Since he is also not able to forecast his revenues and expenses and no accounting records are available with him, the bank refused to extend cash credit. To make things worse, he received a notice from the income tax department to justify his income tax liability. Due to lack of proper books of account, he could not justify his income tax liability and was penalized a huge penalty. At the moment due to a severe cash crunch, he is on the verge of closing his business.
This may be a hypothetical situation, but it amplifies the need to have proper accounting books. Maintenance of books of account is important in any business, whether it is small or large sized. Sad to say, most of the small and medium business entrepreneurs often neglect this process, which has a direct adverse effect on the business.
In fact, some SMEs failed in financial management due to weak or no accounting records. They do not maintain their books of account, because they think maintenance of books of account for their small business is worthless. On the contrary, financial management is very crucial to the success of a small business.
Without it, there is fear of hitting cash flow crisis, wasting money and other financial information issues, which could lead to the closure of a business. In this competitive market, accurate book of account is a necessity for every small business. Khandelwal R Sethi & Company, Partner, Ravi Khandelwal says “Starting and maintaining solid accounting records is essential for the growth of a small business.”
Maintaining books of account is the process of recording and maintaining of financial transactions and information relating to a business, on day-to-day basis. It ensures that records of the individual transactions are correct, comprehensive and updated with accuracy.
Q: Why SMEs should maintain books of account ?
A: To prepare Financial Statement: Balance sheet, profit and loss account, cash flow statement are the key elements for reporting to your investors/ financiers/bankers on crucial information about the financial status of the enterprises, and to prepare these financial statements you need books of account.
To fulfill tax obligations: If you want to do business, you have to pay taxes like income tax, sales tax, excise duty, service tax, central sales tax etc and to know the correct amount of tax obligation and to settle the business/legal litigations, you should have adequate and accurate books of account.
Legal requirement: As per Section 44AA of the Income Tax Act, every person whose income from business or profession exceeds Rs. 1.20 lakh or the Total sale/ turnover /gross receipt exceeds Rs. 10 lakh are mandatorily required to maintain books of account for income tax purpose. Further Section 128 of the Companies Act 2013 also requires every company to maintain their books of account.
Better financial management: At present, better financial management provides a better picture about the health of a company. To make forecasting of financial requirement, acquiring necessary capital and to analyse investment decisions, you should have adequate records of business transactions.
Price fixation: Price fixation is the biggest issue for the small businessmen – at what price he should sell his product or service? Price of most the products have been fixed on cost plus margin basis and to ascertain the cost of a product you should have proper records of cost elements of the product. “A business that does not have books of account is like a blindfolded driver who can easily cause an accident,” says Gxpress Solution India Pvt Ltd, Promoter Director, Praveen Vashistha.
Q: How to maintain books of account?
A: For the simplicity, accuracy and security of books of account, small business entrepreneurs can maintain his books of account in electronic mode. Even Companies Act 2013, under section 128, also allows maintenance of electronic books of account. There are many software available in the market for the maintenance of books of account at an affordable rate. While keeping books of account, every transaction must be recorded according to applicable accounting standards and principles, because these principles/standards ensure the accuracy and all requirements of the industries and law. Hence, the following aspects need to be considered while preparing books of account.
Double Entry Accounting System: This serves like an error identification system. According to the double entry system of accounting, every transaction has two parts; therefore it affects two ledger accounts while recording a transaction. It involves a debit entry in one account and a credit entry in another account. If the sum of debits does not equal the corresponding sum of credits, then it means an error has occurred. It also ensures accuracy of recording of transactions.
Accrual Basis Accounting: Accrual basis of accounting is considered as standard accounting practice worldwide, because it provides a more accurate measure of a company’s profitability, as it takes into account all revenues and expenses irrespective of cash collections and expenditures. For example, an expense incurred in a period for which no invoice had been received at the end of that period, is considered an accrued expense, and is still recognized.
Recording of every transaction: Every business transaction whether it is a purchase or sale, expenses or income, payment or receipt must be recorded on daily basis into the books or accounting system, because recording of every transaction says we are preparing adequate and complete books of account.
Documentation: There must be a document for each transaction that describes the business transaction like sales invoice, a supplier invoice, a supplier payment, bank payments and journals. These documents provide the audit evidences for each transaction and are an important part of maintaining accurate records in the event of an audit.
Bookkeeping may seem a burden at the growing phase of business but it is essential in order to manage the daily functions of a business which keeps the business running successfully.
Source: The Economic Times