Accounting is an essential part of every business. And not just business but life itself. Moreover, it goes beyond the addition and subtraction of numbers. Its implications for business cannot be over-emphasised.
In starting a business, it helps to be familiar with some basic concepts that you can apply to ascertain the financial health of your business. Of course, as time goes on and your business expands, you will not continue to manage your business finances. You would need an accountant, in-house or outsourced. However, the knowledge of these concepts will remain relevant in overseeing your business. Here are five basic concepts you should know in Financial Accounting.
In financial accounting (FA), you will observe that words do not exactly mean what you have thought them to be, and one of them is Profit. Profit is the balance left from a company’s revenue after deduction of operating costs, Taxes, and a percentage of fixed cost within a period.
Money coming in for the business does not automatically translate to profit. In FA, profit is an abstract concept. It considers numbers as represented on a paper. This means that a business can make Profit without money coming in, and money can flow in, yet no profit. When a business does not generate enough revenue to cover the operating cost and taxes, or the amount generated only covers the operating cost and taxes, it is called Loss.
Profit and losses are reported in the Income statement, which details the company's revenue and expenses with a period. The Income statement is also called the Proft and Loss statement.
It is fair to look at Cashflow after profit because of how both terms are erroneously used to mean the same thing by business owners -especially new business owners. Cash flow is the total amount of money moving in and out of a business. It is simply how much cash was spent and how much cash came in. While profit can be realised, it might not reflect in cash flow if customers are yet to pay. It is necessary to be able to distinguish this, particularly when you have payment plans for your customers. Learn more - Cash Flow
Cashflow is reported in the Cashflow statement. It is completely normal for the Cashflow statement to report different numbers than the Income statement. Learn more on how they differ - Cashflow vs Profit
Bookkeeping is the accounting process of organising and recording all of a business's financial transactions. It focuses on daily financial transactions. It primarily serves to track and retrieve all financial transactions of the company. It is not the same as a financial statement. The company’s financial statement is prepared from the information recorded in the Books. It is the most basic financial report providing raw data for key financial decisions. Bookkeeping has to be thorough as it is the foundation for the company’s Income statement and Cashflow statement.
There are two systems of bookkeeping -the Single entry system and the Double entry system.
In FA, the meaning of an Asset is almost as the word suggests -What do you have? An asset is a resource with economic value owned by a business that can generate revenue presently or in the future. It is important to note that while an asset holds economic value, this value will not necessarily increase as time goes by. It could retain its original value or diminish in value. Assets will continue to reflect on the balance sheet until they are used.
There are four principal categories of assets -Current assets, Fixed assets, Financial assets, and Intangible Assets.
The balance sheet reports a company’s assets, liabilities, and shareholders equity within a period. It details what a business owns, what it owes, and the amount invested by shareholders within a given period. It primarily highlights the financial position of the company alongside the income statement and the Cashflow statement.
The world of Accounting is big, but the ideas are stable. They are not open-ended like we have in disciplines based on continuous research. The point is, you only need to learn these once, and you get to use them all your life.