Double entry bookkeeping is an accounting technique to record the financial transactions of a business where every transaction is entered twice, equal and opposite transactions. Double entry is required for all businesses that must produce both a profit and loss account and a balance sheet.
All limited companies are required to produce a statement of assets and liabilities and maintain a system of financial control and invariably need to adopt a system of double entry bookkeeping usually using an accounting software package.
The same rules may not necessarily to self employed business that does not require to produce both a profit and loss account and a statement of assets and liabilities as the final product of the financial accounting. In the UK a balance sheet is an optional requirement of self employed business.
There are advantages and disadvantages in preparing financial accounts using self employed bookkeeping. The main advantage being the simplicity with which accounts can be produced requiring a much lower knowledge of accounting systems. The main disadvantage of single entry bookkeeping is the absence of financial control due to limited detailed records of asset and liability accounts.
Preparing accounts using single entry bookkeeping involves recording the prime financial transactions once rather than twice. Prime financial records include sales income, purchase expenses and cash or bank transactions.
As the accounts do not require to produce a trial balance and balance sheet then when using self employed bookkeeping recording cash and bank transactions is not strictly necessary but highly recommended to provide additional financial control. While cash and bank transactions are movements of assets or liabilities and not part of the income and expenditure account accurate cash and bank records are useful since cash flow is a highly critical area for small business.
In the absence of a double entry bookkeeping system the small business has less control over the debits and credits of the business. That being the amounts owed for sales invoices from customers who are called debtors and the amount owed by the small business to suppliers who have supplied goods and services on credit and are called creditors.
What is required from commercially available single entry bookkeeping software is not just an accounts package that produces the profit and loss account but also has additional facilities to assist financial management and control of the business by providing optional areas for cash, bank, debtors and creditor accounts to be maintained.
Mismanagement of small business finances is a major area which can drive a small business into liquidation and bankruptcy. The first lesson an accountant might learn when studying accounting and financial control is that the business must always have sufficient cash or availability to cash resources to trade the next day. Bank records and maintaining a positive cash flow is important as without liquidity the business cannot trade..
In a similar vein control over debts owed to the company and owed by the company is also important for the smooth operation of a small business. Bad debts from clients can cripple a small business in fact high levels of bad debts can cripple any size of business as evidenced in recent times with the so called credit crunch. Lack of control over unpaid purchase invoices to creditors can result in serious disruption and higher costs since suppliers stop supplies and may charge recovery costs and relentlessly chase up the debs taking up valuable time.
The conclusion then is while single entry bookkeeping is a viable option anyone who adopts a self employed style of bookkeeping to simply produce a profit and loss account, or income and expenditure account should also have supplemental systems to control assets and liabilities. Bookkeeping software can produce a solution by adding additional financial control.
The advantage of using a single entry bookkeeping system involves the simplest form of keeping records of financial transactions. Essentially the small business makes two lists, one of income received and one of expenses incurred. Using single entry might involve virtual zero accounting or bookkeeping knowledge.
When recording the financial transactions in the two lists of income and expenditure a small amount of extra detail can have magnificent effects on the quality of records produced by grouping together items of a similar nature.
When entering sales invoices or income received to produce the sales turnover total a small amount of analysis can save much time and produce a more sophisticated result. For example the sales can be listed in one column to produce the overall sales turnover but also analysed to a small number of additional columns in which could be entered different types of sales income.
The additional columns might be for different types of product or sales from different sales channels, sources, or perhaps used to separate out interest received if tax differently to business sales income. Some analysis of purchases is usually essential as only the tiniest business would get away with lumping all purchases together as one total.
Single entry bookkeeping would involve making a list of all purchase invoices for goods and services. The analysis of those purchases then achieved by listing each invoice again in an analysis column according to the type of expense incurred. Bookkeeping software should include a simple expenditure analysis.
Having produced the list of sales and the list of expenses all the information is then available to produce an income and expenditure account. Enter the totals from the single entry bookkeeping sheets on a separate sheet with sales income at the top, a list of expenses under each purchase expenditure category. Take the total expenditure from the total sales and the result is the net taxable profit. Bookkeeping software should automate this process.
The financial accounts based upon a single entry bookkeeping are complete and a net taxable profit produced for the tax authority.