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Module: 15

Proper Bookkeeping Tips

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Bookkeeping like any other practice, has methods and uses, which are developed to easily convey

information to people. In the last module, we discussed the basic methods of bookkeeping. Now we want

to discuss how to use some of these processes and develop a solid accounting system and uses from that

system. In this module, we will discuss some proper practices in bookkeeping as well as how to use the

books to help owners understand how the company is performing

What you’ll learn in this module:

15.1 Posting and coding

15.2 Balancing and Testing Books

15.3 Adjustments to entries

15.4 Financial Statement Prep

15.5 Profit Analysis

15.6 Liquidity and Testing

15.7 Internal Controls

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15.1 Posting and Coding

In the last module, the ideas of posting and coding were discussed. Now it is time to have a little

more in-depth discussion on these two concepts.

Proper posting will help in ensuring that the numbers used in the books are the most accurate.

Posting by itself is not too complex. Every posting should have at a minimum two item:

The date

The value of the posting

The date will help keep the books accurate on when the item was earned (income) or when payment

was made (expense). In proper bookkeeping, the goal is to ensure that each item posted on the

books has a date. This will allow the company to backtrack any issues or inaccuracies quickly to

when it was posted. Thus, the date will help to identify items and help in any potential corrections.

The other aspect discussed was the possible use of coding:

Coding helps the bookkeeper track issues too.

It identifies any posting as to what type of transaction occurred. It is

It is another tracking service of postings and numbers.

Both coding and dating help businesses understand how the item relates to the overall books

and if an error occurred, more quickly identifying the issue. Coding systems are not uniform

in accounting. Most will use a numeric code to identify items. However, some businesses

use an alphabetic system, which uses the three letter codes to identify the income or

expense.

Both numeric and alphabetic systems work, but neither is a set standard. Therefore, when

setting up your books feel free to develop a coding system, which works for you.

As a recommendation using a numeric code of 3 to 4 digits works very well for most people.

Recall that the best use of coding is to have the first digit or two be the identifiers of a

grouping to which the posting belongs too. Thus, if the code starts with a 1 in a three-digit

code, then it would indicate an income posting. If the first digit is a 5, this might mean it is an

expenses related to some form of insurance.

The other benefit to this system is that it will allow the records to be grouped together and

then each will be available should something occur in the future, such as an audit. Do you

need a coding system? No, but it can help in your bookkeeping activities.

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15.2 Balancing and Testing Books

As you are now aware, a major reason to keep books is to help ensure the business is well and this

is done through accurate reporting in the books. The books will tell the owner where they stand and

how the future of the business appears. The issue is that the confidence the owner places in this

information is related to the accuracy of the numbers. Accuracy is paramount to this process.

Therefore, bookkeeping needs a process to ensure that accuracy. This is where balancing and

testing comes into the equation.

Balancing the books is just the process of making sure that all books, whether one general ledger or

multiple books all measure out in the end. Recall that this is one thing that is a natural part of the

double entry bookkeeping system. That entire system is built on the ending balances equaling

each other.

The debits always equals the credits is the mantra.

Thus when working with that system the balancing is automatic. However mistakes can still happen.

In the double bookkeeping system, we discussed the idea that transposed numbers do happen.

There is a nifty little trick to find out if a transposed number was used in the bookkeeping. If the

difference between the numbers is a number perfectly divisible by 9 then there is a transposed

number in the equation. You are probably thinking, what? If you find two numbers in accounting,

which should balance out perfectly and the difference between those two numbers are divisible by 9;

then it means there is most likely a transposed number. This is a mathematical trick, but it is an

accurate indicator that a number was transposed. Thus if a number from an income posting was

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written down as 671 and in the credit side of the ledger it was written down as 176, the difference

would be 495. The number 495 is perfectly divided by 9, which equals 55. This would mean there is

mostly likely a transposed number. This is a nice little system to use in accounting, especially in

double entry bookkeeping.

