Bookkeeping is a system of recording all business financial transactions and is based on the idea that recording the result of its operations through the use of accounts provides a measure of the organisation’s financial well-being.
The concept was first formalized in 1494 by the Italian mathematician Luca Pacioli, who was subsequently called the ‘father of accounting’ as a result of him publishing his work. It revolved around using each account as a historical log to record the changes in monetary value of each aspect of the business.
That system is now called double-entry bookkeeping. The people who are employed to enter the transactions are called bookkeepers. The business may employ their own bookkeeper, or may use a bookkeeping service to carry out the work.
The system has changed little over the years, suggesting the basic principles are robust.
So how does the double-entry system work? Each transaction that occurs is recorded in at least two accounts. This is because with each financial transaction, one account is being debited, and one account is being credited. Any entry in the double-entry system has two effects – one of increasing one account, the other of decreasing another account by an equal amount. This means the total debits of a transaction equal the total debits of a transaction, so the overall net result is zero.
In modern accounting, it is done using debits and credits, based on the accounting equation assets = liabilities + equity.
As an example, suppose customer A buys a product from a shop called Thoroughbred Enterprises using a cheque. The bookkeeper working for Thoroughbred Enterprises would credit the account called ‘Sales’ and debit the account called ‘Bank’ [this would result in money going into the bank account].
The bookkeeper working for customer A would debit the account called ‘Purchases’ and credit the account called ‘Bank’. This would result in money leaving the bank account.
The way that the entries are recorded is generally by putting debit entries on the left hand side and credit entries on the right hand side of the general ledger account. The general ledger is the main source of recording the accounting records of the business that use the double-entry bookkeeping system.
The general ledger holds numerous accounts for such items as current assets, fixed assets, liabilities, revenue, expenses, losses and gains.
There is some debate that the double-entry system dates back to the ancient Romans, so clearly it has been a successful system for businesses to adopt.
A lot of small business owners either don’t understand the bookkeeping function, or struggle to find the time to keep it updated. The easiest solution is to outsource it, and focus on overseeing the business.