Understanding Basic Accounting

Understanding Basic Accounting

First, you buy a product or service in a specific month which is then expensed in this month (income statement). Lastly, your customer pays which means your trade receivable (asset) will be non existent, because you received cash from the customer (cash flow statement). Then, your customer owes you the money and you show that on the balance sheet as a trade receivable.

basic accounting

Equity represents your current financial interest in your business and is derived by subtracting your total liabilities total from your total assets. If you have employees or you sell products, you should be using the accrual accounting method. This method records all revenue/income and expenses as they occur, not when your customer pays or you write a check for a bill. After setting up your chart of accounts, you will need to decide what type of accounting method you will use.

Equity. This is assets minus liabilities, and represents the ownership interest of the owners of the business. Matching Principle – When revenue is recorded all related expenses are recorded in the same period in order to provide an accurate picture of the profitability of the business. Receipts is the total amount of cash collected in business transactions over the course of one day. It does not include other revenue collected.

Although these technological advances in accounting applications have made the financial aspects of running a small business much easier, entrepreneurs and other small-business owners should take to time to understand underlying accounting principles, which play an important role in evaluating just how financially sound a business enterprise really is. Over the past decade, technology has had a significant impact on the accounting industry.

One of the most important financial accounting rules is that assets equals liabilities plus stockholders’ equity. This formula applies to the balance sheet, which displays assets, liabilities and stockholders’ equity. An asset is anything the company owns that will provide future benefit, such as cash, accounts receivable and property. A liability is an account that shows what a company owes others, such as notes payable, long-term debt payable and short-term debt. Stockholders’ equity is the amount of money the company receives from its investors as a way to finance the company.

A current asset is an economic resource that is expected to convert into cash in one year. Things like cash, inventory, and accounts receivable are all examples of current assets. Unlike COGS, which centers on how much it cost to make a product, operating expenses show the costs associated with running your business on a day-to-day basis.

Most other countries follow a similar method called the International Financial Reporting Standards, or IFRS. Accounting used to be done by hand in physical ledgers, or books. Today, when we say “closing the books,” we simply mean taking the final steps in the accounting cycle to prepare financial statements.

This allows the accountant to have a visual representation of the account. T accounts are so named because they are shaped like a T. The accountant will put the account name on the top of the T account. The left side of the T account purchases journal will be any debits made to the account in the general ledger while the right side will be any credits made. Gross Profit indicates the profitability of a company in dollars, without taking overhead expenses into account.

In such cases, basic accounting software is very beneficial as they help generate invoices to performing basic accounting entries, prepare cheques, update the financial statements without any additional work. Once you’ve created your chart of accounts, chosen your accounting method, and entered your beginning balances into your current software application, then you can begin to enter your financial transactions. 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.

This document presents the sources and uses of cash during the reporting period. It is especially useful when the amount of net income appearing on the income statement varies from the net change in cash during the reporting period. Accrual Principle – Accounting transactions are recorded in the period when it is earned, rather than when cash was received from the customer.

Software is no substitute for having a solid understanding of accounting basics, though. If you’re unfamiliar with these terms, be sure to study up or consult with an accounting professional to ensure you can adequately assess the financial health of your business. Accounting https://www.bookstime.com/articles/purchases-journal and financial applications typically represent one of the largest portions of a company’s software budget. Accounting software ranges from off-the-shelf programs for small businesses to full-scale customized enterprise resource planning systems for major corporations.

  • They are listed on the balance sheet as current liabilities.
  • Income earned in one period is accurately matched against the expenses that correspond to that period so you see a clearer picture of your net profits for each period.
  • Getting these transactions right, will make a huge impact on your financial statements; such as the income statement, cash flow statement and balance sheet.
  • ROI (return on investments) can help a company determine if they’re getting enough profit for the amount of capital invested in a project.
  • Double-entry accounting is the best way to ensure that your accounts remain in balance.
  • This provides an audit trail to look back at and analyze to determine the financial position of an entity.

basic accounting

The general ledger is a book into which all company transactions are recorded as journal entries. The general ledger can then be used to create financial statements by tracking the changes in specific accounts. After a company closes their books for the month, the accountant will make T accounts in the general ledger for each account used.

Basic Accounting Concepts

The equation balances. People sometimes confuse accounting with bookkeeping. Accounting is a much broader concept. Bookkeeping, the system used to record a firm’s financial transactions, is a routine, clerical process.


The Balance Sheet is one of the two most common financial statements produced by accountants. This section pertains to potentially confusing terms that relate to the balance sheet.

Assets include anything that can quickly convert to cash if necessary. They can be tangible, such as accounts receivable, or intangible, such as ownership of intellectual https://www.bookstime.com/ property. Accountants include all assets on a balance sheet, and the Internal Revenue Service (IRS) allows the depreciation of assets when filing a business return.

FINANCING CASH FLOW; The financing cash flow explains how much cash was received from and paid to investors like debt and equity investors. Let’s have a look at an example of a balance sheet, so you get a better grasp of the basic accounting principles.

basic accounting

It’s time to roll up those sleeves and build your accounting vocabulary. To help with this, we’ve compiled an assortment of basic financial terms and acronyms and created a simple accounting glossary for beginners. Data analytics can be defined as the process of examining numerous data sets (sometimes called big data) to draw conclusions about the information they contain, with the assistance of specialized systems and software. Using data analytics effectively can help businesses increase revenue, expand operations, maximize customer service, and more.

This decrease is also called “depreciation” and is shown in the income statement as an expense. First, you sell your product or service to a customer. In addition you give him an invoice with the amount to be paid and the due date of payment. This will trigger an income (e.g. revenue) and an expense (e.g. cost of goods sold) on the income statement. Let’s have a look at an examplary income statement.