Balancing the books is part of the natural process in double entry. However, as pointed out single

entry is an easier system to use. So does this mean that the bookkeeper cannot balance books in

single entry? No, the bookkeeper or owner just needs to be more vigilant in examining the books.

To ensure balance in the books in single entry bookkeeping, develop more control mechanisms to

prevent issues. Thus, at the end of every week, develop a time to review the books to ensure that

postings are correct. Perform a self-audit every month or week on the books to ensure that they free

of mistakes. Recall that single entry is recommended for most small business. Thus, most of these

businesses do not have many entries per day or week when it comes to income and bills. If you

notice that, your business requires several entries every day or even every few hours then consider

a double entry system.

However, if your business is single entry, conduct your own audits every week, two-weeks, or once a

month. As part of your system, use a monthly process of developing your financial reports- Income

Statement, Cash Flow, and Balance Sheet. By developing these on a regular basis of once a month,

or if you have a software bookkeeping system once a week, you will have a systematic balancing

process. Any large discrepancies in these documents from period to period could indicate a problem.

As a general rule, balance or check your books once a month, but once at the end of a week, is an

even better practice. This is a good practice whether using single or double entry bookkeeping.

Another process is testing your books. Testing is the process of proving the information in the

books. Testing merely follows postings throughout the entire process from when it is first recorded

as income to the end of the balance sheet. It is an audit trail of how the income moves from income

to paying bills or adding to assets and then its availability to owner equity.

The process to test your books is to pick several random postings and verify that each has been

posted properly. In double entry, the system of testing merely is checking that the debits and credits

are recorded properly. In single entry, you will want to verify the posting and that the number is

added cumulatively to the final total. The other aspect of testing is to follow all total numbers and

ensure that each is placed in the proper location on the next record. Thus, looking at the income

total (profit) from income statement is placed on the cash flow and then the totals there are place in

the balance sheet properly.

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15.3 Mistakes and Adjustments

In Module 1 of this course, we mentioned that mistakes happen. The question becomes what to do if

a mistake happens in accounting. Don’t worry you do not have to go back and start over from

scratch with your books. This would be impractical, as you might have to correct books from several

years ago. In addition, this is unethical, as the numbers shouldn’t be changed, even if incorrect.

The main practice to undertake when a mistake is found is to make an adjustment to the books to

rectify the numbers.

Accounting knows that mistakes will happen so this is not a major issue, but there are some

practices to follow to do it right.

In most situations identify what the problem was and make an adjustment to the documents to

correct the problem. Thus if an $8000 bill was recorded as income, probably one of the worst-case

scenarios there is a process to adjust this mistake without too much discourse. The first step will be

to make a notation in the books of the issue. Then an adjustment is made for the problem. Note that

this may mean doubling the effect of the original mistake. For in the case of our $8000 income

mistake, which was a bill, means that we not only have to subtract the $8000 form income. However,

we need to subtract the amount of the bill. Therefore, the total adjustment in this case is $16,000.

However, this would depend on the mistake and how it affects the financial records. Therefore, do

not presume that any correction is always a doubling of the mistake on the books. You might have

forgotten to add a zero on the expenses, thus it is not a doubling in the change.

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The first step in adjustments is to identify the issue or error. Part of this process will be to

determine what type of impact it caused on the books. It could be a forgotten digit, a wrong recording, or

it might have been a miscoded entry (one of the easiest to handle)

The next step is to decide what type of adjustment needs to be done. It might mean that the number

needs to be reclassified or it might need to be adjusted in the reporting. The simple practice is to

examine how the mistake affected the books and what action will truly fulfill the process. While acting

on this process, check to see if financial reports need to be restated. Some action might not have

influenced the reports because they didn’t affect the issues significantly.

