What Are Bookkeeping Principles?
Bookkeeping principles are rules that the business accountant or bookkeeper follows in order to create accurate records of the business’s financial activities. A bookkeeping system tracks money as it flows in and out of the company in the form of income or expenses. The data generated shows you how well your business is doing. Bookkeeping principles tend to be the same whether you record the data on a computer or in written format.
Basic bookkeeping principles need to be understood by anyone who is running a small, medium-sized or even large company since they are the means by which you will understand exactly what is happening in your business – even if you are not the one doing the books.
If you can see the basic business cash balance and understand the way that the accounts are organised to show the reality of the company finances you will know whether you have a healthy or a failing company and therefore what, if any, action you need to take.
Bookkeeping principles follow some very standard rules. There are daily information logging procedures that every bookkeeper will practise. Get to grips with these and you will always have a good working knowledge of what’s going on in the business.
Every bookkeeper will make what are officially called ‘Journal Entries’. These are really only formal written records of the money coming in and the money going out. So, for instance, when you sell something you will log that cash income. When you buy goods or services you will also be making a record of that money which is flowing out of the business.
When you report your financial activities you may use one of several different accounting procedures. You will use either accrual or cash accounting. If you follow the accrual method you will be reporting on the money you are owed or have not yet paid. So you are reporting on what is still to be claimed or spent as if the transactions have been finalised even though they have not. In the cash accounting method you report on the invoices that are actually paid (e.g. you have received the payment and it is in your bank account) and the bills that you have paid (e.g. the money for the expense has left your bank account and the payment is totally paid up). Whichever method you use will depend on your business and how you choose to account for it but you, as the business owner will need to understand which procedure you follow.
When you are working on your accounts you will be using double-entry bookkeeping. For a complicated-sounding name really this only means that for each thing you buy or sell you will need to record where the money came from and where the cash is going to. The ‘Credit’ or where the money came from, would be for instance, say you sold a product to a customer in a shop, the money would come ‘From’ cash given to you by Mrs. White. The cash would go ‘To’ or ‘Debit’ the bank account. If you did not use double entry you would have random transactions e.g. Mrs. White gave you £10 / $10 and somewhere else in your accounts you have have £10 / $10 being deposited in your bank account but we would not know how that money came to be generated. The ten pounds does not magically appear in an account; it was a payment for some thing. A double-entry system is designed to clearly show where the money you place into the bank account came from and how it was generated.
Similarly things that you purchase are made as double-entries too. So, you use part of the £10 / $10 you had earned from that previous sale (from Mrs. White) to buy an item. You say the money came ‘From’ the bank account (a ‘Credit’ in this case) and went ‘To’ (a ‘Debit’) the cost of the thing you bought. If you can understand double-entry bookkeeping principles you have pretty much the basics for any accounting system be it kept on paper or in computer software.
When running a business you will need to grasp the bookkeeping principle of cash flow. In a nutshell you can’t spend what you have not yet received in payments. Or you can, but you may incur debts that could destroy your business completely. Cash flow is all about the movement of the monies into and out of your business bank accounts.
Once you have grasped the basics of double entry and cash flow you will need to understand the profit and loss account. Here you will see the total amount of money you actually received and then the total amount of expenses that you accrued in order to run the business. Hopefully you did not spend everything you earned and you have made an excess of money, a profit. This is a snapshot of your business as at that date.
There is one more area that you will need to account for in recording your business transactions and that is your liability to pay any tax or VAT. In order to do this you will need to create a ‘tax’ or ‘VAT’ account. Your company will accrue taxes with just about every transaction made and you must keep strict records showing what you owe. It is good practice to put the owed monies aside so that you have the funds available without fail when they become due either quarterly or annually. You should always fill any tax forms out accurately and pay any taxes or VAT payments on time.
Bookkeeping principles have not really changed much since the very first accounting records were made. Once you have become familiar with the above terms you will have come to understand almost all of the elements for doing your bookkeeping. The principles apply throughout the world and follow a common-sense pattern which has simply been formalised and been given jargonistic terms.