You didn’t enter business to be an accountant, why should you know these accounting concepts? Well, understanding basic accounting ideas can help you create better predictions about your company’s future based on past trends in sales and costs. This can help you make smarter financial decisions in the long run.
Understanding basic accounting principals will also help you make quick but prepared operational decisions over a day-to-day basis. This will save you time and money – two of your most valuable resources as a business owner. Although you’re using business accounting software, it’s important to truly have a foundational knowledge of these concepts.
Finally, having a basic understanding of accounting concepts will make sure you have productive conversations with your financial advisors when planning strategically for your company’s future.
Listed below are the nine most significant Accounting Basics concepts you should know.
If you’re seeking to understand basic accounting ideas, this is a crucial one. You will discover two main accounting methods which you can use – cash basis and accrual basis accounting. Many smaller businesses start out with cash basis accounting, but accrual basis financial assertions give you a much better understanding of your business’s budget than cash basis assertions. Plus, Generally Accepted Accounting Rules, or GAAP, require general population companies to utilize accrual accounting.
Accrual basis financial statements match income and expenses to the periods in which they may be incurred. Cash basis assertions, on the other side, only echo income and bills when they are received or paid.
Let’s say you invoice a person for services rendered on March 15 and you supply the customer 30 days to pay the invoice. If the client is an excellent customer, the check will arrive on April 15, and maybe even a few days before.
On accrual basis financial statements, the income will appear in March, as a rise in sales and a related upsurge in accounts receivable. On cash basis financial assertions, the income wouldn’t look until April when it strikes your money.
Similarly, let’s say you’d to pay a subcontractor to fulfill the services that you invoiced the client. The subcontractor billed you on March 31 for services rendered that month plus they gave you 45 times to pay the invoice. This means you can pay them on May 15.
On your own accrual basis financial assertions, the expense will appear in March – the same month as you invoiced your customer. On your cash basis financial assertions, the trouble won’t show up until May.
The capability to match income and expenses to the period in which they are simply incurred will help you more accurately identify expenses and trends in your business. That is why accrual basis financial assertions are more advanced than cash basis financial statements for business management purposes.
This second accounting concept is closely related to the first. The consistency idea says that once you choose an accounting method, you should stick with it for any future financial data. This allows the company to effectively compare performance in several accounting periods. The inner Revenue Service also requires steadiness for the purpose of filing small-business taxes. In the event that you choose an accounting method and later want to change it, you must get IRS agreement.
- Going concern
The “going concern” concept says you should assume that your business is at good financial condition and can remain in procedure for the near future. This idea allows companies to sometimes defer the acceptance of certain expenditures into future accounting intervals. Naturally, the accountant or auditor is free to come to a different conclusion if there’s information that the business can’t pay back its loan or other obligations. In that case, the company may need to start taking into consideration the liquidation value of investments.
Beneath the conservation concept, revenue and expenses are treated differently. Businesses should identify revenue only once there’s an acceptable certainty that it’ll be recognized, for example with a purchase order or signed invoice. However, businesses should recognize expenses earlier, when there’s even a reasonable possibility that they can be incurred. This weighs in favor of more conservative financial claims. It’s better for cashflow purposes to overestimate your bills rather than your earnings.
- Economic entity
That is one of the main concepts for small businesses – you should avoid commingling business with personal funds. Business financial claims should mirror only business trades. For example, you should avoid placing personal expenses on a business mastercard. Failure to follow this idea can make your electronic bookkeeping much more difficult and even land you in legal trouble if you’re a organization or limited responsibility company. In those conditions, you can conserve limited responsibility protections only by separating business and personal funds.
This idea is pretty simple and just means that businesses should record any financial transactions which could materially affect business decisions. Even when this leads to minor trades being recorded, the theory is the fact it’s easier to give a detailed look at the business. Actually, business accounting software helps it be very easy to record every small deal, since it automatically syncs up with your standard bank accounts and bank cards.
The “matching” theory says that you should record earnings and expenses related to earnings at the same time. The reason is to enable you to see any cause-and-effect marriage between income and buys. For instance, let’s say you pay a commission rate to a salesperson for a deal that you record in March. The fee should also be recorded in March.
- Accounting equation
There is a basic accounting equation that may help you record transactions:
Belongings = liabilities + owner’s equity
As the formula indicates, assets continue the still left side of the equation and are debited. Just as, assets continue the left area of your general ledger. For example, if you receive cash, your money account would be debited in your accounting software. Liabilities and owner’s collateral go on the right area of the formula and are credited. Similarly, these items continue the right part of your present ledger. For instance, if the business issues stocks of common stock, that amount would be acknowledged to the owner’s collateral account.
- Accounting period
“Accounting period” is the ultimate concept you should comprehend. Under this idea, only financial details pertaining to the period of time at concern should be included. To comprehend this point, you first need to understand the three financial statements that are essential for an organization: earnings and loss affirmation, balance sheet and affirmation of cash moves.
The income and loss statement and assertion of cash flows cover a specific time period, like a one fourth or a calendar year. An equilibrium sheet is a snapshot of an business’s possessions and liabilities by a particular time frame. If you were making a profit and loss assertion for the first 1 / 4 of 2019, for example, you wouldn’t cover deals that occurred before or following the 1 / 4. This means that the business can accurately compare performance in different time periods.
Understanding these basic accounting concepts can you help you flourish in business.
You don’t need advanced accounting knowledge to effectively run your business. However, equipping yourself with an understanding of the basic accounting concepts (and buying some useful accounting catalogs) will help you review your trades and financial assertions with greater confidence. The excess value you’ll get from your conversations with your financial advisors can make the effort to understand these concepts well worth your while, too.