Here’s some accounting basics on using Journals and Ledgers.
If you’re thinking about setting up a simple bookkeeping system for your small business, it will help if you understand some basic accounting principles.
In accounting classes they talk about the Accounting Cycle. This is where you have business transactions occurring, then these transactions are recorded in journals, then the journal entries are transferred to ledgers, then finally the amounts in the ledgers are transferred into financial statements.
This process is the essence of bookkeeping. The recording of transactions. The transfer to ledgers. The preparation of financial statements.
When you start a small business, you may buy an accounting software package, then play around with it until you know how to invoice customers or pay your bills, and then it will automatically prepare some financial reports for you.
But, maybe your business is pretty small yet, or maybe you just like paper and pencil, and want to start with a manual accounting system.
Even if you’re going to use QuickBooks or Xero, you will still benefit from learning the manual system, as then you will know how everything relates and works together. You’ll know what’s going on behind that computer screen. And then maybe financial reports will make more sense to you. I like my customers to understand the numbers.
So bear with me as I try to explain this process of accounting basics, of debits and credits, using accounting journals and ledgers, and putting it all together.
Okay, so you’re going to start a business.
What do you do first? What do you need?
First, you need to initially set up your office. That can be an official office at your place of business, or if you operate a home business, it might be your dining room. Whatever the case, here’s what you need.
- A business bank account
- Cash disbursement and cash receipts journals
- A Chart of Accounts
- A General Ledger
- Business specific forms – letterhead, invoices, etc.
- An initial Balance Sheet
The Accounting Cycle and how it works.
The Accounting Cycle (I mentioned above) starts with business transactions.
These business transactions are entered into Journals. A Journal is a book where transactions are recorded. In the old days, it was an actual book. Today, a journal could be a page in a book, or it may be a page in a computerized accounting software, or it may be an entry in an Excel spreadsheet.
- checks entered into a cash disbursements journal
- cash received entered into your cash receipts journal
All your transactions for a month are entered into journals.
I’ll have blog posts for these two journals covering them in more depth.
These journals can be made in Excel, or from an actual journal book, or a pack of accounting paper, which is green (or white) paper with anywhere from two columns to as many as 20 or more columns on a page. These columns are for entering your data.
At the end of each month, we then total all our columns up.
In our Sales Journal, we will have totals of all Sales for the month, as well as a total for Accounts Receivable (provided we sell on credit or let our customers pay on time).
In our Cash Disbursements Journal, we’ll have totals for Cash Spent, and totals for maybe Purchases, Supplies, Insurance, Rent, Utilities, etc.
In our Cash Receipts Journal, we’ll have totals for Cash Received, and a total for Sales Collected.
The next step would be to transfer the information for a month in these journals to an accounting ledger. A ledger is a book that keeps track of the basic accounting transactions for your business by account. Each account has a page that lists all activity, debits and credits, and a running balance.
These balances are then used to prepare a Balance Sheet and Income Statement, which closes the accounting cycle.
To summarize, business transactions are recorded into journals, which are then summarized into a ledger, which is used to prepare financial statements. This is the Accounting Cycle.
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