For example, most major corporations have minor accounting issues throughout the year. If they

reported each of these infractions, it would severely complicate their reports every year. However, the

actual issue might only change the balance sheet by a few hundred dollars. For a company where the

reporting error is in the hundreds of thousands, this is not that practical. Thus, most will just note it and

adjust the following books rather than constantly adjusting the books for every minor infraction. These

are the types of errors, which have no material effect on the company’s bottom-line or balance sheet.

For larger issues, the procedure to adjust a mistake is to first make an adjustment to assets or liabilities

at the beginning of the newest recording period. Thus if the mistake occurred in May then the

adjustment would be made in the month it was discovered, perhaps September.

If the adjustment will have a material impact on the books, then the mostly likely place to indicate the

change is in the retained earnings of the company. This is part of the owner’s equity on the balance

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sheet. Just as owner’s equity is the catcher of leftover assets on the balance sheet, this is the function of

retained earning with mistakes. Retained earnings are just an intangible concept of earnings staying

with a company. Thus, they can adjust intangible issues in the accounting process. It is possible that

retained earning can be negative. Therefore, it is easier for this section to be influenced by a mistake,

without materially affecting the company’s operations.

15.4 Prep of Financial Documents

Preparation of the financial documents is an easy process, which only requires a good

understanding of the company’s financial position. Recall back in module 2 we discuss the basic

process of developing the Income Statement, Cash Flow, and Balance Sheet. You should develop

these documents at least once a year, as it is the best financial guide as to how the company is

processing. However, as mentioned above, a monthly or weekly development of these documents

would give a very clear picture of your company’s financial position. This among the other reasons

mentioned, it is highly recommended to use accounting software that will develop these documents

for you.

To refresh your memory the first document to develop, out of the three is the Income

Statement. This document will take data directly from the income and expense posting. Also, recall

that single entry bookkeeping will follow this type of document. Therefore, either form of

bookkeeping will develop the income statement from its basic design. All income will be developed in

the top section. Then each expense will be deducted to indicate what the profit or loss is of the

company.

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The next document will be the Cash Flow. This will take the profit and indicate how the cash moves

from the bottom line to the various locations of assets and liabilities. The cash flow will indicate how

certain assets or certain liabilities are increased or decreased. These figures will then move to the

final document, which is the Balance Sheet.

Recall the balance sheet, which is the guiding equation for double entry, is the ultimate indication of

how the company is doing financially. Recall that expanding assets and declining liabilities means

that the owner’s equity is increasing which is the best measure of the company’s success.

The process of preparation of the documents is very simple, mostly requiring the proper placement

of figures. Again, to save time and increase accuracy the use of software for this work would be

helpful. These documents are not too difficult to prepare by hand, each is simply placing numbers

into the correct positions and then carrying out simple math of addition or subtraction. However, the

software will perform it faster and more accurately. It allows the owner the opportunity to examine

the documents rather than spending time to develop it.

15.5 Conducting Profit Analysis

Profit Analysis comes in many forms. In the truest sense, it was originally developed to work in Cost

Accounting to examine efficiency operations. Recall that cost accounting is the forerunner of

management accounting, and that this accounting is mostly for manufacturers. However, just

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because it was originally developed for factories or manufacturing, does not mean that the process

cannot be used in everyday businesses.

Profit analysis for larger companies begins by developing a breakeven point. The best definition of

a breakeven point is one where both income and expenses meet each other, or are balanced. This

simply means that every dollar of income is spent in an expense of the company. Breakeven points

are not fixed; they will often change with time. So while one month the company may be perfectly

balanced between income and expenses. The next month the company may have a loss or a profit.

This happens because many expenses are often variable rather than fixed. For example, a

salesperson may be on commission and one month they may not have as many sales as the next

month, thus causing an expense to change.

In factory or traditional profit analysis, the main concept was examining cost-volume analysis. This

meant that costs were based on volumes, thus a company could examine how profits were changed

based on the number of items produced or steps in manufacturing increased/ decreased. This is a

more time consuming effort and does require a great deal of examination. Some accountants spend

all their days performing this type of analysis. However, for a small business or owner, profit analysis

is useful to determine metrics on how the company is performing.

