BizMove Financial Management

Bookkeeping of Financial Records - Keeping and Checking Financial Records

BizMove business management guides


Bookkeeping of Financial Records

The bookkeeping of financial records of a company are vital for determining the profitability of the business. Without financial records, an owner/manager does not have the information necessary to evaluate the operating effectiveness of the business; to decide on how much additional capital might be needed; to determine realistic prices for merchandise; to expand operations or file for bankruptcy; or to answer a myriad of other questions dealing with the financial health of the business. This discussion provides an introduction to various records-keeping practices

The Accounting Equation

The basis of accounting, the accounting equation, is ASSETS = LIABILITIES + CAPITAL. An asset is anything a business owns that has a dollar value. Some common assets are cash, accounts receivable, buildings, and inventory. A liability is a debt. Anything owed by a business is classified as a liability. Some common liabilities include accounts payable, notes payable, and mortgages. Capital is the difference between assets and liabilities - between what is owned and what is owed.

For example, let's assume that Mr. Smith owns a house (an asset) worth $125,000 and owes a mortgage (a liability) of $100,000. Using the accounting equation, we see that:

Assets = Liabilities + Capital

$125,000 = $100,000 + ?

Mr. Smith's capital (or owner's equity) in this instance is $25,000. The important thing to remember is that assets always equal liabilities plus capital.

Financial Records

The financial records of a business begin when a transaction or event, measurable in dollars, takes place. A purchase of merchandise to sell, the payment of an electric bill, and the sale of merchandise are all financial transactions that need to be recorded. Some sort of written record -sales slips, check stubs, petty cash receipts, etc. - should be kept for each transaction.

The Journal

Transaction information should be recorded from the base documents into a journal, which is simply a record of the daily transactions of the business. Each journal entry should show the date of the transaction, a brief description of it, the amount of money involved, and the accounts affected. The journal, then, contains a record of all transactions.

The Ledger

Information is more usable, however, if it is categorized. Items recorded in the journal are later transferred (posted) to a ledger account. An account is a category within the broader categories of assets, liabilities, capital, income and expense. A book or file in which a number of accounts are kept together is called a ledger. An example of a ledger would be an Accounts Receivable file and an account would be Mr. Smith - Accounts Receivable.

The number of accounts used depends on the size and complexity of the business.

Double Entry Accounting

The accounting system used in most businesses is called double entry. This means that at least two entries are made for each transaction - as a debit entry in one account and as a credit entry in another. Either the debit or credit entry may be broken down into several entries, but the total debit and credit entries for each transaction must equal each other.

Each account sheet in the ledger has a column for the date, a brief description of the entry, the posting reference (where it came from in the journal), and two columns (debit and credit) for dollar amounts. Debit entries are always entered in the left-hand column and credit entries are entered in the right-hand column.

When balancing an account, total the debit column, then the credit column. If the debit column total exceeds the credit totals, the account has a debit balance and vice versa. The total of all debit balances in the accounts must equal the total of all the credit balances.

Trial Balance

Usually, at the end of each month, a trial balance is taken to make certain that the sum of the debit balances does equal the sum of the credit balances. A trial balance is also taken prior to preparing financial statements.

In simple terms, a trial balance is the adding of all debit balances, adding all credit balances, and comparing the two. If no errors have been made, the two totals will be equal.

Financial Statements

The journal provides a complete chronological record of all transactions of the business, but the information is not readily usable. The ledger accounts are useful because they organize information into categories. The information contained in the ledger accounts can be grouped so that financial statements can be prepared.

There are two basic financial statements vital for meeting the decision-making needs of the owner-manager.

The Balance Sheet is a reflection of the basic accounting equation: Assets = Liabilities + Capital. The Balance Sheet shows the balance between assets on the one hand and liabilities and capital on the other at a particular time.

The Profit and Loss Statement (also called the Income Statement) summarizes the revenue and expenses of a business over a certain period of time and indicates the profit or loss that resulted.

Petty Cash

It is advisable to establish a petty cash fund to make what small payments are necessary in the course of doing business. A fixed amount of money is put into the petty cash fund. Each time money is paid out of the petty cash fund, a petty cash slip is completed. The petty cash slip indicates the date, amount, purpose, and accounts to be charged.

