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).