When managing cash flow at your small business, it’s important to understand where your money is going. Accurate financial record-keeping in the form of double-entry bookkeeping helps give you financial clarity because you track and see how each transaction impacts your assets and liabilities.
What Is Double-Entry Bookkeeping?
Double-entry bookkeeping is an accounting method in which every business transaction you make is recorded twice in the general ledger, with equal and opposite entries. This method is based on the idea that every transaction has two sides: a debit and a credit. Ultimately, this double-entry helps minimize reporting errors since both your debits and credits should balance out.
Consider the accounting equation: Assets = Liabilities + Equity.
This equation always has to be in balance, which is the main principle of double-entry bookkeeping. When the entries aren’t in balance, there’s probably an error: Something was either credited or debited incorrectly.
The Rules of the Double-Entry System
There are three important rules for the double-entry system:
- Every transaction must affect at least two accounts. If one transaction is marked as a debit to one account, you must also mark the same transaction as a credit to another account. Depending on the transaction, some may be recorded in more than two accounts.
- Total debits must equal the total credits for each transaction. This is the heart of the double-entry method and ensures visibility, and in turn, accuracy, is maintained in your books.
- Keep the accounting equation balanced after every entry. This is called “balancing the books.”
Examples of Double-Entry Bookkeeping Transactions
Any business transaction should be recorded in your books using double entry. The following examples may be one of many for your business.
Receiving payment from a customer
Let’s say a customer pays an $800 invoice for a logo design project you completed. On receipt, you would mark the $800 as a credit to your cash account because you received the money. You would also need to record an $800 debit to your accounts receivable, as you are no longer waiting on the money to be received.
Paying rent
The same method can also be used for paying rent for equipment or office space. If you make a $2,000 rental payment, you would record it as a debit in your cash account. At the same time, you would record the amount as a credit in your expense account, since you no longer owe the expense.
Advantages of Double-Entry vs. Single Entry Bookkeeping
When comparing double-entry vs. single-entry bookkeeping, think of double-entry as a failsafe method when tracking your finances. It improves accuracy and error detection, as you are using two accounts to track the same transaction. If the sides do not balance, it can indicate a credit or debit that was not properly recorded.
Bookkeeping using double-entry also improves financial transparency. When you record every transaction in at least two accounts, it creates a complete picture that clearly shows where money is coming from and where it’s going. This allows you to quickly assess your company’s financial position, identify trends and spot potential issues early.
It also simplifies preparing financial statements, as the double-entry approach naturally organizes data for balance sheets and income statements. With detailed, accurate information at your fingertips, you can easily track product profitability, analyze expense impacts, and assess the financial implications of business moves.
How to Implement and Avoid Pitfalls with Double-Entry
To start using double-entry bookkeeping, you need to complete the following steps.
Set Up a Chart of Accounts
Avoid misclassifying transactions by using a detailed chart of accounts and clearly outlining how you categorize them. Accounts might include assets, expenses, revenue, liabilities and equity. Consider creating a review process for complex or unusual transactions.
Choose Bookkeeping Software
Consider using mobile apps or cloud-based software to enter expenses and income in real time so all your transactions are recorded in a timely manner.
Establish Internal Controls
Implement processes around who has authorization to place information into the ledger, and when and how to make entries. Address discrepancies immediately, no matter how small. This prevents minor issues from snowballing into major problems.
Implement a Strong Reconciliation Process
For most small businesses, monthly reconciliations are sufficient, but adjust based on your transaction volume. As you check your books against external sources, don’t just try to catch errors. Use the process to gain insights into your financial patterns.
Seek Professional Guidance
Double-entry bookkeeping is a powerful tool for small businesses, as it increases financial transparency, reduces errors and simplifies preparation of financial statements. By implementing this system and seeking expert assistance when needed, you can gain a comprehensive understanding of your financial position, enabling informed decision-making and fostering growth.
Paro offers outsourced bookkeeping services that connect you with elite accounting professionals. Our services are tailored to your needs, whether that’s setting up or upgrading accounting software, determining proper transaction classifications, or reconciling accounts on a more regular basis. Click the button below to learn how we can elevate your financial management and support your company’s success.
