Basic Bookkeeping

There are various levels you can work towards in your bookkeeping system. Someone needs to do it. Period. That need not be you. In fact, if you have trouble working with numbers, it should not be you because you'll never get to it. Find someone with a passion for sorting data, control their tendency to over-complicate or seek detail, and you're on your way. However, you as principal of the company need to understand the system, even if you're not the one doing it. Also, if you hire someone else to do the basics for you, make sure that you have some checks and balances in place.

Organization & Preparation

The basic building block to good books is data entered in the right place. Bookkeeping is merely recording expenses and income. Whoever is entering the data needs to understand the true nature of each and every expense, and be able to put it in its right place. To begin with, you need a system to identify each purchase, and note its account number, or at least identify the category. This can be done by you, going through bills and marking each one with the right account name or number. The electric bill is easy - utilities, 5820. The hardware store might need a bit more thought if you want to separate small tools from supplies - the drill you bought is 4809, the lumber you bought for packaging is 4550. The best trick is to identify the expense category when you make your purchases. How? When you sign the slip at the hardware store, you write right on it - drill: small tools. Lumber: supplies. That way, your bookkeeper can look up the number - you've passed on the wisdom of what category it goes to and you avoid the problem of..."now, what did I buy that for?"

So, begin by figuring out who will identify which account number gets assigned to each item. Get your routine established, and stick to it. This is a critical step. If you don't pay attention, and set up a workable system, you will end up with meaningless information.

The second step in getting your system organized is learning a little about the rules to follow when you are dealing with bookkeeping. A bit of time spent with your accountant is the first step toward saving yourself time and money. Large tools have to be depreciated. New terms here... so bear with me as we go through this section. All that means is that the total cost of the tool cannot be listed as an expense which you deduct from your taxes this year. The thought process is this: Say you purchase a $5,000 saw that will last you 5 years. Therefore, you may deduct $1,000 each year for each of five years. You need to work with your accountant to set up your depreciation schedules: one for your books, and one that recognizes the tax laws. But that's a one time simple project. Give your account information of what the item is (including the serial number), when you bought it, and for how much. Your accountant will return to you a depreciation schedule which that be updated each year with your taxes.

You should always have a list of tools, the value (purchase price) of which exactly equals the item on your balance sheet labeled "equipment" likewise for office equipment and vehicles. Anything included in fixed assets should have a supporting list of what the items are. You will note an item on the asset page of your balance sheet that's called "accumulated depreciation" - that shows the amount by which the assets you are listing have been depreciated. If you take the asset value and subtract the accumulated depreciation, you will see what the book value of your tools is. Eventually, they will be completely expensed and have no value at all. But the theory is by that time, you will have junked them and bought more. So, especially in any business that buy durable equipment, it may well be true that you have more value in tools than your books show, which is a point you can make in person with your banker. You can't change it in your books.

The Double Entry System

Now for the fun stuff. You're ready to learn the "double-entry system." At first it might sound like twice as much work, but over time you'll learn to love and rely on the built-in checks and balances that help you keep accurate records.

As you enter information in your books, you will always make two entries, which exactly balance one another. Each entry has a left side -- these are called debits, and a right side -- these are called credits. These two terms have mystified more people in the history of the world than any other. Just accept that they are part of the language of business and as you begin to use them the mystery will evaporate. So, I'll gratefully accept my chance to further confuse the issue and continue on.

For each entry you must enter at least one debit and one credit, and the total of the amounts on the right must equal the total on the left. Another "rule" is that debits are positive and credits are negative and if you add them all together, the total is "zero." Really, it's just that simple.

If you go to the store and buy a drill, you are decreasing your cash in the bank by $129.50. You are increasing your expenses by the same amount - and there you have your two entries. Cash gets the negative entry, or credit and small tools gets the positive entry, or debit.

What puts a spin on this debit/credit thing is that most people think of credits as minus and debits as plus, but various account types are affected differently because you have debit and credit accounts.

OK, I just lost you - but it's easier than it you think. First I'll provide a description of how each account type is affected by debits and credits, then conclude with a table that summarizes the "rules."

All your asset accounts (1000 series) are debit accounts, which means they are positive numbers. Makes sense, so far? An asset is a positive number in the system. The liability accounts (2000 series) are all credit accounts and they are negative numbers, but generally when you look at them on the balance sheet, you don't show the minus sign. Accounts payable, for example, is listed at $1,235. To the computer, however, liabilities are actually negative numbers - because they need to be subtracted from the assets to come up with the total value of the company. It's not something you have, it's something you owe.

So stay with me - if you credit a liability account, you are actually adding a negative number to a negative number. That just makes a bigger negative number. Increasing your liability. Take the drill example above. If, instead of paying cash, you charged that drill. The expense entry stays the same - the expense is increased, or debited. You aren't touching your cash account this time - instead, you're increasing your accounts payable. So, to increase a liability account, you credit it, because to increase the liability, which is a negative number, you have to add a negative number, or a credit. And, there you have your balancing entry - debit expense, credit accounts payable. Both times you had balancing entries, one debit, one credit - the credit just did different things each time. In the asset account, it decreased cash. In the liability account, it increased accounts payable.

The 3000 series is just something you have to remember somehow- sales are considered a credit account. A friend had a memory trick for learning this concept: " making a sale is a credit to you."   Another way to consider it is by thinking of the simplest sale, where you sell something and get some cash. Cash, as you know, is a debit account. Make a sale, and you better increase your cash - debit cash. Positive entry. So the balancing entry has got to be a credit entry - crediting sales increases the amount you are listing in sales, because sales is a negative number, (credit), and you are adding a negative number - another credit. The number gets bigger.

The 4000 and 5000 series, the expense accounts, are all debit accounts. You enter an expense as a positive number (debit) to increase your record of what you've spent. Whenever you make a purchase of an item that goes to one of your expense accounts, you always increase your expense, which is a debit.

So, now that you've got the basics of the double entry system, the next step is simply a matter of beginning to enter the info. As you enter checks you've written, they will mostly be simple entries - debit (increase) the correct account number, and credit (decrease) cash. This is going to be the drill for the majority of your entries, when you have paid cash for an item. Even those things you charge, if you are keeping your bills current, make your entry after you pay your bill, and the entry will always be credit cash, debit expense. To keep the process simple, when you receive a bill, go through it and total what part of the money due goes to which account, write it on the bill and use that when you make the entry into the system.

Regular exceptions to this process will be:

• When you buy a large tool or piece of equipment that needs to go on the asset page: credit cash and debit the proper asset account. As you make these entries, don't forget the information that you will need to set up your depreciation schedule.
• When you pay an expense that has been listed as a liability, like a bank payment on a loan: credit cash, but debit two accounts, debit the liability account you're paying on for the amount of principal, and debit interest for the amount of interest expense. Doing this will decrease what you owe on the loan by the principal amount you have paid, and it will increase the record of what you have paid in interest expense.
• When you make an addition to inventory: inventory is a cost you need to count as an expense only when you actually use it. Until then, it's an asset. So when you purchase inventory, credit cash and debit inventory - that will increase the value of your inventory. When you USE inventory, credit (reduce) inventory, and debit (increase) the appropriate expense account - materials, supplies, etc., or an inventory change account.