Accounting 101 – the ABC of Finance for Business

research and draft written by Subhadra Kartik

article written by Wayne Brown

It’s important to state at the beginning that we are not qualified or practicing accountants, although we have studied the subject at varying levels. Therefore we have built this series based on research from a range of sources all of which shall be clearly stated where used. At the end of this article you will find additional resources in books, video, TED Talks, etc. as a way of supporting your deeper investigation. Hopefully by linking directly to the source, this provides the blog writers some additional exposure.

Why is Accounting Important in Everyday Life?

– article extract from epci university

Accounting is an often overlooked career, and yet it is a skill that’s used regularly in daily life. While it’s true that accounting is most typically viewed as an essential part of the business world, you’re most likely performing some type of accounting task in the “real world” as well.

Most people like to know how much money they currently have.

Most people like to know how much money they currently have, which means they check it on a regular basis to verify charges. Chances are you were checking the balance and looking to see that all the charges were correct. In the accounting world, this is known as reconciliation.

What happens if you spend more money than you have? The answer isn’t pleasant to think about. When you overspend, you are left with a zero or negative balance, and often you incur additional banking fees that put you further in the hole.

To prevent this from happening, people usually use a budget. You create a budget by looking at your income and your expenses and make sure that at the end of your pay period you have enough to cover everything.

An accountant is doing the same thing for an individual, business or organization, but usually with a different goal in mind: to make a profit. They look at cash flows, expenses, inventory, and more. The goal is to have a positive balance at the end of each cycle or period.

In economically unstable times, it’s common for people to assess the future. The desire is to have enough so you can stop working, pay for your child’s college tuition, and have money for a vacation, a home, or a car. You’re planning ahead financially, and the ultimate goal is a healthy financial future.

Accountants also are consistently working to maintain and expand the financial health of businesses. They do it several ways—just like you do. Investments, savings goals, analyzing, debt control and profitability are just a few key concepts in financial planning. Every time you sit down and think about how you’ll have the money to do important things you are using accounting skills.

What is Accounting and Why is it Important For Your Business?…

– extract from a blog written by Ryan Smith on September 19, 2019

Accounting is how your business records, organizes, and understands its financial information.

You can think of accounting as a big machine that you put raw financial information into—records of all your business transactions, taxes, projections, etc.—that then spits out an easy to understand story about the financial state of your business.

Accounting tells you whether or not you’re making a profit, what your cash flow is, what the current value of your company’s assets and liabilities is, and which parts of your business are actually making money.

Accounting matters for small business

Accounting helps you plan for growth. Every great journey begins with a roadmap. When you’re planning your company’s growth, it’s essential to set goals. What should your profits look like one year from now? How about in five years?

Financial statements let you properly assess how quickly your business is developing. Without accurate financial statements, it can be tempting to fall back on easy metrics like “sales growth,” which don’t give you the full financial picture. Has your cost of goods sold increased? Are margins thinner? Are your growth goals reasonable? Without financial statements, you won’t have an objective answer.

Up-to-date financial statements demonstrate where your company stands. They’re essential if you want to fund your small business with a loan. Accounts and financial statements represent the organization in front of stake holders, such as investors, creditors, debtors, government, customers, and employees. Budgets help businesses plan strategies, save money for expansion plans, and capital expenditure.

Potential investors or buyers will expect accounting records that prove your business is profitable and on-track for growth. These records should be provided by a CPA. Solid accounting gives you complete, accurate financial records, which reduces your risk of breaking tax laws. And, when you have an accountant filing your taxes for you, you can be sure they’ll be done accurately and on time.

Types of Accounting / Branches of Accounting…

– extract from the site AccountingVerse

Different methods of accounting for different applications
  1. Financial Accounting: Financial accounting involves recording and classifying business transactions, and preparing and presenting financial statements to be used by internal and external users.
  2. Managerial Accounting: Managerial or management accounting focuses on providing information for use by internal users, the management.
  3. Cost Accounting: Often times considered as a subset of management accounting, cost accounting refers to the recording, presentation, and analysis of manufacturing costs. Cost accounting is very useful in manufacturing businesses since they have the most complicated costing process.
  4. Tax Accounting: Tax accounting helps clients follow rules set by tax authorities. It includes tax planning and preparation of tax returns.
  5. Auditing: External auditing refers to the examination of financial statements by an independent party with the purpose of expressing an opinion as to fairness of presentation and compliance with GAAP.
  6. Forensic Accounting: Forensic accounting involves court and litigation cases, fraud investigation, claims and dispute resolution, and other areas that involve legal matters.
  7. Fiduciary Accounting: Fiduciary accounting involves handling of accounts managed by a person entrusted with the custody and management of property of or for the benefit of another person.

