The first step in learning how to prepare financial statements is understanding the accounting system. The accounting system is how you get transactions occurring in your business to show up on your financial statements.Explaining the Accounting System
So, what exactly happens with an accounting system? Well, as events happen in your business, you evaluate the best way to handle them.
Keep in mind that accounting is a double-entry system: For every entry into the company accounting records, there has to be an opposite and equal entry. For example, if you buy a new tool for your arts and crafts business that costs $100, you'll have an equal decrease to cash or increase to the amount you owe on your credit card statement. Technology gives you a hand here: No accounting software package worth its salt will let you enter a lopsided transaction into the accounting books.
That being said, your first step in the exciting foray into accounting systems is deciding which journal the business transaction belongs in.
Accounting journals are a lot like that diary you may have kept as a child. They are a day-to-day recording of events. Accountants call journals the books of original entry since no transactions get into the accounting system without being entered into a journal first.
You'll have two cash journals. One records cash you receive (woo-hoo!); the other records cash you pay out. And, remember here that cash also includes checks and credit card transactions. That's because cash is a generic term for any payment method that is assumed to be automatic. When you sign a check or a credit card receipt, you are giving your word that you have the funds to clear the check or have the limit to clear the credit card transaction.
Now, what are the different ways you can bring cash into your business? Well there are a few. For example, you make a sale at an arts and crafts show and the customer pays with paper money. While, some businesses may have few customers paying in cash, I am still amazed by the amount of cash sales my retail clients take in from customers every day.
Maybe your arts and crafts business checking account is interest bearing. When a bank or investment account pays a business for the use of its money in the form of interest or dividends, it's also considered a cash receipt. Also, if you contribute money to your business that's considered to be a cash receipt too.
A lot of times we have to (hopefully briefly!) put our own money into the business checking account in order to clear checks or pay for other business related expenses.
Finally, cash payments for transactions that originally started off in another journal are also cash receipts. For example, when customers make payments on their account. This relates to the sales journal (which I talk about later in this series of articles) and accounts receivable (a balance sheet account), which is money customers owe a business.One more biggie way that a business will have cash receipts is if you sell one of your arts and crafts assets. Selling a business asset like a flex shaft, drill, soldering equipment or office furniture can also result in a cash transaction.
Setting Up the Cash Receipts Journal
The cash receipts journal will normally have six columns. Since all transactions in the cash receipts journal involve the receipt of cash, one of your columns is always for cash. The other is for sales discounts which reflects any discount the business gives to a good vendor who pays early.
For example, a customer's invoice is due within 30 days but if the customer pays early, they'll get a 2% discount. So if the invoice is for $100, they only have to pay $98. To balance these debits, the credit columns in a cash receipts journal are sales, accounts receivable, sales tax payable which is the amount of sales tax the business collects on the transaction (not always necessary) and miscellaneous (a catchall column where you record all other cash receipts like interest and dividends).
The image on this page is a partial cash receipts journal. The next article in this series shows a larger view and walks you through this partial cash receipts journal.