Many small business owners don’t know how accounting works or how to do it properly. The main reason is a lack of enthusiasm for learning the subject.
It’s true that accounting can be a daunting subject, especially if you’re already swamped with business responsibilities. That’s why a lot of entrepreneurs employ the help of reliable bookkeeping firms. But imagine the advantages of just knowing a few accounting basics. For one, you’ll have more information and accounting insights to make better decisions!
So we’re here to help you quickly learn them. This article touches lightly on the essentials, but if you want to dig deeper, keep this as your checklist. This will be the rabbit hole you can keep digging if you’re itching to know more.
Accounting Terms
Learning new things always starts with knowing the terms. This is the same with accounting. This is for you to ease into more complex principles and concepts. For starters, you can commit these terms to memory.
Bookkeeping
This is the process of record-keeping and transaction recording. Bookkeeping works on at least two books: the journal and the ledger. Online accounting software, like QuickBooks Online (QBO) or Xero, follow similar principles that may vary in appearance and format.
You can outsource your bookkeeping to reliable bookkeeping firms. It will benefit you immensely as a business owner because you’ll learn how bookkeeping works while leveraging an expert’s time and skills.
Accounting
This term encompasses a lot of things, bookkeeping being one of them. Accounting also deals with the principles and disciplines of analyzing financial statements, remitting taxes, business auditing, and other accounting sub principles.
It’s important to know that accounting is an umbrella term because most people will mistake bookkeeping and accounting for the same thing. However, the main difference is the scope. Bookkeeping focuses on recordkeeping transactions only, while accounting interprets and makes sense of the data from bookkeeping.
Accounting Cycle
Every bookkeeping activity is governed by what is called the accounting cycle. These are a series of steps that are generally accepted when recording business transactions. It involves opening new books of accounts, classifying them, entering transactions, checking them, and closing the books at the end of the cycle.
Trial Balance
A trial balance is a test every bookkeeper makes to find errors in bookkeeping. The idea is to put together a list of debit and credit amounts and get the total for each. The resulting amount of debits and credits should be the same for both. Hence the word balance.
Chart of Accounts
Before any bookkeeping takes place, the bookkeeper must determine the different accounts first. These are the “labels” where you classify a transaction.
Labels such as Sales, Revenue, Utilities, and Payroll Expenses are examples of accounts included in the chart.
Nominal Accounts
Some accounts comprising the chart are described as nominal. They are meant to be used for temporary transactions that don’t add monetary value to the business. Examples are rent, payroll, sales, and tax accounts.
Real Accounts
These accounts record transactions that stay in your business and add monetary value to it. Examples of real accounts are assets, investments, and loans. The monetary value of real accounts carries over to the next business year.
Fixed Cost
Every business operation incurs a cost. Yet some costs stay the same for a relatively long period—these are called fixed costs. Some of the business expenses that fall under this category are your lease and payroll because they remain the same for a long time.
Variable Cost
This is a cost that changes with purchases or production. These business expenses shift up or down relative to the volume or quantity of the transaction. A perfect example of this is the manufacturing per unit cost. As you produce more of it, the cost also goes up.
Know the Functions of Your Financial Statements
Getting familiar with your financial statements is essential when piloting your business upward. These statements serve as meters and indicators that help you measure your business’s standing once it takes off.
Measuring your business performance is key to making important decisions. But to get a good look at how your business is doing, you’ll need to know how to work with financial statements. There are three.
Income Statement
This accounting document measures your business’s operational performance by summing up sales and breaking down all your business expenses line by line. The difference between sales and expenses will be your net profit or loss.
A profit and loss statement, or a P&L statement, is usually generated annually, especially during tax time. But business managers and owners may request their bookkeepers to prepare this statement for budgeting and cost management purposes.
Balance Sheet
Your income statement’s profit (or loss) will eventually reflect on the balance sheet. Therefore, this financial statement records your business’s tangible and intangible properties in monetary terms.
The balance sheet works using the Assets = Liabilities + Owner’s Equity formula. This means that the assets of your business must total the amount you borrowed for the business and the money or property you invested in it.
Generating a balance sheet is important, especially when you’re positioning to expand your business. In addition, the statement will help potential investors or lenders know where your business stands.
Cash Flow Statement
Your business continues to operate because of cash. Any lack of it will jeopardize your enterprise’s activities and may grind them to a halt. So it’s important to monitor how cash—your business’s most liquid asset—flows in and out of your business to ensure it meets its obligations.
Your cash flow statement sums up all your cash (and cash equivalent) transactions and classifies them into three basic activities: operations, investment, and financing. The resulting bottom line of a cash flow statement must be equivalent to the cash account reflected in your balance sheet. This statement shows you a breakdown of what money flowed in and out to arrive at a snapshot of your business’s total cash assets.
Additional Accounting Basics You Must Know
So far, we’ve covered the essentials you need to know when you want to learn accounting. But here are some other things you’ll want to explore to manage your business well.
Different Accounting Errors
If you’re a startup business owner, you’ll likely do your own bookkeeping. So you’ll need to learn the different accounting errors committed when recording business transactions.
Knowing the different types of errors makes you less likely to commit them. You will avoid errors like transposition or omission because you’re more aware of them. When your trial balance doesn’t total, you’ll be able to identify the error easily.
Alternatively, if familiarizing yourself with accounting errors seems daunting, there’s always an option to outsource the record-keeping and error-finding to professional bookkeeping firms.
Analyzing Financial Statements
Reading your financial statements is one thing. It helps you see how your business is doing. But analyzing them like a business owner is another. This practice will help you gain insights into your business’s performance.
Financial analyses applied to statements will help you clearly see if your operations are cost-efficient on a month-by-month or year-by-year basis. It also helps you better determine the health of your business and put it into numbers that investors or lenders can see.
Finally, learning how to analyze financial statements puts you in a better position to peddle your business if you want out. Now, all you need is the best place to sell the business you’ve worked hard to build.
Accounts Payable Management
Debt is part of business operations. When managing cash inflows and outflows, you’ll come up short at some point. When that happens, you’ll need to ask for credit. This is where accounts payable plays its part.
Having multiple suppliers granting you credit can be hard to manage, especially if they have varying credit conditions. So learning accounts payable management will let you determine which suppliers you must pay at a certain time. This will help your business keep cash in circulation while it fulfills its obligations to its suppliers.
Basic Business Taxes
Lastly, you’ll need to know your business taxes. Get familiar with the different kinds of taxes your business must pay to avoid penalties. E-commerce sales tax, income tax, and capital gains tax are some examples of common business taxes you must pay. In addition, you also need to know how and when to file them.
Ask your accountant or your bookkeeper to educate you about taxes. It doesn’t have to be comprehensive. Knowing the taxes, the rules, and the penalties for non-compliance will be enough.
You Are Now a Better Entrepreneur!
By reading this post and keeping it as your learning checklist, you’re now more knowledgeable than 60% of small business owners. Learning more about these terms and concepts will help you read business transactions and determine if your business is performing as well as it should.
Tune in for more informative entrepreneurial tips, and pave your way to success!
AUTHOR’S BIO:
Mike Pignatelli, CPA, is the CEO of Unloop Accounting, an agency built to meet the accounting needs of modern ecommerce businesses. As an experienced financial controller, Mike has worked with various seven-figure inventory businesses. Mike and his team are your go-to accountants if you need reliable data to make sound financial decisions.