Basic Accounting Principles

– extract from the site AccountingVerse

Accounting principles serve as bases in preparing, presenting and interpreting financial statements. They provide a foundation to prevent misunderstandings between and among the preparers and users of financial statements.

  • The Going Concern Principle

Also known as Continuing concern concept or continuity assumption, means that a business entity will continue to operate indefinitely, or at least for another twelve months. Financial statements are prepared with the assumption that the entity will continue to exist in the future, unless otherwise stated.

  • Accrual Basis of Accounting

The accrual method of accounting means that “revenue or income is recognized when earned regardless of when received and expenses are recognized when incurred regardless of when paid”.

  • Accounting Entity Concept

The accounting entity concept recognizes a specific business enterprise as one accounting entity, separate and distinct from the owners, managers, and employees of that business.

  • Time Period (Periodicity)

The time period assumption, also known as periodicity assumption, means that the indefinite life of an enterprise is subdivided into time periods (accounting periods) which are usually of equal length for the purpose of preparing financial reports on financial position, performance and cash flows. An accounting period is usually a 12-month period – either calendar or fiscal. (A calendar year refers to a 12-month period ending December 31. A fiscal year is a 12-month period ending in any day throughout the year, for example, April 1 to March 31 of the following year.)

  • Monetary Unit Assumption

The monetary unit assumption has two characteristics – quantifiability and stability of the currency. Quantifiability means that records should be stated in terms of money, usually in the currency of the country where the financial statements are prepared.

Analysis and decision making on the back of good financial data

A skilled accountant will save you time by communicating your company’s financial state to you jargon-free while anticipating your financial needs. While a bookkeeper handles ongoing, administrative duties for small business accounting. See comparison table below:

Accountant  
Form your business
Help write a business plan
Audit your cash flow
Find cost-cutting opportunities
Advise on business strategy
Manage debt
Recommend business tools
Help open new bank accounts
Oversee payroll
Year-end financial reporting
Prevent audits
Advise on personal finances
Chase down payments
Write and submit loan applications
Plan budgets
Set up your accounting software
Manage inventory    
Bookkeeper  
Reconcile accounts,
Record transactions,
Manage AR & AP,
Adjust entries
Prepare financial statements
Send invoices
Set up and manage technology and tools
Stay up to date on laws and regulations
Basic payroll
Work with your accountant,
Tax preparer,
and Tax planner    

Accounting 101: Basic Accounting Principles To Know…

Accountants prepare and maintain financial records for businesses and institutions. They are also responsible for examining the data to be used in various reports and analyses.

Double-entry accounting

Double-entry accounting means every transaction entered into your accounting system or ledger will affect at least two accounts. For every debit entry you make, you will need to make a corresponding credit entry.

Debits and Credits

This is the most basic concept in accounting and you will use it many times when preparing journal entries or T-accounts. In general, an increase in assets or a decrease in liabilities results in a debit whereas a decrease in assets or an increase in liabilities results in a credit. When you record them in T-accounts, remember that debits = the left side and credits = the right side.

Balance Sheet, Income Statement, and Cash Flow Statement

Three financial statements that reflect a company’s performance. Each statement is used to measure different things, and because they show up very often in accounting, it’s important you know when to use each one.

The balance sheet is a snapshot of the company at a particular time, and compares their assets, liabilities, and owner’s equity. One of the main functions of a balance sheet is to give the company insight on the revenues they can expect to gain from receivables and expenses they can expect to pay from payables. It also shows the company what they own, for example, the land, buildings, and other assets they possess.

The income statement compares revenues and expenses to measure a company’s financial position over a period of time. This helps the company track their profits and losses, and determine when decreases in production costs are needed.

The cash flow statement reflects a company’s cash position on hand at the end of a fiscal period. This is important for companies because they need to know how much of their revenue is coming from cash compared to other receivables or short term assets.

Return on Assets, Return on Investment, and Return on Sales

Many companies want to calculate profitability based on their current performance so they can determine if they need to make any changes in cost production or total efficiency. There are many ways to calculate profitability, but three popular profitability ratios are ROA, ROI, and ROS.

