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Start Business AccountingStart Business Accounting
If you’re going to successfully run your own business you need to know a little bit about is accounting. Many people are afraid of accounting, but it REALLY is much easier than it looks once you know some basic things. Here are some basic terms you need to learn to start business accounting, whether you do your own books, or if you work with an accountant:
Assets = Liabilities + Owners Equity Profit and Loss Statement Balance Sheet Cash vs. Accrual Accounting Chart of Accounts Double Sided Entry Using QuickBooks
Understanding the basics of these terms will let you do anything in accounting you need to and have confidence that you understand what’s going on with your business and with your CASH and PROFITS.
Start Business Accounting: Assets = Liabilities + Owners Equity
When I entered college at UW-Madison I thought I wanted to major in Chemistry. I liked Chemistry, I was good at it and I thought I would be a chemist. During my freshman year I spent a lot of time in the Chemistry LAB and HATED it. I decided to change to business and took my first business course, Intermediate Accounting. The teaching assistant said accounting is based on ONE EQUATION: Assets = Liabilities + Owners Equity “One equation, how can that be?” I asked my self. “Chemistry is based on thousands of equations!” I was amazed, but he was right. To learn accounting, you need only understand one equation. Why? If you understand this one equation, you’ll understand all of accounting. Let’s break it down.
ASSETS are your tangible property—money, buildings, equipment, computers, etc. LIABILITIES are what you owe, any kind of debt like credit cards (short term) or bank loans (long term). OWNERS EQUITY is what you have invested in the company, stock in the company, and your accumulated profit and loss across the years you have been in business. Let’s take a view examples: You decide to by raw materials for $1,000 to create inventory: You have an ASSET + Raw materials worth $1,000 and you have a Liability the amount you own for the raw materials so Raw Material (Asset) $1000 = Liability ($1,000) Now let’s say you sell your jewelry for $5000: Cash $5000 minus Raw Material $1000 = Owner Equity Sales $4000. This is how every account transaction works. Each transaction has to fit within the standard equation and keep the standard account equation in balance. That’s why credits have to equal debits and it’s considered a DOUBLE Sided accounting system. Both sides of the equation must balance; the sum of all accounting transactions equals zero.
Start Business Accounting: Profit and Loss Statement
A Profit and Loss statement is driven right out of the standard accounting equation. The Owners Equity part of the equation contains profits from prior years, plus revenue and expenses from this year. That’s your Profit and Loss statement: Revenues/Sales form this year – Expenses from this year = Profit or (Loss) for this year. That’s it. It’s that simple. The problem comes in when your costs are higher than your sales and you loss money. Remember revenue IS NOT CASH! Cash is how much is in your bank account regardless of how it got there. It is NOT related to sales/revenue. If you can understand this difference you are ahead of most people when it comes to accounting and you're well positioned to Start Business Accounting. Profit and Loss (P&L) statement records Sales – Expenses. That’s it. They don’t track CASH or Inventory or Liabilities (bills you owe others). Those items are tracked on the BALANCE SHEET, which I’ll talk about next. Your goal with your business is to have more SALES/REVENUE then you have EXPENSE. That’s what you plan for and what you spend your time operating the business to achieve. A Profit and Loss statement is for a period in time… a month, a quarter, a year. P&L’s don’t track running balances like your bank account etc. They simply tell you if you made a profit for this time period. That’s why your P&L is so important. It answers an important question. ARE YOU MAKING MONEY? If you’re making money everything will take care of itself. If you’re losing money eventually your bank balance is going to show it. The P&L is an EARLY warning system that tells you how you’re doing. Start Business Accounting: Balance Sheet The Balance Sheet is everything else that isn’t on the Profit and Loss Statement. It’s everything that isn’t Revenue/Sales and Expenses. The balance sheet includes items such as:
Assets: Inventory (jewelry you have on hand), Bank Account Balances, Accounts Receivable Balances
Liabilities: Bills you owe other companies, Credit card balances, Loans
Owners Equity: Prior years retained profit that is not on the Profit and Loss Statement
Your balance sheet tracks everything from year-to-year and is a running BALANCE not for a point in time. Therefore, it is the reverse of a Profit and Loss Statement. Why is it set up this way? It’s just the way people have chosen to track the standard account equation. Looking at your Balance Sheet will tell you the health of your business quarter to quarter and year to year. If your Liabilities keep growing and growing and your Assets are shrinking, that means you’ve probably lost money in prior periods on your P&L. The good news is if your Assets are growing and your Liabilities are shrinking, that means you’ve made money in prior quarters and you’re on your way to a successful business. So watch your Balance Sheet because it’s CRITICALLY important. Click here to go the Final Page about Start Business Accounting which will cover:
Cash vs. Accrual Accounting which should you choose? Chart of Accounts Double Sided Entry Using Quick Books
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