Accounting is necessary for business. Regardless of who handles the accounting for your business, it’s wise to understand accounting basics.
An income statement shows how profitable a business is and how much the company has made or lost. (Download the template in excel)
Profit and Loss (P&L) Statement
A profit and loss statement is a snapshot of the business’s income and expenses over a given period.
Cash Flow Statement
A cash flow statement analyzes your company’s operating, financial, and investing activities to show how and where you are receiving and spending money.
A bank reconciliation compares your cash expenses to your general bank statements and helps keep your business records consistent.
Basic Accounting Terms
Debits and Credits
Debits and credits track where your company’s money comes from and where it’s going. A debit records all the money expected to come into an account. A credit records all the money that will likely go out of an account.
- Increase goods
- Decrease debts
- Decrease income
- Increase the balance of expense accounts
- The balance of capital accounts decreases
- Decreases assets
- Debt increases
- Increase revenue
- Decreases the balance of expense accounts
- Increases the balance of capital accounts
- Accounts receivable and accounts payable
Accounts receivable are money that people owe you for goods and services. They are considered property (assets) on your balance sheet.
Accruals are credits and debts you have recorded but have not yet discharged. These can be sales you’ve completed but haven’t yet been paid or expenses you’ve made but haven’t yet paid.
Assets are everything the business owns, tangible and intangible. Assets can include cash, tools, property, copyrights, patents, and trademarks.
The burn rate is how quickly the business spends money. To calculate the burn rate, choose a time. Subtract the amount of cash at the end of that period from your cash on hand, then divide that number by the number of months in the period.
Capital is the money you invest or spend to grow your business. Commonly known as “working capital,” capital refers to funds that can be accessed and do not include assets or debt.
Cost of goods sold
The cost of goods sold or sales are the cost of producing your product or delivering your service. Lowering your COGS can help you increase profits without increasing sales.
Depreciation refers to the decline in the value of your property over time. It’s necessary for tax purposes since more considerable assets that affect your business’s ability to make you can write off money based on depreciation.
Equity relates to the money invested in a business by its owners. It is also known as “owner’s equity” and can include items of nonmonetary value, such as time, energy, and other resources.
Have you heard of “Sweat Equity”?
Equity can also be defined as the difference between the assets of the business (what you own) and what you owe.
A business with healthy (positive) capital is attractive to potential investors, lenders, and buyers. Investors and analysts also look at your company’s EBITDA, representing earnings before interest, taxes, depreciation, and amortization.
Expenses include purchases you make or money you spend to generate income. Expenses are also known as “the cost of doing business.”
There are four main types of expenses, although some fall into more than one category.
- Fixed expenses are ongoing expenses, such as rent or salaries. These expenses are not usually affected by business sales or market trends.
- Variable expenses fluctuate with the performance and production of the company, such as utilities and raw materials.
- Accrued expenses are one-time expenses that have been recorded or reported but not yet paid.
- Operating expenses are significant for a company to do business and generate income, such as rent, utilities, payroll, and utilities.
A fiscal year is a period that a business uses for accounting. The company determines the start and end dates of your financial year; some coincide with the calendar year, while others vary depending on when accountants can prepare financial statements.
Debts are anything your business owes in the short or long term. Your responsibilities could include a credit card balance, payroll, taxes, or a loan.
In accounting terms, profit, or “bottom line,” is the difference between your revenue, COGS, and expenses (including interest, depreciation, and operating expenses).
You pay taxes on your net earnings, so it’s essential to plan for your tax liability proactively.
Your income is the total amount of money you collect in exchange for your goods or services before expenses are deducted.
Your gross margin, which is your total sales minus your COGS, this number indicates the sustainability of your business.
Small Business Accounting
- Open a business account linked to all outlets.
- Itemize all expenses by department.
- Comply with all income, employment, and excise taxes.
- Set up a payroll system.
- Identify the best payment method suitable for your needs.
- Periodically review and evaluate your processes.
- Consult with a professional or CPA.
- Accounting will help you see a complete picture of your business and can influence business and financial decisions.