You need the basics to monitor the basics

Accounting 101: The Basics You Need to Know

The effect that a debit or credit has on a particular account is largely dependent on the account type being affected.

For instance, if you post a debit transaction to an asset account, it will increase the balance of that account, while if you post a debit to a liability account, the balance of that account will be decreased. A debit is always on the left side of any accounting transaction, while a credit is always on the right side of the transaction.

TYPES OF ACCOUNTINCREASES BALANCEDECREASES BALANCE
AssetsDebitCredit
LiabilitiesCreditDebit
RevenueCreditDebit
ExpensesDebitCredit
EquityCreditDebit
  1. Assets: An asset is anything of value that your business owns. Assets can include the cash in your bank account, your accounts receivable balance, the building you own, inventory, supplies, computer equipment, and furniture. Assets can also be intangible, such as intellectual property.
  2. Liabilities: Liabilities are anything your business owes. Your accounts payable balances are considered liabilities because that’s what you currently owe your vendors. Loans are also considered a liability.
  3. Revenue and income: Revenue, or income, is any monies received during the course of conducting business, whether that’s selling products or services.
  4. Expenses: Everything from paying your employees to paying your electric bill is considered an expense. For instance, when you enter an electric bill to be paid next month, that’s recorded as an expense. An expense report helps you track your business expenses so you can know where your money is going.
  5. Equity: Equity represents your current financial interest in your business and is derived by subtracting your total liabilities total from your total assets.

Chart of Accounts: A Simple Guide

Every time you record a business transaction—a new bank loan, an invoice from one of your clients, a laptop for the office—you have to record it in the right account. A chart of accounts is a list of all your company’s “accounts,” together in one place. It provides you with a birds eye view of every area of your business that spends or makes money. The main account types include Revenue, Expenses, Assets, Liabilities, and Equity.

The chart of accounts should give anyone who is looking at it a rough idea of the nature of your business by listing all the accounts involved in your company’s day-to-day operations. The chart of accounts is designed to be a map of your business and its various financial parts. A well-designed chart of accounts should separate out all the company’s most important accounts, and make it easy to figure out which transactions get recorded in which account.

It should let you make better decisions, give you an accurate snapshot of your company’s financial health, and make it easier to follow financial reporting standards. A typical numerical system to assign account numbers to these type of accounts would be:

  • Assets: 1000 to 1999
  • Liabilities: 2000 to 2999
  • Owner’s Equity: 3000 to 3999
  • Revenue: 4000 to 4999
  • Cost of Goods: 5000 to 5999
NumberAccount DescriptionAccount TypeStatement
1010CashAssetsBalance Sheet
1020Accounts ReceivableAssetsBalance Sheet
1090Real EstateAssetsBalance Sheet
2010Accounts PayableLiabilitiesBalance Sheet
2030Unearned RentLiabilitiesBalance Sheet
2040Accrued TaxesLiabilitiesBalance Sheet
4010Fees EarnedRevenuesIncome Statement
4020Interest IncomeRevenuesIncome Statement
4030Sales DiscountsRevenuesIncome Statement
5010WagesExpensesIncome Statement
5020RentExpensesIncome Statement
5030Bank ChargesExpensesIncome Statement

Depending on the size of the company, the chart of accounts may include either few dozen accounts or a few thousand accounts. Whereas, if a company is more sophisticated, then the chart of accounts can be either paper-based or computer-based.

Recording Accounting Transactions: The Source Documents, General Journal, General Ledger, Trial Balance

extract from the article on site – Universal Class

The Journal

In this computer age, some of these concepts now are incorporated into a computer database that we enter data directly into, and the database makes all the associations we need automatically, storing everything in one central, categorized area. It might seem at first glance that to learn about all these items is useless because everything is computerized, but that is not true. Even though electronic processes have eliminated a lot of physical paper trails that get lost in misfiling, the concepts driving these computerized accounting systems are all rooted in the accounting structure. Everything that we learn here is pretty much represented the same way in a computer system.

In the accounting world, the journal is a book that contains original entries for financial transactions. Journals store financial transaction information ultimately derived from source documents. Later, these journal entries are summed up and then posted, or transferred, to a ledger.

Types of Journal in Accounting

  • Purchase journal.
  • Sales journal.
  • Cash receipts journal.
  • Cash payment/disbursement journal.
  • Purchase return journal.
  • Sales return journal.
  • Journal proper/General journal.

In any typical general journal, you will have a date, description, posting reference, debits, and credits.

