Accounting is a part of any business and as a business owner, you should be able to know at least its basic terms and concepts.
When I started my first business, I had no accounting background and believed that I really didn’t need to know anything about it.
I thought to myself, is it really necessary to learn accounting? Isn’t it just a matter of making sure that the business is earning more than what it is spending?
A few months into the business, I started to realize how wrong I was to think that I didn’t need to know anything about accounting to run the business. I specially struggled with the terms and legalities involved in filing taxes, insurance, loan applications and others.
That’s when I decided to hire a freelance accountant to help me. And from that moment on, I began to understand how important it really is to have some basic knowledge of accounting for your business.
Here are some of the things I’ve learned through it all. I hope that by sharing with you some of these basic accounting terms and concepts, I can clear some of the confusing jargon you’d often encounter in business accounting.
Debit and Credits
All business transactions are recorded as either a debit or a credit. A debit “adds value” to an account while a credit “removes value” to an account.
What is an account? It is the area or item where value (i.e. money) comes in or out. For example, your bank savings account. When you make a cash deposit, then that is considered a debit transaction. When you withdraw money, then you’re making a credit transaction to your savings account.
Assets, Liabilities, Equity, Revenue and Expenses
These are the different types of accounts in a business or accounting system.
- Assets – things that the business owns such as cash on hand, the value of equipment and machinery, future money collections, intellectual properties and many others.
- Liabilities – the opposite of assets, these are financial obligations of the business such as bank loans, credits to suppliers and so on.
- Equity – also called the owner’s equity, at the most basic, this is assets less liabilities and represents the net worth of the business. Equity can also refer to the amount of money invested into the business.
- Revenue – this is the account that tracks the income of the company such as product sales, service fees and commissions.
- Expenses – the opposite of revenue, this is the account that tracks the costs of generating the income for the business such as salaries, utility bills, depreciation, rent and others.
The General Ledger and Accounting System
All these business accounts are listed in the general ledger. Nowadays, many businesses use a computer accounting system software to track its accounts.
The Accounting Equation
The accounting equation states that the sum of the assets and expenses must be equal to the sum of the liabilities, equity and revenue of the business. This is the equation that the general ledger or an accounting system must keep balanced. In mathematical equation it is:
Assets + Expenses = Liabilities + Equity + Revenue
By ensuring that this equation ALWAYS holds true for your business, you then have the guarantee that all business transactions were properly accounted for. Accounting is as simple as that.
So for example, let’s say you borrowed P10,000 from a friend. Then you used that money and P2,000 of your personal cash to buy 100 pieces of an item that costs P120 each. After which in just one day, you were able to sell 30 pieces of that item for P180 each at a bazaar stall which rents for P200 a day. Then your accounting equation at the end of the day will somewhat look like this:
Please understand that these are all very basic and simplified explanations. If you want to know more about small business accounting, I suggest that you take a short course in a business training institution, read and research on books and online references or consult an accountant.
Moreover, you might be interested to read my previous article on how to calculate your net worth by making a personal statement of your assets and liabilities. Doing this will help you practice some of the basic accounting terms and concepts you just learned and at the same time, help you discover where you are in your financial road map.
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Photo courtesy of emilioo
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