Introduction to Bookkeeping

History was never a strong suit for me in school, but I was always curious how what is known as “double entry” bookkeeping (defined later in this article) got it start and who started it. Double-Entry bookkeeping was first known about the end of the 15th century (yes, it is over 500 years old) and was believed to have been used by Venetian merchants.

The most common method of record keeping used by most businesses, bookkeepers, and accountants is what is knows as “double entry” bookkeeping as opposed to “single entry”.

The “double-entry” bookkeeping system is a bit more complicated. It uses debits and credits. There is at least one debit and one credit in each transaction, and the debit amounts must equal the credit amounts help ensuring accurate and complete recording of business transactions.

At the heart of the “double-entry” bookkeeping system is what is known as the “accounting equation.” The accounting equation is A (Assets) = L (Liabilities) + OE (Owner’s Equity). It is sometimes referred to as the balance sheet equation.

Now that we got the basic concept of “double-entry” bookkeeping identified we should further define its’ more complex parts.

Simply put a debit is a business transaction that increases an asset or expense and decreases a liability, revenue, or equity account (generally speaking, there are a few exceptions that I will go over in another article “advanced bookkeeping”).

Simply put a credit increases liability, revenue or equity accounts and decreases assets and expense accounts.

There is a saying in the bookkeeping/accounting world that “debits” are on the left and “credits” are on the right. This comes from to sources. The first is the accounting equation. Most of the debits are on the left of the equals sign and most of the credits are on the right of the equals’ sign. For people like me that are visual there are also what we old timers use called t-accounts which is basically what it sounds like. You draw a T and put the account name across the top of the T and the debit amount goes on the left side of the stem of the “T” and credits go on the right.

An asset is something with monetary value that a business owns or controls with the expectation that it will provide a future benefit.

Liabilities are a company’s financial obligations. Some examples include accounts payable, wages payables, and loans payable.

Equity is the remaining value of an owner's interest in a company, after all liabilities have been deducted from the total assets.

There are two basic accounting methods called cash and accrual. The main difference between the two are in the timing of when sales and purchases are recorded. Cash accounting recognizes revenue and expenses when money exchanges hands. Accrual accounting recognized revenue when its’ earned and expenses when they are billed.

There are four main types of financial statements. They are balance sheets; income statements; cash flow statements; and statements of shareholders' equity.

A balance sheet provides detailed information about a company’s assets, liabilities, and shareholders’ equity. Balance sheets show what a company owns and what it owes at a specific point in time.

An income statement shows how much revenue a company earned over a specific time period. It also shows the expenses associated with earning that revenue. The literal “bottom line” of the statement usually shows the company’s net earnings or losses. This tells you how much the company earned or lost over the period.

Cash flow statements report a company’s inflows and outflows of cash. It can tell you whether the company generated cash. It shows changes over time. It uses and reorders the information from a company’s balance sheet and income statement.

The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Cash flow statements are typically divided into three main parts. Each part reviews the cash flow from one of three types of activities: (1) operating activities; (2) investing activities; and (3) financing activities.

The first part of a cash flow statement analyzes a company’s cash flow from net income or losses. This section reconciles the net income (as shown on the income statement) to the actual cash the company received from or used in its operating activities. To do this, it adjusts net income for any non-cash items (such as adding back depreciation expenses) and adjusts for any cash that was used or provided by other operating assets and liabilities.

The second part of a cash flow statement shows the cash flow from all investing activities, which basically include purchases or sales of long-term assets, such as PPE (property, plant and equipment), as well as investment securities.

The third part of a cash flow statement shows the cash flow from all financing activities. Sources of cash flow include cash raised by selling stocks and bonds or borrowing from banks. Likewise, paying back a bank loan would show up as a use of cash flow.

I will go over ratio’s in a future article.