The General Ledger

As we have seen from the general journal, we have every financial transaction the company has made recorded chronologically. Now we need to take these transactions and rewrite them again into the general ledger, or special ledgers that in turn are summarized and get posted to the general ledger. At first glance, this might seem redundant. However, every transaction that is specified chronologically in the general journal gets posted to the general ledger in its own ledger account. The general ledger is organized into many different accounts and classified by what each transaction represents.

The general ledger is the book of a company. It contains all accounts and their balances for the accounting period. The main difference between how the general journal works and how the general ledger works is that the general journal itemizes financial transactions by date, and the general ledger is a record of financial transactions by account (or summarized by account).

Trial Balance

The trial balance is exactly as its name suggests: It is a trial balance or test run of balancing the books. This is not a report that is seen by owners and investors; it is a report generated for the accountant, by the accountant, to determine not only where the company stands financially, but how well the books are in balance.

The trial balance is generated from the general ledger. The trial balance consolidates all this information into one convenient statement for the accountant to review and check against other financial reports, ledgers, and journals.

When the general ledger has been reviewed, balanced, totaled, and transferred to the trial balance sheet, it will look something like this:

At the end of the accounting period, all debit and credit transactions are totaled for each account and placed into a two-column report that compares all resulting debit and credit balances. The sum total of all debits for all accounts must equal the sum total of all credits for all accounts. If the totals are equal, then the trial balance is in balance.

If the trial balance does not balance, this means there could be errors, ranging from a simple numeric miscalculation to an improperly entered journal entry or journal posting. The best remedy against a disastrously non-balanced trial balance report is to run the report frequently and balance it frequently. In other words, try to catch the errors as quickly as they appear, instead of trying to fix everything at the year-end.

Find the software which best suits your needs

The Best Business Accounting Software for 2020

As a small business owner, managing your business accounting—including everything from bookkeeping to tax preparation—is one of the most important aspects of your operations. But while these business accounting tasks are essential, they’re also complex and time-consuming, especially if you’re performing them manually.

One of the best actions you can take as a business owner is to automate, if not entirely outsource, your business accounting processes. Choosing and utilizing the right business accounting software can help you automate your books, manage your finances, and ultimately reduce errors, save time, and contribute to your business’s growth and success.

In order to find the best accounting software for your small business, you’ll want to follow a few steps:

  • Identify Your Needs– Do you simply want to be able to manage your expenses and invoices or do you need additional tools for handling tasks like inventory or payroll? Would you prefer a web-based solution or local, desktop option?
  • Determine Your Budget- Price can play an influential role in your small business accounting software search, and therefore, you’ll want to decide early on what you can afford.
  • Compare Your Options- As you explore the different small business accounting software solutions on the market, the right one for you will be the one that can best meet your requirements as you’ve outlined them

Compare your options based on qualifications such as:

  • Price
  • Plan offerings
  • Accessibility
  • Features (Bookkeeping, accounting, business taxes, time tracking, inventory, etc.)
  • Add-ons and integrations
  • Customer support
  • Ease of use
  • Growth potential and scalability

A sample of Small business accounting software options:

  • QuickBooks Desktop
  • QuickBooks Online
  • FreshBooks
  • Xero
  • Wave
  • Zoho Books

Additional material from our research…

Books

Accounting 101: A Simple, Comprehensive Guide to the Basics and Principles of Accounting

Author: Max McCoy – Published: May-20

Accounting For Small Business Owners: Learn the Basics and Principles of Accounting (Even for Complete Beginners

Author: Chris Walton – Published: May-20

Financial Statements, Third Edition: A Step-by-Step Guide to Understanding and Creating Financial Reports

Author: Thomas Ittelson – Published: Mar-20

Videos

Accounting 101, accounting overview, basics, and best practices
Bookkeeping Basics for Small Business Owners
Customising your Chart of Accounts
The Books – Journal, Ledger, and Trial Balance
Accounting For Beginners #20 / Chart of Accounts / Assets, Liabilities, Equity, Revenues, Expenses
SME Guide: Choosing the Right Accounting Software
Best Accounting Software for Small Business

Category: Finance 4 Execs

This is a new series for executives just starting out in this world of finance. In the following 9 articles we will cover the basics to help to navigate your way around the financial reports.

NEXT UP – UNDERSTANDING AND READING THE PROFIT AND LOSS STATEMENT.

Until then, enjoy. Wayne