You’ve probably heard of double-entry bookkeeping during your time, but what does it mean exactly?
Double-entry bookkeeping is a way of accounting for debit and credit on all company transactions. Not only is it a way to reduce any errors in your accounts, but also helps with financial reporting.
This article will explain how double-entry bookkeeping works and why it’s important for your business.
How does double-entry bookkeeping work?
Double-entry bookkeeping is the process of recording all of your business transactions in terms of debits and credits. For example, if you’ve started working with an investor, you’ll have to take into account the equity you’ve given up as part of the deal.
This way, both sides of each transaction you make have been acknowledged and are reflected in your books.
Usually recorded in ledgers, double-entry bookkeeping requires you to list all your debits on the left and credits on the right. From this, you should be able to put together a financial report based on all closing balances in your ledgers, known as a trial balance, when both debits and credits are equal.
Why it’s important
By using the double-entry bookkeeping system, you’ll be able to create your profit and loss statement and balance sheet from your trial balance.
This is done by using the accounting equation, which is: assets = liabilities + equity.
Your business’s assets will be something of value that you own or part-own, so unpaid sales invoices, tools or accounts receivable are prime examples of this.
Your liabilities will be something your business owes, like loans, unpaid bills and taxes.
To create your balance sheet you’ll have to deduct the total cost of your liabilities from your asset value which will provide the true value of your business.
For a profit and loss statement, you’ll need to follow a similar formula but deduct your expenses from your revenue. The result will be your business’s profitability.
Having these two documents is essential for any business wanting to keep track of its financial health. In turn, it shows the importance of double-entry bookkeeping.
Benefits of double-entry bookkeeping
As well as providing another level of accuracy when it comes to calculating your profit and loss, double-entry bookkeeping will also help you prevent errors as it introduces a system of checks and balances.
Any errors that may arise will be easier to catch due to the credit and debit amounts being equal. That said, there’s still a chance a mistake may happen, so it’s worth being extra diligent.
Double-entry bookkeeping is also a preventative measure when it comes to fraud. This process will leave an audit trail, allowing you to trace back transactions from the journal entries. If your cash balance were to seem too high on your balance sheet, for example, you’d be able to look back and check to see if this is accurate.
When it comes to preparing your financial statements, you’ll be able to shorten the process as you’ll be able to collect all the necessary information from your double-entry bookkeeping transactions. This will make you more efficient and allow you to share accurate financial information with investors, proving your creditworthiness.
Talk to us
Now is the best time to start if your business hasn’t adopted double-entry bookkeeping methods. At Diamond Accounts, we can help you with your bookkeeping processes and help you stay in control of your finances.
Talk to our team about your business’s bookkeeping needs.