Accounting is the practice of recording, analyzing and interpreting your business’ financial information. It helps you stay organized in operations, adhere to legal obligations and make more informed business decisions.
Accounting isn’t something you can learn overnight, so you need to put in effort and time into mastering it. Begin by understanding the fundamental concepts and terminology required for success.
Basic accounting terms
Understanding accounting fundamentals will not only enable you to better interpret your business’s financial statements, but it will also enable informed decisions. Whether you are a small business owner, accountant or just someone with an interest in finance, having a firm grasp on accounting can be instrumental for success.
Accounting, also known as bookkeeping, is the process of keeping track of money movement within and outside your company. This involves using various accounts such as debits and credits, a general ledger, and journals to keep tabs on all business transactions.
One of the most essential books in any business owner’s toolbox is the balance sheet. This shows what’s in your business bank account and allows you to determine how much money is left over for current expenses. It’s an invaluable asset in planning finances and monitoring growth within a company.
Another essential bookkeeping document is the trial balance. This can help ensure all your debits and credits balance correctly, saving you from future headaches.
Although accounting can seem intimidating, there are a few essential terms every small business should know. These include:
Debits and credits
Debits and credits are the two fundamental accounting terms that ensure your business’ bookkeeping entries remain balanced. They form the basis of double-entry bookkeeping, which most businesses utilize to record their transactions.
In short, debits increase asset, expense or liability accounts while credits decrease them. This inverse principle is essential to remember for various reasons.
As an example, suppose you paid for supplies with money from your checking account. Once received, debited the checking account (and another was credited).
Now that your checkbook is full of cash, it’s time to credit it back into your bank account. To do this, write down a credit transaction on the right side and a debit transaction on the left.
If you’re not an accountant, learning all the different financial concepts can seem intimidating. But with some dedication and practice, you’ll become an expert at recording simple accounting entries.
No matter your background, mastering the fundamentals of debits and credits can help you keep track of your business accounts and make sound financial decisions. They’re essential for keeping everything balanced, so it’s essential that you become well-versed in them.
In the past, debits and credits were recorded manually on paper ledgers; however, nowadays most accountants use accounting software for this task. For beginners, double-entry accounting is recommended; where each transaction is posted to two accounts – one on each left side and one on each right. Once you become proficient with this double-entry system, all other more intricate accounting tasks that come along with running a business will become much simpler for you.
Balance sheet
A balance sheet is an invaluable resource for business owners and investors, providing insight into a company’s financial condition as of a given date. It includes data on assets and liabilities such as short-term cash, accounts receivable, inventory and long-term fixed assets.
Depending on your industry and business size, you may choose to create your own balance sheet or hire an outside accountant for this task. No matter how it’s done, it is essential that you comprehend its significance and know how to utilize it effectively.
Assets on a balance sheet refer to any items of value that can be converted to cash, such as cash and cash equivalents, accounts receivable, marketable securities (stocks, commercial paper and Treasury bills), property, plant and equipment. These line items should be organized in ascending liquidity order from current assets towards long-term assets.
Liabilities on a balance sheet refer to any debts or expenses that a company anticipates incurring in the future, such as accounts payable, notes due within one year and current maturities of long-term debt.
The balance sheet also displays shareholders’ equity, which is the difference between a company’s total assets and liabilities. This number can be used to assess a firm’s financial health, calculate investor returns, and make decisions about purchasing shares in the business.
Balance sheets are essential tools in accounting, providing an overview of a company’s financial state on any given date. As such, they’re vital for small business owners’ analysis processes as they help identify strengths and weaknesses within their operations. By mastering balance sheet generation and analysis, you can gain invaluable insights into your company’s performance as well as its growth potential.
Profit and loss statement
A profit and loss statement (P&L) is a financial report that displays how much your business has earned and spent during a certain period. This document, typically prepared at the end of each month, quarter or year, can be useful for assessing the health of your company and helping you forecast future performance.
The Profit & Loss (P&L) accounts show the total cash your business has earned or lost, making it one of the most important documents for small business owners to prepare and keep on hand. Banks and investors use P&Ls to assess a business’ income potential as well as debt load.
As a general guideline, your Profit & Loss statement (P&L) should include all revenue earned by your business as well as all expenses related to running it. This includes sales, credit sales, advertising, payroll services, rent payments and insurance.
Your P&L statement can be generated manually or automatically through accounting software. Most accounting packages will generate useful P&L statements based on how your business is organized and the transactions recorded in your accounts.
If you’re new to accounting, it is essential that you comprehend two essential terms on the Profit & Loss statement (P&L): operating income and net income. Operational income refers to your company’s revenue after all operational expenses have been deducted, which can help assess the overall strength of core operations.
Net income on the other hand, refers to your after-tax earnings after nonoperational expenses like taxes and interest on debt have been deducted. It may also include any earnings from sales of assets like equipment or real estate.
A profit and loss statement is essential for small businesses, as it provides insight into whether your venture is profitable, growing, or needs restructuring. Furthermore, this document serves as an essential requirement when applying for loans from banks or other financial institutions.
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