by Alan Knott.
In simple terms the main reasons for book-keeping are:
- to keep records of income (money coming in) and expenditure (money spent) so that the profit or loss during a period of time can be easily worked out
- to keep records of assets (property and stock owned) and liabilities (bills or money still owing to others) so that the financial situation of the project or business can be worked out at any time.
There are two main systems for keeping the accounts of small businesses. These are single entry book-keeping and double-entry book-keeping. Their names really explain themselves. In double-entry book-keeping, for every entry recorded, it is in fact recorded twice, whereas in single entry book-keeping, it is just recorded once. For very small businesses, the single entry system is often preferred, but I personally prefer the double entry book-keeping system, because when mistakes happen (and they always will!) they are much easier to find. This system can also deal with unpaid bills and accounts. Therefore the rest of this article will concentrate on double entry book-keeping.
There is much more that can be learnt about this subject - and if there is enough interest, further articles may be possible. However, I trust that this article will help you as you seek to serve the Lord in whatever work you are involved with.
Whenever possible, use the advice of a trained book-keeper when you are preparing your accounts.
The book-keeper records information from the point of view of the business and their effect on the business, not from a personal point of view. The business or project is thought of as a separate concern, even though - especially with small businesses - the business and the manager are in fact the same.
Some worked examples
Now we can begin to look at how we actually set out the accounts and record the entries. These examples all look at the small business set up by Samuel Gomez selling cooking pots. No currency is used so that these examples will be useful in every country. They can be used for any other kind of business or project. The notes refer to the transactions recorded in the accounts.
(You may find it very helpful, after each example, to record each item on a separate piece of paper, so that you become familiar with the process. If you try and simply read through this article, you will probably get rather confused.
So look at each example in turn, writing it out for yourself. When you have understood each example, try re-writing it using some of the items for which you need to keep accounts - e.g. medicines, bandages, seeds, or vegetables. Don’t move on to the next section until you fully understand the one before it.)
Section 1: The Ledger
- Every transaction is entered into an account called a Cash Account as well as an account that describes the transaction (the business carried out). The reasons for this are because cash is involved on each occasion. Sometimes items are bought or sold on credit, but the recording of such items is complicated and we will not look at it in this article.
- Every transaction should be dated with the day it took place. This is very important when you are trying to sort out accounts. It is much easier, if possible, to record transactions as they happen.
- Notice the layout - debits (Dr) are on the left hand side of the page and credits (Cr) are on the right.
- Appropriate headings are made to the various accounts. Normally each account would use a separate page.
- There are two entries for every transaction…
For every debit there is a credit.
For every credit there is a debit.
This is the basis of this system of accounting.
If we were to total all the entries recorded on the debit side, the total should agree with the total of all the entries on the credit side. Every entry is in fact two entries. For example, if goods are bought for cash, goods are received and this needs to be shown in the Purchases Account, but cash has gone out of the business and therefore this needs to be shown in the Cash Account.
Note 1 Jan 1: Samuel Gomez begins his own business selling cooking pots with 100.00 cash.
Note 2 Jan 1: He buys four cooking pots, paying 60.00 in cash. Note 3 Jan 2: He sells two cooking pots for 60.00 cash.
Note 4 Jan 10: He sells two pots for 50.00 cash.
Note 5 Jan 10: He spends 10.00 on advertising.
Section 2 The Question of Profit
Under this section, we are going to look at the Trading Account, the Profit & Loss Account and the Balance Sheet.
I do appreciate that not all of you will be involved in projects or businesses that make a profit. However, there will be times when you want to know how the project is performing and perhaps, at the end of a project, what funds are remaining.
It is important that we understand that making a profit is not wrong! In India, where I have a particular interest through ACTS Institute, the students are trained to establish their own businesses, and at the same time to be church leaders. They live on the profit that they make from their business.
Using the example above, Samuel now wants to know if he made any profits from the transactions.
(Normally you would only check the book-keeping, either at the end of each month or every three months. For small businesses, books are often only balanced once a year. However, these examples are deliberately kept short to make them simpler to follow.)
