The double-entry bookkeeping system is one of the most amazing commercial tools available. Without it businesses of all shapes and sizes would collapse into monetary mayhem. They would lose money right, left and centre without even being aware of it, until the day the coffers were cleaned out and the cheques started bouncing.
Whether you are a business owner, director, partner or manager, or whether you are a bookkeeper or accountant, you need to read this chapter. Even if you choose not to make the effort to understand it fully you need to be aware of the key lessons it contains.
It may strike you as strange that since this work has been produced for the benefit of business owners, and potential business owners, more than for any other group, it should contain a section on bookkeeping! Show me an entrepreneur who is interested in bookkeeping and I’ll show you a pig with wings. Yet all business owners have to ensure their accounting systems are working properly, which is tantamount to ensuring that their bookkeeping is working properly. And they all need to understand their accounting information, and that too has its roots in double entry bookkeeping.
The fact that many, in truth probably the majority, of business owners feel uncomfortable with their accounts has a lot to do with them having little idea of how the figures making up their accounts are built up. And that starts with bookkeeping.
Do yourself a favour and get your head around the next few pages here and now – it really won’t take long. The understanding you are about to obtain will last you for the rest of your business life. It is more far-reaching than you would at first expect, as you will soon see. You will draw on your new-found understanding, without realising it, almost literally every day of your business life, and certainly every time you look at a set of accounts, or a plan, budget or forecast. It’s that fundamental.
Numbers are the language of business. You are about to be shown the grammar.
But there is another important practical reason for revealing to you the basic workings and logic of the double entry system. It is this. Most business owners quickly delegate their bookkeeping to a staff member – which invariably is the right thing to do, except perhaps when you are just starting out, and in a few atypical situations. But where things go wrong is that it doesn’t even occur to the majority of business owners that bookkeeping is any more complicated than typing a letter, or sending an email, using a spreadsheet or entering data into a database. Therefore they frequently ‘dump’ the task of bookkeeping on some poor unfortunate person who also knows no better. Then they wonder why they foul up!
In the coming pages you will see that bookkeeping does require a degree of technical understanding. And I suspect you will find some of the logic – even though we will skim it – mildly challenging. Having read these next few pages you will never make the mistake of appointing an unskilled person to look after your books.
And if by chance you do want to get involved with bookkeeping personally, for whatever reason, you will find the following explanations give you the deepest and clearest understanding of the fundamentals on which the system rests. That will prove invaluable in preventing you from getting into a knot as you sit at your keyboard with your accounting software displayed on screen.
Furthermore, once you understand the extent of the benefits conferred by the double entry system, you will be less likely to try to side-step it. You are less likely to succumb to the lure of simplicity which is put forward to promote accounting software which does not use the double entry system. You will understand that simplicity of use, if it comes at all, comes at a hefty price. That price is in the form of reduced reliability of the information within the package. In short, data and reports are likely to be error-prone.
The simple truth is that the double entry system of bookkeeping lies right at the heart of finance and accounting. It is an extraordinarily neat system. It has remained virtually unchanged since the fifteenth century. It is so enduring because it is sound in logic and robust in practice. It is applicable to all businesses everywhere regardless of size or activity, whether a corner shop or a global banking consortium.
Yet for all its importance it is often misunderstood. It has baffled many would-be accountants, many bookkeepers and many business owners, managers, directors and partners.
One of the two reasons for this widespread confusion is that it is usually only technicians – that is, accountants and bookkeepers – who ever get to grips with the double entry system. Unsurprisingly, business owners and managers rarely do so.
The second cause of confusion is that only rarely is the double entry system explained properly. It is usually taught as a system of rules – in this situation do this, in that situation do that – with little explanation, or worse sometimes even incorrect explanation of the logic and truths behind the rules. It is often assumed to be simpler than it actually is (“it’s only bookkeeping”) and so tends to be presented with little depth of explanation.
Well, pay attention, because I am now going to take you right to the heart of this pivotal and tantalisingly clever system. Let’s dive in.