Any business that wants to become successful needs accurate financial records to keep track of progress. Good books help you analyze patterns in your business’ financial behavior, allowing you to create accurate budgets, set realistic business goals, and make smarter business decisions.
Below, we answer the question of what is bookkeeping, discussing its definition, benefits, components, and methods.
What is bookkeeping?
Bookkeeping is the practice of recording, categorizing, and reporting an account’s financial transactions in a financial ledger. The process helps businesses monitor their overall financial health.
The difference between bookkeeping and accounting
Where bookkeeping is the practice of recording financial transactions, accounting is the practice of interpreting those records. An accountant will use the information in the bookkeeper’s records to provide financial advice, perform business audits, produce financial forecasts, and more.
Our Bookkeeper vs. Accountant article can provide more information.
Why Do Small Businesses Need Bookkeeping?
Bookkeeping plays a vital role in maintaining good financial health. Accurate records help you make better business decisions while complying with government requirements.
It Helps You Budget Accurately
Financial records reflect how much you earn, how much you spend, and what categories you typically spend on. This data is valuable for budgeting. Analyzing past spending and income patterns makes it easier to forecast budgets accurately.
For example, if a cafe’s financial records show that sales increase during the Christmas season, it can adjust its December budget to accommodate its inventory needs.
It Prepares You for Tax Season
Every business should expect to file taxes at the end of the year. Bookkeeping records provide all financial information relevant to the process. They also help you calculate solid estimates of what you owe in tax.
It Keeps You Compliant with Government Regulations
The government typically requires businesses to maintain accurate financial records. Bookkeeping ensures that financial information is readily available, keeping the business compliant with legal requirements.
It Paints a Clear Picture of Your Financial Health
Bookkeeping records paint a clear picture of your company’s financial standing. Ledgers provide snapshots of account activity, reflecting trends in spending, revenue generation, cash generation, and debt. Meanwhile, financial statements help you measure performance in multiple aspects, such as profitability, liquidity, cash flow, debt reliance, and overall asset value.
Performance indicators are valuable because they help creditors and investors assess the risk of funding your company. They also help job applicants determine the company’s ability to support its employees.
It Helps You Monitor Business Goals
Bookkeeping records provide evidence that you are meeting your business targets. Without your books and financial reports, you would rely on guesswork to gauge progress.
A company goal, for example, might be to increase profits within four months of operations. Income statements collected over that period can help determine whether that goal was achieved.
What are the Key Bookkeeping Terms?
The first step in understanding bookkeeping is defining basic terms. Some of the most common terms you’ll encounter in bookkeeping include transaction, account, debit, and credit.
Transaction
A transaction refers to any type of monetary exchange.
Account
An account is a storage unit for recording transactions of a similar purpose or nature. Accounts fall into five categories: assets, liabilities, equity, revenue, and expenses.
- Assets: Business-owned or controlled resources that provide economic benefit. Asset account examples include cash, inventory, properties, equipment, and trademarks.
- Liabilities: These are sums of money that the business owes. Examples include payable bills, loans, and lines of credit.
- Equity: Money invested into the business by owners, shareholders, and other sources. It is the total value of the company after subtracting liabilities from assets. Examples of equity accounts include owner’s capital, stock, and retained earnings.
- Income: This refers to money the business receives from payments, sales, or interest. Examples of revenue accounts include sales revenue and dividend revenue.
- Expenses: These are sums the business pays to operate. Examples of expense accounts include wages, rent, electricity, and depreciation.
Debits and credits
Debits and credits are terms used in double-entry booking to represent the flow of economic benefit from one account to another.
- Debits denote the flow of economic benefit from an outside source to your business. They increase assets and expenses and decrease liabilities, equity, and revenue.
- Credits denote the flow of economic benefit from your business to an outside source. They increase liabilities, equity, and revenue, and decrease assets and equity.
| Debits | Credits |
| Increases asset and expense account balances | Increases liability, equity, and revenue account balances |
| Decreases liability, equity, and revenue account balances | Decreases asset and expense account balances |
What Are the Typical Small Business Bookkeeping Responsibilities?
Bookkeeping encompasses a wide range of activities. Below, we cover the most common bookkeeping tasks.
