Easy Understanding of Bookkeeping - Part 3 Purpose of Bookkeeping
This article is meant as a guide for non-accountants and non-bookkeepers, who may be contemplating doing his own bookkeeping for his business but does not know where and how to start, or it could be for students who have just started in a bookkeeping or accountancy course, and need a quick and easy guide to refer to, rather than the thick and bulky text books that they are provided with as part of their recommended reading material.
-- Introduction --
In Part 1, I explained in simple terms the meaning of Bookkeeping and Double Entry.
In Part 2, I explained the basis of the Double Entry System, the Debit and Credit.
In Part 3, I will explain the Purpose of Bookkeeping.
In order to understand why we do certain things, which we do in the first instance, while doing our bookkeeping we need to examine and understand the purpose of bookkeeping.
The purpose and the end-products of the bookkeeping and accounting cycle are what are known as The Final Accounts.
Here I will explain briefly what these Final Accounts are (read section on Final Accounts to know how to prepare your Final Accounts).
The Final Accounts are:
-- The Trial Balance
The Trial Balance is a list of all the balances from your ledgers (read section on Ledgers to find out more on ledgers), these are the Debit and Credit balances (read section on Double Entry to find out more on Debit and Credit).
The Trial Balance is used to determine if the ledgers are balanced. The total debit and the total credit balances in the Trail balance must equal each other, for example if the Debit balances in the Trial Balance equals to 6,596,087.99, then the Credit Balance must also equal to 6,596,087.99. Nothing more nothing less, not even a single penny.
Any differences in these balances means that the double entry in the ledgers are incorrect and has to be corrected before the other Final Accounts can be prepared.
-- Income Statement
The Income Statement which is also known as the Trading Account and the Profit and Loss Statement is basically a statement that you prepare to calculate your Gross Trading Profit by calculating how much Sales you made, how much was your Purchases and Cost of Goods Sold and any other expenses which are directly connected with your sales and purchases, for example Transport Charges for goods purchased or Delivery Charges for goods sold.
After determining your Gross Trading Profit you would then deduct it from your Administrative and other expenses to calculate you Nett Profit or Nett Loss for the year.
-- Balance Sheet
The Balance Sheet is used to calculate and get a snapshot of your company's current financial position by listing all the Current and Fixed Assets, the Current and Long Term Liabilities, the Shareholdings and Capital and the Profit or Loss for the year and the Accumulated Profit or Loss of your company.
It will reflect what is known as your company's Nett Worth. A positive Nett Worth means that your company has more Assets than Liabilities and a negative Nett Worth means that your company has more Liabilities than Assets and would be hard pressed to meet payments to Creditors and banks.
I will go into more details in the Section on Final Accounts in later articles.
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