The difference between the cost of buying the goods and their selling price is known as the Gross Profit (or Loss). This is worked out by looking at the Purchases and Sales Accounts…
Purchases total 60.00 (note 6) and Sales total 110.00 (note 7). The difference of 50.00 is known as the Gross Profit (note 8). For book-keeping purposes, this is transferred to a new account called the Trading Account (Figure 2b) and the Purchases and Sales Accounts are closed as they have served their purpose…
We still have a 50.00 Gross Profit debit entry on the Trading Account for which, under double entry book-keeping, we must create a credit entry. This is made in a new account called a Profit & Loss Account (note 8).
The Profit & Loss Account is a summary of the profit or loss made and the expenses of the business. There were expenses of 10.00 for advertising. We therefore credit the Expenses Account with 10.00 (note 9) by transferring the balance to the Profit & Loss Account. Like the Purchases and Sales Accounts, the Expenses Account has served its purpose.
We are now able to see that our Net Profit is 40.00 (note 10). It is possible for the expenses to be greater than the Gross Profit, in which case the business would have made a loss.
The balance of the Profit & Loss Account is one entry and in this example is on the debit side and therefore a credit entry must be made.
The net profit is a result of the trading activities of the owner of the business, or manager of the project, either by him or her directly, or through others. The profit therefore belongs to the owner of the business. The Net Profit is transferred to the owner’s Capital Account as a credit. This is in addition to the original sum of money that he or she put into the business. If the business had made a loss, it would have reduced the owners Capital Account.
All that remains now, is for the Cash Account to be balanced and the balance carried forward. The balance carried forward is the amount of cash available for the next trading period.
The Balance Sheet
The Balance Sheet is in two parts; the assets and the liabilities of the business.
ASSET all forms of property and possessions that the business holds, including amounts owing to the business.
LIABILITY all sums owed by the business.
The balance of the Cash Account brought down (140.00) represents the amount of cash in hand at the date of balancing and which is available for future trading. The cash in hand is an asset and is a possession of the business. The Capital Account balance of 140.00 represents the amount to the owner’s credit at the date of balancing.
The Balance Sheet is a statement of all the assets and liabilities of the business after all the transfers have been made in preparing the Trading and Profit & Loss Accounts. All remaining balances are either assets or liabilities and the Balance Sheet statement is prepared with assets on the right hand side and liabilities on the left hand side.
Section 3 The Question of Stock
In practice, it is unusual to find that all the stock has been sold. If there is stock remaining, then this forms part of the business and has to be included in the accounts.
Let us suppose that Samuel Gomez continues in business for a further period, as shown in Figure 3a.
Note 11 Jan 12: Bought 4 pots for 36.00 cash.
Note 12 Jan 15: Sold 2 pots for 12.00 each.
Note 13 Jan 16: Paid lighting bill 10.00.
Note 14 Jan 17: Sold 1 pot for 25.00.
Note 15 Jan 18: Withdrew 10.00 for personal needs out of profit.
The value of the stock at the close of this trading period was 9.00 (note 16). The stock should be valued at cost price and you should not include any potential profit.
A separate Stock Account (Figure 3b) is opened so the value of the stock remaining is not confused with the purchases. If this is not done, it distorts the trading position of the business.
Samuel Gomez continues in business for a further period (see Figure 3c).
Note 17 Jan 19: Bought 4 cooking pots for 40.00.
Note 18 Feb 10: Sold 2 pots for 30.00.
Note 19 Feb 12: Paid various small (sundry) expenses 10.00.
In Figure 3d, I detail the new Trading and Profit & Loss Accounts as at the 12th February and the Balance Sheet. The stock of pots at the end of the period, at cost, was 29.00 (note 20).
In this trading period, we have stock at the beginning as well as at the end. The total stock is available for sale.
This is how you work out the total ‘cost of goods sold’ during this period… Stock at start 9.00 (note 16) Add Purchases 40.00 = 49.00
Less stock at close 29.00
Cost of goods sold 20.00
These goods sold for 30.00
Gross Profit (30.00 - 20.00) 10.00 (note 10)
We hope this brief summary of book-keeping principles will be of practical use. Please let us know if you find it helpful in your own book-keeping.