Chapter 1

So You Want to Do the Books

IN THIS CHAPTER

Introducing bookkeeping and its basic purpose

Maintaining a paper trail

Managing daily business finances

Making sure that everything's accurate

For many small-business owners, while they love working in their chosen field using the skills they know and love, they don't always like to perform "bookkeeping" duties. Most company owners prefer to employ the skills of a qualified bookkeeper. Some may, perhaps, prefer to give their bag full of receipts to their accountant and simply hope that a useful set of accounts comes out of the end of the accounting sausage machine!

In this chapter we help to demystify the role of a bookkeeper. It may be that you're just starting off in business and, as a result, can't afford the services of a bookkeeper just yet! Think of this chapter as a checklist of jobs that need to be done.

Throughout the book, we introduce Have a Go sections, which are practical exercises aimed at helping you understand the bookkeeping principles we discuss. Feel free to draw all over these sections of the book - we want it to be as useful for you as possible.

Delving into Bookkeeping Basics

Like most businesspeople, you probably have great ideas for running your own business and just want to get started. You don't want to be distracted by the small stuff, like keeping detailed records of every penny you spend; you just want to build a business with which you can make lots of money.

Well, slow down there - you're not in a race! If you don't carefully plan your bookkeeping system and figure out exactly how and what financial details you want to track, you've absolutely no way to measure the success (or failure, unfortunately) of your business efforts.

Bookkeeping, when done properly, gives you an excellent measure of how well you're doing and also provides lots of information throughout the year. This information allows you to test the success of your financial strategies and make any necessary course corrections early in the year to ensure that your business moves towards your year-end profit goals.

Looking at basic accounting methods

You can't keep books unless you know how to go about doing so. The two basic accounting methods are cash-basis accounting and accrual accounting. The key difference between the two methods is the point at which you record sales and purchases in your books. If you choose cash-based accounting, you only record transactions when cash changes hands. If you use accrual accounting, you record a transaction on its completion, even if cash doesn't change hands.

For example, suppose that your business buys products to sell from a supplier but doesn't actually pay for those products for 30 days. If you're using cash-based accounting, you don't record the purchase until you actually lay out the cash to the supplier. If you're using accrual accounting, you record the purchase when you receive the products, and you also record the future debt in an account called Trade Creditors. You might also see this written as Trade Payables, depending on whether the business is preparing its accounts using UK and Ireland accounting standards or International Financial Reporting Standards.

HM Revenue & Customs (HMRC), which has an interest in every business in the UK, prefers cash-basis accounting for small businesses such as sole traders and partnerships with a turnover of less than £150,000. In fact, from the 2024/25 tax year, it has become the default method for sole traders and partnerships with a turnover of under £150,000. You must opt out of the cash basis if you wish to use the accrual method. The benefit of accounting using the cash-basis method is that it is much simpler to use and more helpful to small-business owners who don't want to overcomplicate their accounts. Just as an additional note, HMRC refer to accrual accounting as "traditional accounting."

The accrual basis is required for businesses with a turnover of more than £150,000. It is also the default method for limited companies and larger entities, where the cash-basis method of accounting is not allowed for statutory accounts.

If you need to decide whether you should be using cash-basis accounting or accrual accounting, you can read more in Book 1, Chapter 2, where we discuss the pros and cons of each.

Understanding assets, liabilities, and capital

Every business has three key financial parts that must be kept in balance: assets, capital, and liabilities. Of course, for some of you, these may be alien concepts, so maybe a quick accounting primer is in order.

We can use buying a house with a mortgage as an example. The house you're buying is an asset; that is, something of value that you own. In the first year of the mortgage, you don't own all of it, but by the end of the mortgage period (usually a minimum of 25 years), you will. The mortgage is a liability, or a debt that you owe. As the years roll on and you reduce the mortgage (liability), your capital or ownership of the asset increases. That's it in a nutshell.

• Assets include everything the business owns, such as cash, stock, buildings, equipment, and vehicles.
• Capital includes the claims that owners have on the assets based on their portion of ownership in the business.
• Liabilities include everything the business owes to others, such as supplier bills, credit card balances, and bank loans.

The formula for keeping your books in balance involves these three elements:

Assets = Liabilities + Equity

Because this equation is so important, we talk a lot about how to keep your books in balance throughout this book. You can find an initial introduction to this concept in Book 1, Chapter 2.

Introducing debits and credits

To keep the books, you need to revise your thinking about two common financial terms: debits and credits. Most non-bookkeepers and non-accountants think of debits as subtractions from their bank accounts. The opposite is true with credits - people usually see credits as additions to their accounts, in most cases in the form of refunds or corrections in favour of the account holders.

Well, forget all you think that you know about debits and credits. Debits and credits are totally different animals in the world of bookkeeping. Because keeping the books involves a method called double-entry bookkeeping, you have to make at least two entries - a debit and a credit - into your bookkeeping system for every transaction. Whether that debit or credit adds or subtracts from an account depends solely upon the type of account.

We know all this debit, credit, and double-entry stuff sounds confusing, but we promise that this system will become much clearer as you work through this book. We start explaining this important concept in Chapter 2 of Book I.

Charting your bookkeeping course

You can't just enter transactions in the books willy-nilly. You need to know exactly where those transactions fit into the larger bookkeeping system. To know where everything goes, you use your Chart of Accounts, which is essentially a list of all the accounts that your business has and the types of transactions that go into each one. (We talk more about the Chart of Accounts in Book 1, Chapter 3.)

Discovering different business types

Before you start up in business, you're wise to sit down and have a think about the structure of your business.

For example, if you're a window cleaner and only ever see yourself doing your own rounds and not working with anyone else, then sole trader status would be more than adequate. However, if you're planning to be much bigger and take on staff, then you need to read Book 5, Chapter 1 to see how you should structure your business and what sort of advice you may need.

Planning and controlling your activities

Many businesses just start up and trade from day to day without any real planning or control of the activities they undertake. Often, businesspeople become so busy that they're fire-fighting continually and lack any real direction. We like using checklists, because they help to organise your bookkeeping activities in a methodical and orderly manner. This level of organisation means that you can pick up and put down the accounts from day to day or even week to week. You can always start from where you left off quickly and easily by simply adopting some of the hints and tips contained within Book 2, Chapter 1.

Instituting internal controls

Every business owner needs to be concerned with keeping tight controls on business cash and how that cash is used. One way to implement this control is by placing internal restrictions on who can enter information into your books and who has the necessary access to use that information.

You also need to control carefully who has the ability to accept cash receipts and spend your business's cash. Separating duties appropriately helps you to protect your business's assets from error, theft, and fraud. We talk more about controlling your cash and protecting your financial records in Book 2, Chapter...