Bookkeeping services for small businesses are essential to their effective growth and maintenance. Keeping track of every financial transaction simplifies cash flow management, evaluating profits and losses and making sound business decisions. Although various bookkeeping procedures exist, the double-entry bookkeeping system approach is the most commonly employed in commercial settings. This article will give tips for your company’s finances utilising double-entry bookkeeping.
Double-entry accounting can help improve the accuracy of a company’s financial records. There are the two terms “debit” and “credit in accounting. Understanding these phrases is essential for comprehending double-entry bookkeeping and accounting language.
But what exactly are debits and credits? What is their significance in the accounting world? Continue reading to see how these essential principles are at the heart of every financial transaction and serve as the foundation of the accounting system.
What is the Double-Entry Bookkeeping System?
Each business transaction is recorded twice in the double-entry bookkeeping system, also known as double-entry accounting. These are called accounting entries, appearing in equal but opposite quantities. The income source of each transaction is in one entry, and the destination of the money is in the other. The double-entry system displays these entries in two columns termed debits and credits.
The two columns must balance, which is a critical element of double-entry. This allows you to track the money that comes into and goes out of your firm. You assure account accuracy through periodic evaluations known as trial balances.
What is the Value of a Double-Entry Bookkeeping System?
A double-entry accounting system is more dependable than a single-entry accounting system, which records purchases and payments as additions or subtractions to a single firm account. Double-entry accounting lets you create additional charges to track money that has not yet been collected (accounts receivable) or paid (accounts payable), as well as products held for sale (inventory).
How Does Double-Entry Mechanism Work?
The accounting equation is tied to a fundamental idea of finance known as double-entry bookkeeping and balancing a business’s accounts (ensuring that debits equal credits). It appears as follows:
Assets = Liabilities + Equity
This equation summarises a company’s balance sheet, which, along with the income and cash-flow statements, is one of three fundamental financial statements. A balance sheet is so named because the firm’s assets must equal, or balance, the loans and liabilities used to finance them.
All accounts must be balanced
Accounting personnel can balance business accounts using double-entry bookkeeping. They can accomplish this by ensuring that each transaction recorded into the system has an associated debit and credit. Employers put these transactions into a ledger and categorise them by account type, making it easier for anyone to identify any inaccuracies or missing entries.
Ensuring adequate cash is available
Staff can use double-entry accounting to monitor a company’s financial health to ensure adequate capital is available. Employees can see all the money coming in and out of business using double-entry bookkeeping, making it easier to discover possible errors or concerns with cash flow.
Examining for missing or double-counted transactions
Employees can use double-entry bookkeeping to ensure that no transactions are missed or double-counted by checking to see if both sides of the equation balance. If there is no entry on the revenue side, it signifies that money is missing from the firm because it was not recorded or was counted twice.
Keeping track of liabilities and assets
Keeping track of all the assets and liabilities can be challenging when a company expands quickly. Double-entry bookkeeping is a straightforward and dependable technique for monitoring these items. When a company buys something, it records it as an asset. When they sell something, it becomes a liability. When an employee examines the accounts, they can determine whether the organisation has more assets than liabilities or vice versa. This is significant since it indicates whether a corporation has difficulty paying its bills.
No commercial transactions or operations are overlooked
Staff can utilise double-entry bookkeeping to verify that no company transactions or activities are overlooked by comparing the current period’s financial accounts to those from previous periods. If there are any discrepancies, it is possible that a colleague overlooked a transaction or that information was misreported.
Correctly categorising all revenues and expenses
Because it allows them to evaluate the trial balance, double-entry bookkeeping can assist staff in ensuring that all revenues and expenses are appropriately classified. The trial balance is a list of all accounts and their respective balances. If it does not match the accounts recorded on the general ledger, it indicates that a mistake has occurred somewhere.
Which Software Works with the Double-entry Bookkeeping System?
A double-entry accounting software program, which usually contains features such as a general ledger, accounts receivable and payable, and a trial balance, assists you in keeping track of your financial operations.
Here is some of the software regularly used in the market today:
Advantages of Double-entry Bookkeeping System
1. Provides a Comprehensive Financial Picture
Small firms can utilise double-entry accounting to track their financial health and the rate at which they are growing. This bookkeeping system records every financial transaction to prevent fraud and confusion.
A double-entry accounting system is required for any business with more than one employee, inventory, debts, or many accounts.
Businesses that fit these characteristics require the comprehensive financial picture that double-entry bookkeeping provides. Double-entry accounting may generate important financial reports, such as balance sheets and income statements.
2. Improved cash flow management
A double-entry system improves cash flow management by tracking and recording all financial transactions. This involves recording each transaction, one on the credit side and one on the debit side, to provide a complete and accurate transaction record.
