Bookkeeping For Dummies
Bookkeepers manage all the financial data for small companies. Accurate and complete financial bookkeeping is crucial to any business owner, as all of a company's functions depend on the bookkeeper’s accurate recording of financial transactions. Bookkeepers are generally entrusted with keeping the Chart of Accounts, the General Ledger, and the company journals, which give details about all financial transactions.
Building Blocks of a Bookkeeping System
Your bookkeeping system is built on a few key elements fundamental to keeping your books in order. With these building blocks, any bookkeeper can set up a solid system for tracking all the business’s transactions. Here are these important components:
Chart of Accounts: List of all accounts in the books; the road map of a business’s financial transactions
Journals: Place in the books where transactions are first entered
General Ledger: The book that summarizes all a business’s account transactions
Key Steps for Keeping the Books
Bookkeeping is, among other things, a step-by-step process that lets you methodically track the transactions in your company’s books. Monitoring a transaction every step of the way helps bookkeepers keep an eye on the bottom line at all times. Check out the following keys to bookkeeping success:
Transactions: Make purchases or sales of items to run your business and start the process of bookkeeping.
Journal entries: Enter transactions into the books through journals.
Posting: Post journal entries to the General Ledger.
Trial balance: Test accounts in the General Ledger to see whether 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 General Ledger.
Financial statements: Prepare the balance sheet and income statement 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
Although bookkeepers are the ones who record what happens to your business’s cash, they aren’t the only ones who control where that cash goes. Controlling your company’s money is important; a business’s cash can be a pretty tempting siren for employees who aren’t accountable to the right checks and balances. Follow these suggestions to limit any one person’s access to your company’s money:
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 check or dispersing the cash.
Separate the duties of your bookkeeping staff 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).
Calculating Cash Flow with the Current Ratio
In bookkeeping, the current ratio compares your current assets to your current liabilities. This ratio provides a quick glimpse of your company’s cash flow — its ability to pay its bills. The formula for calculating this important ratio is as follows:
Current assets ÷ Current liabilities = Current ratio
The following is an example of a current ratio calculation:
$5,200 ÷ $2,200 = 2.36 (current ratio)
The current ratio is one way lenders test your cash flow when they consider loaning you money. Lenders usually look for current ratios of 1.2 to 2, so any financial institution would consider this example’s current ratio of 2.36 to be a good sign. A current ratio under 1 is considered a danger sign because it indicates that the company doesn’t have enough cash to pay its current bills.
Testing Cash Flow with the Acid Test or Quick Ratio
In bookkeeping, the acid test or quick ratio evaluates your company’s current assets and liabilities, but it’s a stricter test of cash flow than the similar current ratio. Many lenders prefer the acid test ratio when deciding whether to give you a loan because of that strictness; it doesn’t include the inventory account in the calculation.
Calculating the acid test ratio is a two-step process:
Determine your quick assets.
Cash + 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 company with an acid test ratio around 1 to be in good condition. An acid test ratio less than 1 indicates that the company may have to sell some of its marketable securities or take on additional debt until it’s able to sell more of its inventory.