You didn’t get into the business as an accountant. Why Do You Need To Know These Accounting Concepts? Understanding basic accounting concepts will help you make better predictions about the future of your business based on past sales and cost trends. This will help you make smarter financial decisions in the long run.
Understanding basic accounting principles will also help you make quick but well-informed operational decisions on a daily basis. This saves you time and money – two of your most valuable resources as an entrepreneur. Even if you use Accounting softwareIt is important to have a basic understanding of these concepts.
When you have a basic understanding of accounting concepts, you can have productive conversations with your financial advisors as you plan strategically for the future of your business.
Here are the top nine accounting concepts you need to know.
Understanding basic accounting concepts is vital. There are two general ledger accounting methods that you can use – cash based and accrual based accounting. Many small businesses start out with cash accounting, but accrual-based accounts give you a much better understanding of your company’s financial position than cash-based accounts. In addition, generally accepted accounting principles (GAAP) stipulate that public companies must use accrual accounting.
The accrual-based financial statements assign income and expenses to the periods in which they are incurred. Base cash statements, on the other hand, reflect income and expenses only when they are received or paid.
For example, suppose you invoice a customer for services performed on March 15 and give the customer 30 days to pay the invoice. If the customer is a good customer, the check will arrive on April 15th, or maybe even a few days earlier.
On an accrual basis, the income in March is shown as an increase in sales and a corresponding increase in receivables. On a cash basis, earnings will not appear until April when they arrive in your bank account.
Suppose you had to pay a subcontractor to perform the services for which you billed the customer. On March 31, the subcontractor billed you for the services it provided that month and gave you 45 days to pay the invoice. This means that you pay them on May 15th.
The costs appear on your accrual annual invoice in March – the same month in which you billed your customer. The expenses will not appear on your cash statement until May.
The ability to allocate income and expenses to the time period in which they are incurred can help you to better identify expenses and trends in your company. For this reason, accrual-based financial statements are superior to financial statements on a cash basis for economic reasons.
Bottom line: Know the difference between accrual basis and cash basis.
This second accounting concept is closely related to the first. The concept of consistency states that once you have selected an accounting method, you should adhere to it for all future financial records. This allows the company to accurately compare performance in different billing periods. The Internal Revenue Services also require consistency for filing taxes for small businesses. If you select a billing method and want to change it later, you will need to obtain IRS approval.
Bottom line: Stick to a billing method.
The “going concern” concept states that you should assume that your company is in a good financial position and will continue to operate for the foreseeable future. This concept allows companies to sometimes defer the recording of certain expenses to future accounting periods. Of course, the accountant or auditor may come to a different conclusion if there is evidence that the company is unable to repay its loan or other obligations. In this case, the company may need to consider the liquidation value of assets.
Bottom line: Suppose the business unit has a good reputation and will continue.
In the context of the conservation concept, income and expenditure are treated differently. Companies should only recognize revenue if there is reasonable assurance that they will be recognized, e.g. B. through an order or a signed invoice. However, companies should start recording expenses sooner if there is even a reasonable possibility that they will be incurred. This speaks in favor of a more conservative annual financial statement. For cash flow purposes, it is better to overestimate your expenses than your income.
Bottom line: Expenses should be realized earlier than income.
This is one of the most important small business concepts – you should avoid mixing businesses with personal funds. Deals should only reflect business transactions. For example, you should avoid writing personal expenses on a business credit card. Failure to follow this concept can make your virtual bookkeeping much more difficult and even get you into legal trouble if you are a company or a limited company. In these cases, the only way to maintain limited liability protection is by separating business and personal finances.
Bottom line: Don’t mix up personal and business finances.
This concept is pretty simple, and it just says that companies should keep a record of all financial transactions that could have a material impact on business decisions. Even if this results in smaller transactions being recorded, it is better to have a comprehensive view of the business. In fact, the accounting software makes it very easy to keep a record of all small transactions as it is automatically synced with your bank accounts and credit cards.
Bottom line: Record all major transactions on the books.
The concept of “matching” is that you should record income and expenses related to income at the same time. The purpose is to show you a cause and effect relationship between income and purchases. For example, let’s say you pay a seller a commission for a sale you recorded in March. The commission should also be recorded in March.
Bottom line: Record the sales in the same period as the sales.
There is a basic accounting equation you can use to record transactions:
Assets = liabilities + management equity
As can be seen from the formula, the assets are on the left side of the equation and are charged. In the same way, assets will show up on the left side of your general ledger. For example, if you receive cash, your cash account will be debited in your accounting software. Liabilities and equity are on the right side of the equation and are credited. Likewise, these items are on the right-hand side of your general ledger. For example, if the company issues common stock, that amount is deposited into the owner’s equity account.
Bottom line: Assets = liabilities + management equity.
“Billing Cycle” is the final concept that you should understand. According to this concept, only financial records for the period in question should be included. To understand this point, the first thing you need to understand is the three financial statements that are important to a business – income statement, balance sheet, and cash flow statement.
The income statement and the cash flow statement cover a specific period, e.g. B. a quarter or a calendar year. A balance sheet is a snapshot of a company’s assets and liabilities as of a specific date. For example, if you were to run an income statement for the first quarter of 2019, you would not cover transactions that occurred before or after the quarter. This ensures that the company can accurately compare performance over different time periods.
Bottom line: Only record transactions for the reporting period.
If you understand these basic accounting concepts, you can be successful in business.
You don’t need advanced accounting skills to run your business effectively. However, if you familiarize yourself with these basic accounting concepts (and invest in some useful accounting books), you will be able to verify your transactions and financial statements with greater confidence. The added value you will get from talking to your financial advisers will also be worth it to understand these concepts. If you need accounting software that will help you understand and easily implement these concepts, give it a try QuickBooks Online.