Double Entry Bookkeeping – All Entries Are Recorded Twice
Double entry bookkeeping is a system of recording transactions where each entry is recorded twice, as a debit and a credit. Debits are on the left and usually show where the money in the transaction went. Credits are on the right, and usually show where the money came from. This system was originally developed to reduce mistakes. At the end of the day, debits have to equal credits, otherwise something is wrong.
The early Italians have been credited with developing double entry bookkeeping. The earliest known evidence of this came in 1211 from a Florence banker. From this time double entry bookkeeping continued to grow throughout Italian businesses, notably in Florence, Genoa, and Venice.
However, it was not until 1494, two years after Columbus sailed to America, that the principles of double entry bookkeeping were put into print. Luca Paciola, a monk from Venice and friend of Leonardo da Vinci, published a book on mathematics. The book was called “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” (Everything About Arithmetic, Geometry and Proportion). This book, written as a guide to existing mathematical knowledge, covered five topics. One of the topics was bookkeeping, for which there was 36 short chapters. History has credited this book as being the official beginning of double entry bookkeeping.
However Paciolo never claimed to be the inventor of double entry bookkeeping as the first known book about the subject was written by Benedetto Cotrugli in 1458. This book, however, was not published until 1573. Paciolo, was familiar with the 1458 transcript and always credited Cotrugli as being the inventor of the double entry method.
The basic principles of double entry bookkeeping that were developed by the Italians during the 13th, 14th, and 15th centuries have generally remained unchanged to this day.
Importance of Financial Statements?
Most businesses must file financial statements to satisfy lenders and to file annual tax returns. However, an understanding of financial statements also provides business owners with the ability to determine the financial state of their business and how it is performing, Financial statements are a valuable management tool. They provide a “picture” of your business and reflect its financial performance. This information can be used to enhance the quality and timing of business decisions.
Balance Sheet vs Income Statement
The two basic components of financial statements are the balance sheet and the income statement, or statement of earnings.
The balance sheet is often described as a “picture of your business taken at a specific point in time.” It shows:
- What you own (assets),
- What you owe (liabilities), and
- The resulting net worth of your business (equity).
The balance sheet should always be balanced. This means that assets should equal liabilities plus equity.
The income statement summarizes the income and expenses of your business or operations over a period of time. Unlike the balance sheet, which is a picture at a specific point in time, the income statement tells you what has happened over a period of time.
The balance sheet and income statement are related to each other. The income, or loss, shown on the income statement is reflected on the balance sheet as an increase, or decrease, in equity. The balance sheet will still be in balance as the income or loss will be offset by an increase or decrease in assets and in liabilities.
Key Elements of Financial Statements
- Assets – Items that have future value to the business, such as cash, inventory, accounts receivable, property and equipment, and goodwill.
- Current assets – Those assets that are expected to be converted to cash within the next year, such as accounts receivables and inventory.
- Liabilities – Obligations of the business such as accounts payable and loans.
- Current liabilities – Liabilities that must be paid within a year. These usually include accounts payable, taxes payable, and short-term loans.
- Long term debt – Debt that will be repaid over more than one year, such as bank loans, mortgages, and lease arrangements.
- Working capital – The amount of current assets minus current liabilities. This shows a company’s ability to pay its current liabilities.
- Gross profit – Sales less the direct cost of producing those sales, or cost of sales. The gross profit should be in line with industry standards. Most well run companies will have adequate and consistent gross profit percentages over many periods,
- Net income – Sales less all expenses of the business.
- Cash flow – Incoming cash less outgoing cash, over a set period of time.
The two major components of financial statements are the balance sheet and the income statement.
The balance sheet shows a company’s financial position at a set point in time, usually at a year end or month end. It lists the company’s assets, or what it owns, and its liabilities, or what it owes. Next it shows the difference between assets and liabilities, which represents the company’s net worth, or equity.
The Balance Sheet is always in balance, thus its name. Assets equals Liabilities plus Equity. The assets are shown on the left side of the balance sheet, or at the top. The liabilities and equity will be shown on the bottom, or on the right.
The income statement reflects how a company has performed over a period of time, such as a month or year. It usually shows a company’s sales and expenses over that period of time, and the resulting profit or loss.
It is important to understand the balance sheet shows a company’s financial position at a set point in time, while the income statement shows a company’s performance over a set period of time. The income statement usually shows performance over a period such as a year, or month. The balance sheet shows a “snap shot” of it’s financial position exactly at the year-end or month-end.
Accounting is a “double-entry” system, which means that every accounting entry has two sides to it, a debit and a credit. For example, when a company makes a sale, it not only has the sale (or credit), but it also will have an increase in an asset such as cash or accounts receivable (the debit). Conversely, when a company records an expense (the debit), it will also have a decrease in cash or an increase in accounts payable, which is the credit side of the entry.
What Is Cloud Accounting?
One of the latest trends in small business accounting is the use of cloud accounting packages rather than in-house software programs. The main feature of cloud accounting is that your accounting software and data are hosted by a remote server, as opposed to being stored on your in-house computer. Your accounting software and data are stored online, in the cloud, and you enter or review your transactions online. Data that you enter is processed by the online software which provides the various financial statements and reports which you can view and save to your computer.
There are several cloud accounting providers to choose from. You simply sign up through the internet, make the necessary payment, and establish an account with a password. You can then log in, set up your accounting, and start making your transactions. Many of these providers have Apps for your phone and tablet which allow you to make transactions with these devices. Want to record your business lunch expense? You can do this with your phone while still in the restaurant.
Advantages to cloud accounting:
- Updates are eliminated. Your accounting package is always kept up-to-date by your service provider, which eliminates the continuous software updates required with in-house software. There is nothing to install and backups are done for you.
- Your accounting package is more accessible by employees and by your accountant. Rather than being kept on one computer in your office, your accounting is readily available to whomever you wish.
- Cloud accounting allows you to make entries from any computer or device that is hooked up to the internet, rather than from one computer in your office. You can keep your accounting up-to-date while traveling, or from home, even during vacation if you wish.
- Your data is more secure. Even though there is some fear of online storage, your accounting is much more secure in the cloud than it would be if it were stored on one computer in your office, where it can crash, be stolen, or damaged. Most cloud providers have very sophisticated backup procedures for their clients.
- In most cases, cloud accounting will be less costly than hosting and maintaining software and data in-house.
Please contact me if you would like more information about Cloud Accounting.
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