What is Bookkeeping? Does My Business Need it? (Yes.)

A question mark on a piece of paper symbolic of the question: what is bookkeeping?

What is bookkeeping and why is it important?

Today we ask a very simple question: what is bookkeeping? On its most basic level, bookkeeping is the recording of day-to-day financial transactions. Whether for a business, nonprofit, government agency or individual, bookkeepers ensure that every financial activity related to a specific entity is documented in a consistent and accurate way. Some of these transactions include sales, purchases, payments, and expenses. This documentation is important because it helps business owners and accountants understand the financial well-being of a company.

What is the Difference Between Bookkeeping and Accounting?

Whereas accounting refers to comprehensive financial management and planning, bookkeeping is the specific task of recording and categorizing each transaction. While bookkeeping and accounting and are often referred to synonymously, bookkeeping is actually a subset of accounting. However, bookkeeping is more than simple financial data entry. It is a through storytelling of financial health, both at present and historically. By using the numbers you have recorded, you can analyze your current situation and compare how it looks over time.

What Can Bookkeeping Show A Small Business?

As bookkeepers know, if companies don’t record and understand their numbers, it is very difficult to grow them. The cycle of money coming in versus going out is known as cash flow. Keeping track of cash flow is one of the most important jobs of bookkeepers. Say for example you own a brewery and know only the total number of beers sold instead of how each type of beer is selling individually. Maybe you are making money, but you don’t know specifically where your money is coming from and therefore cannot grow your business. If you don’t know what your strengths and weaknesses are, you can’t strategically plan for continued success. In the case of a brewery, it’s important to note each individual beer that you pour in order to know which beers are selling better than others.

While this may seem obvious, often times businesses allow their books to fall months (or years) behind. This is dangerous because companies may be unable to see they are in financial trouble until it’s too late. Or, they may miss opportunities for expansion because they are unaware of their current strengths. Or, they may be unprepared come tax time. (More on this below.) Say you run out of your best-selling beer without realizing it’s your best seller. By the time you brew another batch your business may have lost out on revenue simply due to a lack of planning. Therefore, one of the major benefits of diligent bookkeeping is the ability to make better financial decisions and to plan for the future based on concrete numbers.

Basic Bookkeeping Categories

When you start to monitor each transaction individually, it’s easy to become overwhelmed by the sheer amount of activity. This is another important function of bookkeepers: keeping everything organized. Bookkeepers use five top level categories to achieve this organization. This creates a universal language that all bookkeepers can read without requiring additional knowledge of the business.

The categories are: assets, liabilities, equity, income, and expenses. (There are also a large number of subcategories, but we will address those in a follow up post.) These categories are used to create three financial statements: the balance sheet, the statement of cash flows, and the income statement (also know as profit and loss statement). You need all three to understand the overall financial health of your company, and they all start with the diligent categorization work by your bookkeeper. (For more detailed information on bookkeeping categories see our Basic Bookkeeping Categories blog post. And if you still want to learn more, check out this blog post to learn some income statement basics and check out this blog post for an introduction to balance sheets.)

Bookkeeping and Taxes

Bookkeeping is essential for tax purposes. As we have already noted, bookkeepers organize a business’s transactions. This means having all of the pertinent information at one’s finger tips come tax time, and being confident that it is correct and supported by a digital paper trail. Otherwise you will find yourself in a mad scramble for financial data and be far more likely to make costly mistakes, or even get audited. Forgot to include a $2,000 expense back in July? Too bad, you’ll have a higher tax bill. Don’t know how much money you spent on your work automobile? Can’t write that off anymore. Accidentally double counted your expenses? Time to prey for forgiveness.

If you do happen to get audited having organized and up-to-date bookkeeping records will make your life far easier. Because IRS agents will be able to access all of your financial records easily, the audit will be quicker and therefore less painful than it would be if your numbers are not up-to-date. (Looking for more information on taxes? Check out the IRS website here. Or, take a look at all kinds of great websites for small businesses here.)

What is Bookkeeping – Summarized

So, what is bookkeeping? Bookkeeping is the systematic recording of each financial transaction that affects an entity. To organize all of this information bookkeepers use established categories that are combined to create financial statements. Bookkeeping is important because it allows you to track your company’s financial behavior showing you where you are making money and where you are spending it. It also paints a picture of the financial stability of a company, which allows for better planning and decision-making. And finally, bookkeeping is essential for taxes because it ensures that every transaction has been recorded appropriately.

Enjoy our post? Be sure to reach out to My OC Bookkeeper, Orange County’s best small business bookkeeper for your bookkeeping and tax needs. And check out Orange County, California’s best bookkeeping blog here. Last but not least, enjoy the video below to learn a bit more about the advantages of using an outside bookkeeper and the services that My OC Bookkeeper offers.