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Business Book-Keeping Part 1

By Paul Michael
27th October, 2009

 

Accounting and Book-keeping

Often people refer their business financial affairs to their accountant to sort out. Many business owners literally take boxes of receipts to their accountant for them to do their magic and deliver the trading figures and tax returns. There is no magic to what the accountant has to do. The very first activity is to laboriously transform each box of receipts into ledgers of accountable transactions. This is book-keeping.
 
Accountants are so called, because their training takes them way beyond basic book-keeping. They are knowledgeable in wider fields of financial and taxation expertise. They also charge an accountant’s rate, as opposed to a book-keeper’s rate, for the services they undertake.
 
In simple terms, book-keeping is about maintaining all the firm’s financial transactions within ordered ledgers and accounts – usually on a computer nowadays. There are professional book-keepers out there that will be glad to process boxes of receipts and they normally cost less than an accountant’s rate.
 
Why not do our own book-keeping? Once we get our heads around the concepts, it really isn’t difficult. It’s one of those chores that takes an hour or so and must be done religiously every week. The benefit is that we can keep our finger on the pulse of our business without having to rely on other people. We get to know first-hand of any issues and we can respond accordingly.
 
If an accountant is used to process the accounts for VAT and tax purposes, we can get them to help with choosing appropriate accounting software and setting it all up. We then have someone at the end of a phone to help with awkward transactions or quirky aspects of the software.
 
Even if we don’t intend doing any book-keeping, it pays to understand what our book-keeper and accountant have to do and what it means.
 
Let’s take a look at basic book-keeping.
 

Book-keeping Basics

A business must record its financial transactions for these reasons:
 
Businesses therefore have no choice; it’s a chore that must be undertaken by law. However, it is the second and third points that really should be emphasised as the key benefit for undertaking the chore. How can a business begin to determine its performance or its near-current status without financial records?
 
Good record-keeping enables businesses to determine their financial performance in terms of profitability and solvency, and more importantly, to examine the flow of cash in and out of the business. Record-keeping is essential for VAT and personal taxation analysis and reporting.
 
From factual records, we can analyse trends and extrapolate figures to provide forward projections, such as the details and reports needed for budgeting, business planning and alike.
 
The difficulty with book-keeping is setting everything up. We need to create a Chart of Accounts and each account will be linked to a specific ledger within the General or Nominal Ledger. Then we can get down to entering our transactions using the double entry book-keeping system. Confused already? Don’t despair, these are just words. All will be explained.

Ledgers and Accounts

The General Ledger, or Nominal Ledger as it is sometimes known in the UK, is a book of accounts and their associated balances for all of the Assets, Liabilities and Owner’s Equity employed in the business. These terms are explained later, but for now consider a big old book with lined paper, in which we will enter transactions related to Assets, Liabilities and Owner’s Equity.
 
Assets, Liabilities and Owner’s Equity will, more realistically, each be sub-divided. For example, Expenses is a division of Owner’s Equity. Think of the big book again, in which we will write summary records that correspond to the detailed records that we will write into an Expenses only book. Here are some other examples:
 
                                                General / Nominal Ledger
 
Ledger:          Assets                 Liabilities                         Owner’s Equity
 
Sub-Divs:      Debtors               Creditors                         Expenses
                                                                                       Revenue/Sales
                    
The ledgers for Creditors and Debtors are used to maintain transactions for suppliers and customers respectively. These are usually suppliers and customers where, for example, we hold 30-day trade accounts, rather than immediate payment accounts. They are often called Trade Creditors and Trade Debtors. The ledgers would determine what monies are outstanding and what has been settled.
 
Subsidiary ledgers might be associated with, for example, Debtors and Creditors. We might maintain the transaction details for every supplier of our business within a Trade Creditors sub-ledger. This would enable us to track each supplier so that we can determine, for example, how much we spend with each of them.
 
Ledgers and sub-ledgers are sub-divided into accounts; or rather each account in a Chart of Accounts is associated with a ledger or sub-ledger. For example, we might have the account, Maintenance, linked with Expenses. Why would we sub-divide Expenses even further?
 
Let’s look at one branch: Owner’s Equity
                     General / Nominal Ledger
Ledger                                     Owner’s Equity
Sub-ledger                                                                      Expenses
Account                                                                          Maintenance
Account                                                                          Motor Fuel
Account                                                                          Cleaning
Account                                                                          Staff Wages
 
Sub-ledger                                                                      Revenue
Account                                                                          Daily Sales     
                      
If we were to sum up the balance totals of all the transactions within each account we will be able to determine the values of our Revenue, Expenses, and then, some of our Owner’s Equity (there are other sub-ledgers yet to discover in Owner’s Equity).
 
Some ledgers need only one linked account. Revenue might be one such ledger for many small businesses that only ever have one type of income. By contrast, there are many categories of business expenses that are better represented with a number of individual accounts. We might have an account for Maintenance, Staff Wages, Motor Expenses, and so on. Each account enables us to report on that aspect of our business. Each account includes the starting balance, the actual transactions within the reporting period and the end balance. They are sometimes called ‘T Accounts’. They are like the account we have with a bank and the statement we get is a ledger of all our transactions over a given period in that account.
 
Expenses - Maintenance
Start Balance £0.00                                                                 Debits             Credits
03/02/2009   ACE Plumbing                                                        120.00
                                                                                                                              -0.00
End Balance £120.00
 
One account only provides a part of the story. In this Maintenance account we can see a transaction for 120.00 against ACE Plumbing, but did ACE Plumbing get paid? We don’t know. We would need to look at the balancing transaction and the account for ACE Plumbing. There might be a bank payment. Even better, there might be a specific account for ACE within the Trade Creditors sub-ledger. In that account we will see invoiced transactions that we owe and bank payments where we settle. We’ll have a look at this later.
 
In the days when book-keeping was paper based, accounts would have been created in line with the benefit of the burden of maintaining them. Computers have made the chore much easier, and so we can have as many as we like – with or without any necessary benefit.
 
Collectively, the accounts are known as a Book or Chart of Accounts – a list of accounts in the General or Nominal Ledger.
 
The transactions are written (sometimes called journaling or a journal of transactions) to accounts; the accounts are linked to separate ledgers and sub-ledgers of the General or Nominal Ledger. Transactions are entered using the double entry book-keeping system.
 
We'll take a look at double entry book-keeping in the next installment

 

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