Is your business spending too much money on materials? Can you afford to hire a new engineer? Good financial statements will help you answer those questions and more. Journal entries are the fundamental building blocks that financial statements summarize to help you understand your company’s profitability and other financial metrics.
Learning how to create a journal entry is one of the essential steps to ensuring a company’s accurate financial record keeping. In addition, these transaction entries keep tight controls around the most important financial metric, an organization’s cash flow.
Since the 15th century, many companies have employed the accrual accounting system to track their debits and credits. Even though numerous businesses continue to follow a cash basis system, it is crucial to understand journal entries within the double-entry system for both types of accounting.
What Is a Journal Entry
A journal entry (JE) is a way to record or correct a financial transaction in a company’s accounting system. These transactions are recorded in the company’s book/journal, called the general ledger.
JE’s consist of header and row information, are the first step of the accounting cycle, and record the detailed transaction on a specific purchase, for example.
For taxes and other external stakeholder requirements, businesses use double-entry accounting. This bookkeeping system involves debits and credits, and each side must match or “balance” exactly. There’s a specific report to check for “out of balance” transactions called the trial balance.
Maintaining consistent records of your transactions helps keep your company information organized. Recording this data chronologically makes it easy to locate important information, identify potential accounting errors, and simplify your cash flow management.
Since journal entries are the first step in the recording process, it is a precursor to creating financial statements such as the income statement, balance sheet, and statement of cash flows.
In addition, auditors use the information contained in the journal entries to monitor company performance and profitability.
Debits and Credits
Money doesn’t just disappear or appear out of nowhere. It has to come from somewhere, and go somewhere. Here is where debits and credits become valuable.
Debits and credits are bookkeeping entries that balance each other out. These two terms signify actual accounting functions, both of which cause increases and decreases in accounts, depending on the type of account.
An example of a debit and credit is purchasing a piece of equipment such as a laptop for your company. Economically, one asset (cash) has been traded for another (equipment). In this scenario, we would credit cash to reduce it and debit equipment to increase it by the value of the laptop.
Recording Journal Entries
To record a journal entry, begin by entering the date of the transaction in the journal’s date column. In the rows, list each account affected by the transaction on a separate line.
Identify if the transaction is a debit or credit. You can use this acronym for guidance: DEA-LER
DEA represents the debits that go on the left side: dividends, expenses, assets, and LER represents the credits on the right: liabilities, equity, revenue.
An example of a journal entry within the service industry would be payroll. If you pay someone $5,000 this period, this transaction is considered a business expense under the debit entry, and the credit entry must equal the $5,000 under cash or liability.
Automation to the Rescue
An automated journal entry system saves you time and reduces the amount of duplicate work accountants, and bookkeepers often need to endure. As accounting systems grow in complexity and the number of journal entries increases exponentially, at some point, it only makes sense to employ an automated accounting software system.
Transactions like the examples provided in this article are automatically entered into the correct account when paying a bill or invoicing a client. Invoices are credited, payments are processed, and bills are paid automatically according to your dictated parameters.
Even with automation software, accountants still need to make a few manual journal entries, such as adjusting accruals, depreciation, and amortization sometimes referred to as “non-cash” entries.
Try FINSYNC’s accounting software with no upfront cost. The all-in-one platform allows you to create, review and approve journal entries while simplifying your cash flow management.