The slips are kept with the petty cash. The balance in petty cash, reflecting the total of cash on hand and petty cash slips, should match the fixed amount initially put into the fund. When the cash in the fund gets low, the slips' total is used as the basis for writing a check to be cashed to replenish the fund. The petty cash slips are the base documents for making journal entries, debiting appropriate accounts, and crediting cash. The petty cash slips should then be marked to prevent them from being used again. Examples of uses of the petty cash fund are local taxi fares, or quick purchase of light bulbs, paper towels, etc.

Sales and Cash Receipts

Every cash receipt and every charge sale must be recorded, regardless of whether you use a cash register, sales slip, or both. At the close of business each day, the actual cash on hand is counted and balanced against the total receipts recorded for that day.

Daily Summary

The Cash Receipts portion of the Daily Summary records all cash received during the day. The cash sales total is taken from the cash register tape or by totaling the cash sales slips.

Total payments by customers on accounts receivable should be entered in the collections on account category. Receipts or other paperwork indicating customers' payments should then be held for posting to the customers' accounts in the Accounts Receivable ledger. Cash receipts that cannot be classified as cash sales or collections on account should be entered on the Daily Summary as "Miscellaneous Receipts." Examples of Miscellaneous Receipts include refunds from suppliers for over-payment, advertising rebates or allowances, etc. Total Receipts, then, is the total of all cash received on that day.

The second section of the Daily Summary of Sales and Cash Receipts is a count of the cash actually on hand. The money in the cash register or till is counted in the categories of coins, bills, and checks, then recorded and totaled on the Daily Summary.

Because petty cash slips represent cash on hand that has been paid out, but will be replaced, they are totaled and included in the cash on hand section. The cash on hand is then totaled.

The Daily Summary then records the petty cash slips on hand in the category, less change and petty cash funds. The coins and bills category reflects a combination of change that will be available for use and not deposited.

The combined change and petty cash fund is kept on hand for use in the next day's operations and the balance of funds is deposited in the bank. It is not uncommon to have the amount to be deposited and the total receipts for the day not balance. Human error in making change may result in cash short or cash over, and when this occurs, the appropriate entry should be made.

Sales and Cash Receipts Journal

The Daily Summary of Sales and Cash Receipts can be thought of as a worksheet for figuring and recording the results of the daily operations. The Sales and Cash Receipts Journal brings together on one page the information from a number of Daily Summaries. The Journal provides a more comprehensive, permanent record and displays the information in a format that is easier to work with. Normally, total sales, charge sales, collections on account, and total cash deposits are entered on the same line of the Journal.

Cash Disbursements, Purchases, and Expenses

All business expenditures should be made by checks drawn on a business account. A typical business writes checks for purchases of merchandise, salaries, rent, utilities, etc. When a check is written, record on the stub or in the register the date, payee, amount, and the purpose of the payment. A running balance should always be maintained. Voided checks should have "VOID" written across their face; they should be stapled to the back of the checkbook and "VOID" should be written on the stub.

Never write a check without supporting documentation. An invoice, petty cash voucher, a payroll summary, or some other document should serve as the basis for writing a check. If no documentation is available, a memo should be written stating the purpose of the check. Supporting documents should be approved and signed by an authorized manager.

When a check is written, the supporting documents should be marked "paid" and the date and check number should be written on the document. The signer of a check should have the documentation available to verify when signing. It is advisable to require two signatures on all checks if the size of the business warrants it.

Cash Disbursements, Purchases, and Expense Journal

Each day's checks should be entered into the Cash Disbursements, Purchases, and Expense Journal. Make sure that each check number is accounted for in the journal. Voided checks should be entered by writing the check number and - in the description column - entering "VOID".

A Cash Disbursements, Purchases, and Expense Journal typically has amount columns for: Amount of Check, Merchandise Purchases, Gross Salaries, Payroll Deductions, Miscellaneous Income and Expense Items, and General Ledger Items. Again, in all entries in the journal, make sure that debits and credits are equal.

Accounts Payable

An unpaid bills file should be maintained for all bills and invoices received for merchandise purchased on credit. When a bill is paid, all packing slips, invoices, and statements relating to that transaction should be kept as supporting documentation.

At the end of each month, prepare a list of unpaid items showing the supplier and amount owed. The total amount owed is entered in the Cash Disbursements, Purchases, and Expense Journal as a debit to Merchandise Purchases and a credit to the general ledger account, Accounts Payable. Later, when a check is written to pay the supplier, the journal entry is a debit to Accounts Payable and a credit to Cash.

