Step 1: Understand Double-Entry Bookkeeping
Double-entry bookkeeping gives you a complete picture of where your money is going and helps you avoid mistakes—at least two records for each transaction. Because every commercial transaction involves an exchange of one item for another, it makes logical. The double entry system shows precisely how this exchange occurred and the results.
Suppose you own a coffee shop and pay $500 for a box of the finest coffee beans. If you look at your cash balance, it will appear that you lost $500 because your balance went down by that amount. Of course, this coffee has worth; you’re adding it to your supply (inventory), and you’ll use it to create beverages for clients. As a result, you’d make two entries:
- Inventory: + $400
- Cash account: – $400
Tracking cash losses and inventory gains gives you a more accurate picture of what’s happening in your organization.
Step 2: Create a Balance Sheet
It means that you will track every transaction that affects your business and adjust the balance accordingly for every key area of your business.
In the cafe transaction above, for example, we added $500 to the inventory account to reflect the addition of the coffee crate. We would keep this account updated so that inventory will adjust the balance every time we buy new supplies or run out of them. That way, we always know how much we have on hand. Treat the cash account in the same way.
Aside from cash and inventory, here are vital accounts to keep track of, according to SCORE:
- Receivables (money due by customers)
- Liabilities (money you owe others)
- Sales (the income you get from selling products)
- Purchases (supplies you buy for your business)
- Labor costs (staff salaries and other costs)
- Equity (the amount that you or other owners put into the company)
- Retained Profits (the profits you have accumulated)
Depending on how many details you wish to include in your comprehensive data, you can create various accounts that keep track of various aspects of your finances.
The number of accounts can quickly multiply for larger businesses, so it’s essential to set up a chart of funds right from the start: a list of all the charges you manage, with a number for each.
Step 3: Balance the Books
You’ve probably heard of companies that balance the books. So, we will examine what this term means and how you can effectively balance your books.
So, from the step 1 example. We bought $500 worth of coffee beans. Then, grind them, brew some lattes and cappuccinos, and sell them to customers. We do, and our satisfied customers pay us $750 in sales.
First, we received $750 in cash to increase the cash account by $750. But we also used up $500 of the inventory, so the inventory account needs to be reduced by $500.
$250 is a profit to your business so you will add it to the Retained Earnings account.
- Cash account: + $750
- Inventory: – $500
- Retained earnings: + $250
Assets = liabilities + equity
When we added $850 to the cash account and removed $600 from the inventory account, we created an imbalance – assets increased by $250, but no corresponding entry was on the other side of the equation—adding $250 to retained earnings restored the balance. Our net worth increased by $250, and equity increased by $250, so the equation still works.
Your goal as a business owner is to ensure that the “accounting equation” always holds and that the books always balance (e.g., monthly or quarterly).
Step 4: Creating Degrees
Earlier, we looked at the critical financial statements that a company produces: the balance sheet, income statement, and cash flow statement.
The information for these statements comes straight from the accounts we just covered. The balance sheet structure mirrors the accounting equation, which combines all assets on the one hand and all liabilities and equity on the other, guaranteeing that they are always in balance.
The income statement uses the accounts we looked at in Step 2, such as the income, expenses, and costs of goods sold. The cash flow statement is primarily based on the cash account while pulling in information from other accounts to check where all that cash went.
The balance sheet depicts your company simultaneously, whereas the income and cash flow statements represent changes over time.
Step 5: When You Require Assistance, Seek it Out
Keeping perfect accounts can be complex, especially as your business grows. A single transaction can have multiple entries in multiple accounts, and it can get overwhelming when you have to record hundreds or even thousands of transactions.
Technology helps, of course. Accounting systems like QuickBooks, Fresh Books, NetSuite, and Xerox are more accessible to operate than the old-fashioned way of recording every transaction in physical ledgers.
Although you often hear the terms “accountant” and “accountant” interchangeably, they serve different roles. An accountant performs the day-to-day tasks of recording transactions and ensuring everything flows correctly. A tax advisor will focus more on the big picture, preparing high-level financial statements and helping you with things like recording taxes and securing funding.
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