Recording Transactions
The primary function of bookkeeping is recording and organizing transactions. Bookkeepers log transactions chronologically in a general journal, then organize them by account in the general ledger.
Financial Statement Preparation
After bookkeepers record and organize your transactions, they summarize your financial activity through financial statements. These reports outline your financial performance, helping you identify strengths, weaknesses, trends, and opportunities.
Account Reconciliation
Bookkeepers ensure that the numbers on your financial statements, such as credit card and bank statements, align with those on your books. In a process known as account reconciliation, bookkeepers cross-reference bank records with business records to identify and correct discrepancies, such as missed check deposits and incorrect funds.
The most common form of account reconciliation is bank reconciliation, which checks bookkeeping records against bank statements.
Tax Preparation
It can be challenging to stay on top of taxes. Not only do you need to ensure that everything is filed correctly, but you also need to ensure compliance with local regulations. A layman might also be unfamiliar with how to qualify for tax returns.
Bookkeeping maintains accurate records of business transactions to ensure preparedness during tax season. With a dedicated bookkeeper, you can keep your tax paperwork organized and legally compliant while maximizing all possible tax returns.
Accounts Receivable
Bookkeepers help you track down unpaid client payments. They are in charge of creating, sending, and tracking down client invoices. A good bookkeeper will also know how to work with clients and collect late payments. The process prevents you from losing money to untracked invoices.
Accounts Payable
Conversely, bookkeepers also stay on top of the money your business owes. It ensures that the payments you submit to contractors, vendors, and other companies arrive on time. The accounts payable practice allows you to build solid reputations with the entities that work with you. Increased credibility allows your business to maintain longevity.
Payroll
Bookkeepers ensure that you pay your workers accurately and on time each pay period. They also assist in organizing relevant employee documents, such as timesheets. They use their expertise in tax to file taxes on your employees’ behalf.
What Are The Main Documents in Small Business Bookkeeping?
Because the primary purpose of bookkeeping is to log financial activity, the process involves multiple documents. Bookkeeping documents help record, organize, and present the company’s financial activity within a given period.
Journal
The journal is the first place bookkeepers log transactions. It consists of rows of journal entries, which represent financial transactions. Each journal entry provides the following information:
- The date the transaction occurred
- A unique reference number
- The account affected or a description of the transaction
- The transaction amount as an income or expense (single-entry bookkeeping) or a debit or credit (double-entry bookkeeping)
- The balance remaining after the transaction (single-entry bookkeeping)
Below is an example of a typical journal page in single-entry bookkeeping.
| Date | Reference Number | Description | Income | Expense | Balance |
| XX-XX-XXXX | 01 | Rendered service to Client A | $7,000 | $7,000 | |
| XX-XX-XXXX | 02 | Paid rent | $2,000 | $5,000 | |
| XX-XX-XXXX | 03 | Purchased supplies | $1,000 | $4,000 |
Meanwhile, a double-entry bookkeeping journal with the same transactions as the example above would look like this.
| Date | Reference Number | Account | Debit | Credit |
| XX-XX-XXXX | 001 | Cash (Asset) | $7,000 | |
| XX-XX-XXXX | 001 | Sales Revenue (Revenue) | $7,000 | |
| XX-XX-XXXX | 002 | Rent (Expense) | $2,000 | |
| XX-XX-XXXX | 002 | Cash (Asset) | $2,000 | |
| XX-XX-XXXX | 003 | Supplies (Asset) | $1,000 | |
| XX-XX-XXXX | 003 | Cash (Asset) | $1,000 |
Bookkeepers often create dedicated journals for different transaction categories. The added organization makes transactions easier to locate. The seven types of bookkeeping journals include:
- Cash disbursements journal: This journal records all cash payments to creditors, vendors, payroll, and other billers. It is also known as the cash payments journal.
- Cash receipts journal: This journal tracks all cash payments received from clients, customers, debtors, and other sources.
- Purchase journal: This journal records all credit purchases of merchandise and inventory.
- Purchase returns journal: This journal records any returns of items previously purchased on credit.
- Credit sales journal: This journal records goods and services sold on credit.