Bank Statement Reconciliation

A checking account statement is received each month with a list of checks cashed by the bank, deposit records, bank charges, and the ending balance according to the bank's records. It is important to reconcile your checkbook with the bank statement and account for all discrepancies. In order to make the reconciliation, you will need the preceding month's reconciliation, the checkbook stubs, the canceled checks from the bank, and the bank statement. The process for reconciling a bank statement is as follows:

  • Arrange all the canceled checks in numerical order.
  • Compare deposits listed on the bank statement with deposits listed in the checkbook. List in the first section of the reconciliation any deposits recorded in the checkbook during the month but not appearing on the bank statement.
  • There may be canceled checks from the previous month. Check these off the list of outstanding checks shown on the preceding month's reconciliation. Then list in the first section of the current reconciliation the checks still outstanding.
  • On the check stubs check off all canceled checks drawn during the month being reconciled. Add the checks recorded on the remaining stubs to the list of outstanding checks on the reconciliation.
  • If errors in amounts are discovered in the preceding steps, list them in the second section of the reconciliation as adjustments to be added or deducted.
  • Examine the bank statement for service charges, interest, or other adjustments to the account and enter them in the second section of the reconciliation.
  • Compute additions and subtractions as shown on the bank reconciliation. The adjustment balance given by the bank statement should equal the adjusted balance in the checkbook.

Bank Errors

Occasionally, a bank may make an error in the account. Such errors should be reported at once. When the next month's bank statement is received, make sure that bank errors from the previous month have been corrected.

Adjustments to the checkbook resulting from the Bank Reconciliation must be entered in the checkbook and also in the journals. Some typical errors and ways to correct them include:

Check records in the wrong amount. Enter the amount of the adjustment in the Amount of Check column of the Cash Disbursements Journal. Enter the same amount in the other column in which the check was originally entered. If the check was recorded as less than the correct amount. simply enter the adjustment in the two columns. This will have the effect of an addition. If the check was recorded as more than the correct amount, enter the adjustment as a deduction (circled or in red).

Deposit recorded in the wrong amount. Enter the amount of the adjustment in the Total Cash Deposit column of the Cash Receipts Journal. If the adjustment can be identified with a specific receipt, it should also be entered in the column for that type of receipt. It is more likely, however, that the error was made in balancing the day's work. In this case, it should be entered as a cash short or over. If too small an amount was recorded, the adjustment should be entered in the journal as an addition; if too large an amount was recorded, enter a deduction.

Bank service charges. All bank service charges should be entered in the Amount of Check column of the Cash Disbursements Journal and as a debit in the Miscellaneous Income and Expense column. The checkbook balance should be corrected by adding or subtracting the net adjustment.

Merchandise Inventories

One of the most important steps in the preparation of financial statements is determining accurate inventory figures. There are a number of methods for keeping perpetual (continuous) inventories, but a truly accurate inventory can be obtained only by actually counting all the merchandise on hand - a physical inventory. If a perpetual inventory has been kept, a comparison of the two inventories can reveal shortages or overages.

Many small businesses, however, do not want to maintain a perpetual inventory. In such cases, the inventory can be estimated for monthly statements and a physical inventory conducted only at the end of the year.

Estimating Inventory

Inventory can be estimated by using the gross margin method. Under this method, it is assumed that the gross margin (sales less cost of goods sold) for the period will be a certain percentage of sales. The gross margin percent for the period between the last two physical inventories is most often used for this. The cost of sales for the current period will then be the cost of sales percent (100 percent less the gross margin percent) times the sales for the period. Ending inventory is then computed as in the following example.

Suppose that sales for the month are $10,000, that the beginning inventory was $3,000, and that the merchandise purchases during the month amount to $6,000. Assume that gross margin is estimated at 25 percent of sales. The ending inventory can be computed as follows:

Beginning inventory $3,000

Merchandise Purchases 6,000


Merchandise available for sale $9,000

Estimated gross margin percent 25

Cost of sales percent (100-25) 75

Sales for the month $10,000

Cost of goods sold (75% of $10,000) $7,500

Ending inventory $1,500

If the gross margin method of computing inventory is used, it should be applied separately to each category of merchandise. While this method can give fairly accurate results for monthly financial statements, the fact remains that the resulting amount is only an estimate. A physical inventory could should be determined whenever possible.