One of the best forms of profit analysis for a small business is to examine the company

ratios. Ratios are merely percentages of one number as a part of another number. For example,

the profit margin is a percentage of the net profit divided by net sales. It indicates how much of each

dollar of income is a part of the bottom-line.

Many people wonder what a good profit margin is. The answer is dependent on the industry the

business belongs too. A company that makes items may have a very low profit margin, possibly

under 5% while some service companies may have margins that are as high as 50%. Margins and

all ratios are specific to individual businesses and industries. Thus, to perform a good profit analysis

one needs to compare numbers to other businesses in the same industry. Although, there is merit to

looking at the numbers of a business on an individual basis.

For example, a profit margin at 5% for one business could be perfect, if that margin means the profit

is $10,000,000. That is the point of analysis, it is meant as an internal examine of the company’s

success. While outside numbers are comparisons, the real value comes from the owner using the

numbers to increase their business.

To develop ratios of industries, there are several sources online. Some industries post numbers

online of their industries standards. However, one of the best sources of ratios is from companies

that post do-it-yourself business plans. Several of these companies have information on ratios for

specific industries.

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15.6 Liquidity and Testing

Liquidity is the quickness that a company can access cash. This can come from cash balances or

any assets that is easily converted to cash (stocks, bonds, accounts receivable, etc.)

Therefore, liquidity is just how quickly and how much cash the business has to pay an item or

items. These can be sudden issues or more likely all of the normal and expected current liabilities.

The reason that this is important is not so much for unexpected bills, but the availability of the

company to pay regular bills. Banks or other lender/ investors want to know how much cash a

business can “raise” in a short period of time. This will indicate whether the company is well

capitalized and liquid. This is an important concept as some businesses are very well capitalized, but

many of those assets could be tied up in hard, illiquid assets. Thus, the company may have plenty of

capital for the needs of the getting financing, but not enough to pay bills if sales slow down for a time

period. Liquidity indicates how quickly those bills can be paid and for how long.

The exact term of this information of liquidity is the Quick Ratio. The quick ratio is the ratio of the

company’s current assets (cash or cash equivalents) to pay current liabilities. The ratio is current

assets, minus inventory (because inventory takes time to sell) divided by current liabilities. This ratio

is usually reported then as a number higher than one. For example, a company has $2 of cash for

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every dollar of current liabilities. This ratio then would be $2/$1, which means the company, has a

quick ratio of 2. Although this number could be a bad number too. If the company only has $0.75 for

every $1 of liability then the ratio would be .75. This would indicate a company that may well have a

liquidity problem. This ratio is sometime called the Acid-Test Ratio. It is just an indication of how

quickly the company can pay bills from its current assets.

This form of testing helps companies determine their overall health. Although there are some ways that

companies can improve this ratio. The most obvious is to increase sales and retain more of the money

into cash. However, this may not always be possible. Other items may be used to decrease costs, saving

more money. Although, decreasing costs may not always be a practical business option. One possible

option is to convert current liabilities into long-term liabilities. This may seem somewhat unusual, but it

is a time-tested method to improve the quick ratio. The reason is that the liabilities remain the same

since the current liabilities is the issue in this equation, decreasing the current liabilities improves the

situation. It does not matter to the equation how the current liabilities decrease, just that they do

decrease.

15.7Internal Control

From this review of the bookkeeping process, it demonstrates that a major goal of record keeping is

control of the financial situation of the company. The processes of bookkeeping and accounting, besides

bringing standards, it develops a checks and balance system for the financial accounts of a company. It

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helps to ensure that the company meets its obligations and control the process, rather than be

controlled by the process. It keeps the company in good standings and protects it from problems. These

problems could be as bad as employee theft or defaulting on bills, to ensuring that the company is taking

every advantage possible to grow.