- Sales return journal: This journal records all returns on goods and services previously purchased on credit.
- General journal: For companies that use specialized journals, the general journal logs all transactions that do not belong to a specialized category. For companies do not use specialized journals, the general journal is simply the main journal for tracking all types of transactions.
General Ledger
In double-entry accounting, bookkeepers must transfer journal entries to a general ledger, which segregates transactions by account. The general ledger provides an organized view of account activity. It also makes transactions easier to locate.
Each account is represented by a table consisting of the following columns:
- Date: When the transaction occurred
- Description: What the transaction was
- Reference number: The transaction’s identifying number
- Debit: The amount debited
- Credit: The amount credited
- Balance: The account’s remaining balance after adding or subtracting debits or credits
| Account Name: Cash | Account No: 001 | ||||
| Date | Description | Ref | Debit | Credit | Balance |
| XX-XX-XXXX | Client A paid for service | 001 | $7,000 | $7,000 | |
| XX-XX-XXXX | Rent payment | 002 | $2,000 | $5,000 | |
| XX-XX-XXXX | Purchased supplies | 003 | $1,000 | $4,000 | |
Entries on an account table follow chronological order. Meanwhile, accounts are arranged by account type, with assets first, followed by liabilities, equity, revenue, and expenses.
Chart of Accounts (CoA)
The chart of accounts (CoA) is an index that lists and categorizes every account in the business’s general ledger. It helps illuminate where you spend, earn, and invest your money.
The CoA consists of the following columns:
- Number: A unique account identifier
- Description: What the account is
- Account type: Whether the account falls under assets, liabilities, equity, revenue, or expenses
- Financial statement: The financial statement that the account affects. Assets, liabilities, and equity affect the balance sheet, while revenue and expenses affect the income statement.
Account types in the CoA follow the same order as the general ledger. Assets go first, then liabilities, equity, revenue, and expenses.
Below is an example of a CoA.
| Number | Description | Account Type | Financial Statement |
| 1-01 | Cash | Asset | Balance sheet |
| 1-02 | Accounts Receivable | Asset | Balance sheet |
| 1-03 | Inventory | Asset | Balance sheet |
| 1-04 | Fixed Assets | Asset | Balance sheet |
| 2-01 | Accounts Payable | Liability | Balance sheet |
| 2-02 | Taxes Payable | Liability | Balance sheet |
| 2-03 | Wages Payable | Liability | Balance sheet |
| 2-04 | Loan Account | Liability | Balance sheet |
| 3-01 | Common Stock | Equity | Balance sheet |
| 3-02 | Retained Earnings | Equity | Balance sheet |
| 4-01 | Sales Revenue | Revenue | Income statement |
| 4-02 | Sales Returns | Revenue | Income statement |
| 5-01 | Cost of Goods Sold | Expense | Income statement |
| 5-02 | Wages Expense | Expense | Income statement |
| 5-03 | Rent Expense | Expense | Income statement |
Trial Balance
In double-entry accounting, the trial balance is a worksheet that tallies the closing balances of all general ledger accounts at a specific point in time. It consists of three columns:
- Account: The affected account
- Debit: The amount debited
- Credit: The amount credited
The purpose of the trial balance is to ensure bookkeeping accuracy before generating financial reports. The trial balance subtracts the sum of all credits from the sum of all debits to confirm that they add up to zero. A mismatch between total debits and total credits indicates a mistake in recording.
Below is an example of a trial balance.
| Accounts | Debit | Credit |
| Cash (Asset) | $4,000 | |
| Inventory (Asset) | $1,000 | |
| Accounts Payable (Liability) | $1,000 | |
| Owner’s Equity (Equity) | $2,000 | |
| Retained Earnings (Equity) | $2,000 | |
| Sales Revenue (Revenue) | $1,050 | |
| Rent Expense (Expense) | $1,000 | |
| Electricity Expense (Expense) | $50 | |
| Totals | $6,050 | $6,050 |
Financial Statements
Financial statements are reports that summarize a company’s financial activities and performance. The main types of financial statements are balance sheets, income statements, and cash flow statements.
- Balance sheet: This is a kind of financial statement that lists everything the business owns and owes. It shows businesses their overall book value.
