Although many business owners do not wish to understand the intricacies of double entry bookkeeping, they are interested in invoices. By understanding how an invoice is processed through the books you will gain understanding of the bookkeeping process but also how your accounts can be used to assess how your business is doing.
A businesses books are made up of a set of accounts or (nominal accounts) with transactions debiting and crediting these accounts such that the sum of the balances of these accounts is always zero. There are also accounts for customers and suppliers – although these do not form part of the businesses financial position.
Impact of the Invoice
When an invoice is raised there are 3 nominal accounts impacted – the debtors control account, the sales account and the sales tax control account.
So, an invoice for £100 + VAT at 17.5% will have the following impact.
| Account | Debit | Credit |
| Debtors | 117.50 | |
| Sales Tax Control | | 17.50 |
| Sales Type A | | 100 |
The customers account will also be debited £117.50 – but this does not form part of the financial accounts.
What can we use this for?
Manage debt
The debtors control account will show us the total amount owed by all our customers. Keep this low! Most software will also have an aged debt report which will apportion this debt to each customer and show how long it has been due for. Use this to manage your cash flow.
Typical Aged Debt Report
Most software will also allow you to create statements for the customer showing what amounts are outstanding.
Monitor how much VAT you will have to pay.
For companies using standard VAT (rather than cash accounting) VAT is due on invoices raised. So, the amount of VAT to pay in the next return will be the (approximately) the difference between the Sales Tax and Purchase Tax control accounts. Make sure you have taken this into account in your cash flow – make sure you have enough money in the business to pay the VAT.
Sales analysis
This invoice was raised to the sales account “Sales Type A”. The sales accounts accumulate the total invoices or sales over the financial year. So, by creating different sales accounts to represent different areas of the business you can see which areas of business are generating the most revenue.
For example, you may choose to create sales accounts based on geographic area – creating Sales North, Sales South, Exports etc.
Alternatively you may use different areas of your business such as consulting, advertising, wood products and metal products.
Impact of the Receipt
Hopefully you will get paid for your invoice.
When this happens you record a customer receipt.
| | Debit | Credit |
| Debtors | | 117.50 |
| Bank Account | 117.50 | |
The customer account and the individual invoice will also be credited with the received amount.
The customer receipt has the effect of debiting the Debtors control account by the amount received and debiting the Nominal account representing the bank account.
The original debt has been removed from the Debtors' control account and the same amount Debited to the bank account.
Many people (including myself) become confused at this point. Having received money from a customer and paid it into my bank account – why is the account debited?
To understand this we first look at the accounting equation:
Assets = Liabilities + Owner’s Equity
In order to ensure that this equation always balances bookkeepers use a trick – they record an increase in the value of everything on the left of this equation as a Debit and an increase in the value of everything on the right as a Credit.
(In my opinion the equation should read: Assets + Liabilities + Owners Equity = 0).
This is why when you pay money into your account the tiller will “Credit” your account. To the bank your account is a liability so to increase the value they credit it. You debit your account because to you its an asset.
If you didn’t follow this – don’t worry. What you do need to know is - both the Debtor’s control account and the Bank Account are assets of the company so we debit these accounts to increase their value.
What can we use this for?
Monitoring the cash position of the business
The books tell us how much money is actually in our bank account.
Monitoring the speed, frequency and pattern of payments from customers
Look historically at customers who take a long time to pay and maybe ask for up front payments from them. Look for payment patterns – if a customer always seems to pay at the end of a quarter perhaps this is the best time to do business with them or to ask for payment.
Reconciling our bank accounts.
Since we have a complete list of transactions against the bank account on our books and a complete set
Conclusion
A basic understanding of double entry bookkeeping coupled with a decent accounting system can help you manage your cash flow more efficiently.
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