It improves cash flow management and provides a clear and detailed picture of a business’s financial activities. It also assists with unnecessary expenses and develops strategies for improving cash flow.
3. Helps in Better Financial Decisions
Financial accounts from double-entry bookkeeping reveal how successful small businesses are and how financially robust certain aspects of their business are. You can check your spending and get a report on the financial health of your business.
By delivering precise and timely information about your company’s financial position, the double-entry accounting system can help you make smarter financial decisions.
This data can be used to make educated decisions regarding how to distribute resources, how much debt to incur, and whether to invest in new projects.
4. Errors in Bookkeeping Reduced
In double-entry bookkeeping, liabilities and equity (net worth or “capital”) must match assets when creating a balance sheet. If they don’t, your books are incorrect.
This failsafe alerts businesses when their journal entries are incorrect. This accounting system also makes it easier to identify and remedy problems. The double-entry approach is also a more transparent means of keeping your books and aids in the accountability of firms.
5. Appreciated by Statutory Bodies, Investors, Banks, and Buyers
The double-entry system is complete and transparent. It makes it easier for firms to attract investors and secure finance. The reports generated by the double-entry bookkeeping system provide banks and investors with a thorough and accurate picture of the business’s financial health. The Income Tax Department prefers this bookkeeping system. The statutory bodies that control enterprises, such as the Registrar of Companies, SEBI, and the RBI, all accept the double-entry bookkeeping system.
6. Ready for Tax Preparation at Year-End Closing
Tax preparation at the end of the year often entails analysing the financial transactions that occurred throughout the year and determining which transactions are taxable. It must be recorded on the company’s tax return. The following steps are frequently involved in the double-entry process:
- Be Tax preparation ready at the year-end’s closing.
- It ensures that each entry is balanced. This reduces the possibility of errors, saving time and money when filing taxes.
- Finally, double-entry accounting helps with cash flow management. This ensures the correctness and completeness of the financial records and makes preparing the tax return easier.
Documents for Recording Transactions
The income and expenses for transactions are entered in a cash register in single-entry accounting. In contrast, the double-entry method begins with a diary, followed by a ledger, a trial balance, and financial statements.
- Journal: An accounting book documenting transactions consecutively and chronologically.
- Ledger: A book of final entries in which transactions are separated and documented in distinct accounts. It needs to be balanced.
- Trial Balance: It is a bookkeeping worksheet showing all ledger accounts’ credit and debit balances. The trial balance is significant because it preserves the arithmetic precision of transactions.
The Drawbacks of Double Entry Bookkeeping System
The following are the drawbacks of double-entry bookkeeping:
Unorganised and Illogical
This technique of tracking financial transactions is unsystematic since no proper principles or standards exist.
Incomplete Method and system
Every company transaction has two financial components, but this system only records one. Businesses in this system only keep a cash book, neglecting transactions that influence the real and personal accounts.
Inadequate Arithmetic Accuracy
This bookkeeping system is untrustworthy because it does not ensure arithmetic precision. This system’s account balance occasionally fails, leading to fraud and account manipulation.
Not Useful for Tax Purposes
Sometimes, this system lacks data or creates confusion, so like this the double-entry bookkeeping system cannot be considered totally correct.
On A Final Note
Double-entry accounting is a very efficient and effective way of recording financial transactions. While it is more challenging to execute than single-entry accounting and requires more effort and precision, it provides various benefits that make it worthwhile. It maintains an accurate, up-to-date record of financial transactions and makes comparing income and expenses easier. It also enables faster identification of flaws and anomalies, making detecting and correcting problems easier.
Despite its numerous advantages, the double-entry system has several disadvantages. If not done properly, it may become more time-consuming and difficult, leading to errors and discrepancies. Furthermore, it might not be suitable for small businesses or organisations with limited resources.
Overall, the double-entry system is an effective and efficient means of documenting financial transactions; nevertheless, it is necessary to consider the benefits and drawbacks before using it. With proper training and guidance, the help of the double entry system may be well worth the effort.
Frequently Asked Questions
What exactly is a double-entry system?
A double-entry accounting system works based on debit and credit and records both debit and credit transactions. Every transaction is recorded on both the debit and credit sides of the ledger.
Can we employ both single and double-entry bookkeeping simultaneously?
It is a waste of time, although it is possible. Because double-entry bookkeeping incorporates all components of single-entry bookkeeping, they do not need to be done concurrently.
Is substantial accounting knowledge required for double-entry bookkeeping?
Because the double-entry system of debits, credits, and various accounts can be intimidating to a newbie, some fundamental accounting understanding is helpful. Many small-business software programs are readily available and simple to install.