- Income statement: This represents the difference between a company’s revenue and expenses within a set timeframe. It helps businesses understand their financial performance over a given time period.
- Cash flow statement: The cash flow statement uses changes in balance sheets to track how much cash went in and out of an account within a specific period. It shows a company’s cash-generating capacities.
Companies use financial statements to guide their business strategies. For example, reporting cash flow statements monthly can show seasonal cash generation trends and help companies prepare for times of low cash flow.
Business Documents
A business document is any type of document that shows proof of financial activity. Unlike the above documents, business documents aren’t always prepared by bookkeepers. Instead, they are generated by the company, its billers, customers, and other related institutions as regular business activities occur. Bookkeepers use business documents to confirm recording accuracy.
Examples of business documents include:
- Account statements: Documents financial institutions generate to outline transactions within an account over a given timeframe. Examples include bank statements, credit card statements, loan statements, and mortgage statements.
- Sales and purchase records: Documents that provide official proof of sales and purchases. Examples include invoices, receipts, purchase orders, sales orders, sales tax records, and inventory records.
- Payroll and Employee Records: All documents related to employees and their compensation. Examples include employee contracts, timesheets, payroll summaries, payroll tax filings and reports, benefits plan documentation, and retirement plan documentation.
- Tax Documents: All documents related to tax, such as tax returns, estimated tax payment records, and employee or contractor tax forms.
How Are Transactions Recorded in Bookkeeping?
There are two systems for recording transactions in bookkeeping: single-entry bookkeeping and double-entry bookkeeping. The former provides simplicity at the cost of accuracy, while the latter provides the reverse.
Single-entry bookkeeping
Single-entry bookkeeping records just one journal entry per financial transaction. Entries represent money flowing in and out of your cash account. You add income and subtract expenses until you arrive at a final balance.
Single-entry bookkeeping journal entries consist of the following information:
- Transaction date
- Reference number
- Transaction description
- Transaction value
- Remaining balance
Suppose you’re a graphic designer recording all transactions within the first week of September.
- 9/01: Your deposit $3,000 from your personal checking account to your business checking account.
- 9/02: You invest in a better computer, jotting down $1,000 under expenses. You subtract the amount from your starting balance, leaving you with $2,000.
- 9/03: A client pays you $2,000 for a service incurred the previous month. You write the amount under income and add it to your account balance, which increases to $4,000.
- 9/04: Your suite of graphic design tools charges you the monthly subscription fee. You write $40 under expenses and reduce your account balance by the same amount, resulting in a total of $3,960.
- 9/05: You pay for your internet subscription. After jotting the number down under expenses, you subtract $55 from your account balance. You end the week with $3,905.
| Date | Ref | Description | Transaction Value | Account Balance | |
| Income | Expense | ||||
| 9/01 | 001 | Starting balance | $3,000 | $3,000 | |
| 9/02 | 002 | New computer | $1,000 | $2,000 | |
| 9/03 | 003 | Payment received | $2,000 | $4,000 | |
| 9/04 | 004 | Software subscription | $40 | $3,960 | |
| 9/05 | 005 | Internet | $55 | $3,905 | |
Single-entry bookkeeping is a cost-effective small business bookkeeping method. Since it does not require advanced accounting knowledge, it helps small businesses save money on professional bookkeeping services.
However, the method only tracks your cash balance, overlooking the value of assets, liabilities, and equity. Therefore, only consider single-entry bookkeeping if your small business is cash-based.
Double-entry bookkeeping
Double-entry bookkeeping records two journal entries per financial transaction: one for debits and another for credits. Each debit will have an equal and opposite credit. Double-entry bookkeeping journal entries consist of a date column, a reference number column, an account name column, a debit column, and a credit column.
Let’s reconsider the example above.
- 9/01: You deposit $3,000 from your personal account to your business account. The transaction debits your cash account and credits your owner’s equity account.
- 9/02: You invest in a better computer. You lose $1,000 in cash, but gain $1,000 in equipment.
- 9/03: A client pays you $2,000 for a service incurred in the previous month. You gain $2,000 in cash, and lose $2,000 in accounts receivable.