Conducting a Physical Inventory

The frequency of conducting a physical inventory depends upon the type of business and whether it has a reliable inventory system. In all cases, a physical inventory should be taken at least once each year, normally at the close of the fiscal year.

To ensure accuracy in counting, care should be taken to see that merchandise is in good order on display and in storage. It is often impractical to try to conduct a physical inventory during normal business hours, so the actual counting may be done at night or on a weekend. The orderly arranging of merchandise, instructing personnel on the methods to be used, and perhaps counting some reserve stocks, however, can be done ahead of time.

A part of the planning for a physical inventory is to establish shipping and receiving "cutoffs"; that is, making certain that all items entered in the books as purchased before the inventory have been received and are counted and all items recorded as sold before the inventory are removed and not counted.

If the merchandise being counted requires weighing or any other kind of measuring, the equipment needed should be available.

In some kinds of business, a complete description of each item is needed. In these cases, inventory tally sheets showing this information should be prepared in advance, so that the only writing necessary while taking inventory is to record the quantities counted. A tally sheet should have a space for inserting the unit prices and extending the dollar value of the stock. The order of the items on the list should follow as closely as possible the order in which the items are arranged in the store.

If tally sheets are not necessary, inventory can be taken on "tags." A tag is placed with each different item in stock before the count. The description of the item and the number of units in stock are then entered in the tags by the counters. It is advisable to include a space for the price and extension.

If a large number of tags is to be used, they should be numbered. This is necessary to make sure that none are lost or misplaced after the inventory count is made and before the final summarizing of the inventory value.

In some cases, a complete description of the items is not necessary; the number of items and the price might be enough for the counters to enter.

Inventory Valuation

After the physical count of the inventory is completed, each item must be priced. A generally accepted method of pricing inventories is valuation of the items at cost or market, whichever is lower.

The price at which the item was purchased is obviously the "cost." Theoretically, this would be the invoice price, plus "freight-in", less any purchase discounts taken. In a small retail business, however, the factor of freight-in is generally not significant and is often ignored in pricing merchandise. Discounts may not be significant, either. If a small cash discount is applicable to most of the purchases, a percentage reduction in the overall inventory could be made instead of trying to reduce the price of each item.

Inventory valuation using "market value" consists of applying one of the following:

1. The replacement price of the item;

2. The current selling price, less normal gross margin, if the item has been marked down; or

3. The scrap or salvage value, if the item is no longer salable at retail.

Computing the cost of each item can be avoided by using the retail method of valuing inventory. Under this method, retail prices are entered on the tally sheet or tag as the count is made. The retail value of the inventory is then totaled and reduced by the year-to-date gross margin percentage. In the case of marked-down items, the marked-down retail price should be used.

Another method of inventory valuation is called "coded cost." This method involves marking the merchandise with a coded cost, as well as retail price, at the time it is made available for purchase. For example, a letter code can be devised using a ten letter key word with no letter repeated, like the following:

1 2 3 4 5 6 7 8 9 0

Using the above code, an article that cost $3.17 and sells for $5.00 would be marked "RPS $5.00." When taking inventory, the counters enter the decoded cost on the tag or tally sheet.

The practice of marking merchandise with a coded cost is common in gift shops, jewelry stores, and other stores where inventory turnover is comparatively slow and items have a fairly high gross margin. It serves primarily as a guide to the owner/manager in making markdowns and in bargaining with customers. The coded costs methods used in inventory valuation is made less attractive by the work involved in coding the merchandise in the first place and the fact that decoding of prices by the inventory counters can be confusing and subject to errors.

After all inventory items have been priced under the inventory valuation method selected as most suitable, the total dollar values are computed by multiplying the prices by the quantities. This may be done on the tags or on the tally sheets containing the quantities counted.

Perpetual Inventory

Some businesses maintain a continuous, or perpetual, record of their inventory.

One type of perpetual inventory involves keeping records at both retail and cost. Purchases are added to the beginning inventory at retail, (with each invoice priced at the expected selling price), and all sales and markdowns are deducted. This results in a perpetual inventory at retail. At any time, this inventory can be converted to cost by dividing total purchases at cost by total purchases at retail, then multiplying the inventory balance by the result.

If these records are carefully kept, theoretically, they should provide a very accurate inventory. Inventory shortages, however, will not be disclosed. A physical count is still necessary at least once a year to determine inventory shrinkage. If this method is desirable, it is advisable to have a qualified accountant set up the system and explain it in detail.

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