- 9/04: When your suite of graphic design tools charges you the $40 monthly subscription fee, you debit your utility expense account and credit your cash account.
- 9/05: Your internet service provider bills you $55, debiting your utility expense account. Should you choose to pay on a different day, you can credit the amount to accounts payable, increasing your liabilities.
| Date | Ref | Account | Debit | Credit |
| 9/01 | 001 | Cash (Assets) | $3,000 | |
| 9/01 | 001 | Owner’s Equity (Equity) | $3,000 | |
| 9/02 | 002 | Equipment (Assets) | $1,000 | |
| 9/02 | 002 | Cash (Assets) | $1,000 | |
| 9/03 | 003 | Cash (Assets) | $2,000 | |
| 9/03 | 003 | Accounts Receivable (Assets) | $2,000 | |
| 9/04 | 004 | Utility Expense (Expense) | $40 | |
| 9/04 | 004 | Cash (Assets) | $40 | |
| 9/05 | 005 | Utility Expense (Expense) | $55 | |
| 9/05 | 005 | Accounts Payable (Liabilities) | $55 |
Instead of tracking balances at the end of each row, you add up the balances of each individual account when you transfer your journal entries to your ledger.
Double-entry bookkeeping tracks more than just your total income, total expenses, and cash balance. It also shows you the overall value of your assets, liabilities, and equity, capturing a complete picture of your financial health. It best suits organizations with complex transactions.
What are Common Small Business Bookkeeping Challenges?
While bookkeeping is an essential part of running a business, the process often costs businesses time and money. Below, we name a few challenges that get in the way of good bookkeeping and provide tips on how to remedy them.
Lack Of Time
Bookkeeping is a time-consuming process. It involves the manual load of organizing records, tracking accounts payable and receivable, running payroll, staying on top of tax laws, and tracking tax returns. Investing in these activities shifts time away from running your business and nurturing client relationships.
If time efficiency is a priority, your best option is to outsource bookkeeping to professionals. As bookkeeping experts, they have strong organizational skills and know their way around your local regulations.
Canada-based businesses should consider outsourcing bookkeeping to EpicBooks to experience first-class bookkeeping services that cover financial reporting, tax preparation, budgeting, and more. Refer to the EpicBooks service page for more information.
Poor Organization
If you’re split between running your business and maintaining your books, it becomes difficult to keep everything organized. Worse if you keep records manually through mediums like pen-and-paper or spreadsheets.
Disorganized records eliminate the main benefits of bookkeeping. Inconsistencies in records create unclear or erroneous estimates of overall financial health, leading to misinformed business decision-making. You might also encounter government fees if you fail to submit accurate records during tax season.
Aside from hiring a bookkeeper, it’s best to use bookkeeping software. Digital bookkeeping tools automate many processes, such as expense tracking, invoicing, and reporting, reducing the likelihood of human error.
Basic bookkeeping software typically charges around $20 per month, but free versions are available for businesses that only need basic functions. Read our guide to the best small business bookkeeping software for recommendations.
Security Threats
Your books contain some of your company’s most valuable data. If you don’t have good security measures, you risk losing financial data to malicious phishing attacks, malware attacks, and insider threats.
Fortunately, there are multiple ways to secure your bookkeeping data:
- Enforce multi-factor authentication (MFA) on accounting tools: MFA makes it more difficult for third parties to enter your accounts.
- Use trusted bookkeeping software: Cloud-based software typically offers top-level security to ensure that your data never lands in the wrong hands.
- Back up your data: In case your data gets hijacked, data backups help you keep records that would have otherwise been lost.
Conclusion
Bookkeeping plays a crucial role in ensuring business success. By tracking and organizing transactions, bookkeeping generates accurate snapshots of financial performance, providing evidence that can guide you through budget forecasts, tax preparation, goal monitoring, and other business decisions. They also help creditors, investors, and job applicants assess the value of working with you.
Leverage Reliable Bookkeeping Services in Ontario
EpicBooks provides personalized bookkeeping solutions for organizations navigating Canada’s competitive business landscape. Leave payroll, tax preparation, and more to our premium bookkeeping services and focus on boosting your business. Refer to the EpicBooks pricing page for more information.
