Accounting Basics 101 – The Fundamentals

Accounting Definition

Accounting is an important part of business and it is useful to know the basics of accounting, if your are a business owner a bookkeeper, or just curious. The accounting process starts by posting financial transactions and then the generating of reports, these reports can assist business owners with financial decisions.

Why is Accounting so Important?

Most businesses need accounting its one of the few services they can go without. Its importance can not be over-emphasised.

• Business Financial Position – Proper bookkeeping gives a reliable measure of your business’ performance. For a business to continue trading it needs to be making a profit and have enough money to pay its bills.
• Taxes – You will need to know how much tax you owe and with the help of an accountant you will know this, through profit and loss, balance sheets and journal adjustments inc allowable expenses.
• Borrowing Money – Getting a business loan requires you to show your financial statements. This may include cashflow projections, profit/loss and a balance sheet. Proper bookkeeping will furnish the accountant with the information required to produce these important reports.
• Business Strategy – When starting in business you will have put together a business plan. Accounting reports will help you see if you can buy that new equipment you need. Sales trends can help you prepare for busy times and help with ideas for quiet times.
• Legal Requirements – It is important that most business file their company accounts on time and accurately. An accountant can carry out this important obligation so you do not receive any fines or other penalties.

Bookkeeping Vs Accounting, what is the difference?

Bookkeeping is a vital process of recording daily transactions and organising financial documents. Accounting uses the data generated from bookkeeping records to make sense of a company’s finances and progress.

Simply put, a bookkeeper tracks finances, and an accountant analyses them. There is some overlap between bookkeeping and accounting tasks.

Accounting Process

The accounting process contains 8 steps, comprising of receiving source documents, entering transactions to closing the books at the end of the financial year.

The Accounting Equation

The accounting equation is the fundamental basis of the double entry accounting method and the balance sheet. This can be broken down into assets, liabilities and capital. The equation states that the business assets must always equal the liabilities plus the owners equity [assets = liabilities + equity]

Debits and Credits

To understand accounting, you need to forget everything you know about debits and credits. Debit from your personal bank account normally means a decrease, the opposite is true with the business bank account when in fact a debit is an increase.

Double Entry Accounting

Double entry accounting/bookkeeping is the fundamental method which uses the accounting equation. The double entry system records each business transaction twice. The result is one debit and one credit entry which affect two different accounts, these entries are in balance.

Chart of Accounts (COA)

A chart of accounts (COA) lists all financial accounts used in an organisation to track assets, liabilities, capital income, expenses. it lists all the accounts a business needs to keep track of its money.

Accounting Concepts

Ground rules of accounting that are (or should be) followed in preparation of all accounts and financial statements. The four fundamental concepts are:

Accruals concept: revenue and expenses are taken account of when they occur and not when the cash is received or paid out.

Consistency concept: once an entity has chosen an accounting method, it should continue to use the same method, except for a sound reason to do otherwise. Any change in the accounting method must be disclosed.

Going concern: it is assumed that the business entity for which accounts are being prepared is solvent and viable, and will continue to be in business in the foreseeable future.

Prudence concept: revenue and profits are included in the balance sheet only when they are realised (or there is reasonable ‘certainty’ of realising them) but liabilities are included when there is a reasonable ‘possibility’ of incurring them. Also called conservation concept.

GAAP

Generally Accepted Accounting Principles

Profit and Loss Statement

The Profit and Loss Statement  summarises your business financial transactions for a given period, such as a month quarter or a year, it comprises of [Sales – Cost of goods sold – Expenses] to arrive at a Net Profit Figure

• Income: Sales of goods/services, grants and commissions.
• Expenses: Salaries, insurance, training, electricity, postage, cost of goods sold (*COGS e.g materials, tooling, sub contractors etc)

Balance Sheet Accounts

Every Business has three key financial parts that must be kept in balance, The formula used to keep the books in balance is the accounting equation

The Balance Sheet is a snap shot of the businesses financial health. It is balance by the accounting equation [Assets = Capital + Liabilities]

• Assets: These are items the business owns, such as vehicles, machinery, stock, also money that is owed in from debtors.
• Liabilities: Money owed by the business to creditors, VAT, Payroll liabilities and loans
• Capital or Owner/Shareholder Equity: This the balance of what is owed to the owners. It comprises of money withdrawn money invested and profits.

Business Assets

Business assets are just that assets that belong to the business. The business assets are shown the balance sheet generally a annual report but can be looked at the end of any given period. It contains two main asset sections:

Current Assets	Long Term Assets
Current Assets can be converted into cash within 12 months of the balance sheet date	Long Terms Assets are due to be converted into cash more than 12 months after the balance sheet date.

Fixed Assets

A further classification other than long-term or current is also used for assets. A “fixed asset” is an asset which is intended to be of a permanent nature and which is used by the business to provide the capability to conduct its trade.

Investments in other companies which are intended to be held for the long-term can also be shown under the fixed asset heading.

Fixed assets can be further classed into tangible or intangible as follows:

• Tangible fixed assets” may include plant & machinery, land & buildings and motor vehicles.
• Intangible fixed assets” may include goodwill, patents, trademarks and brands – although they may only be included if they have been “acquired”.

Business Liabilities

Business liabilities are just that, a liability to the business or a debt that is owed. The business liabilities are shown the balance sheet generally reported annually but can be looked at the end of any given period. It contains two main asset sections:

Current Liabilities	Long Term Liabilities
Current Liabilities are due to be repaid within 12 months of the balance sheet date	Long Term Liabilities are due to be repaid more than 12 months after the balance sheet date.

Owners Equity

This generally the owners investment in the business and contains, owners investment, shareholders funds, and profit.

Writing off Bad Debts

On occasion a business may need to write off a debt that it can not retrieve. There are several steps to be taken before the debt is written off, if it is un-retrievable a journal entry will be required to write off the bad debt in the accounts

Depreciation

As assets age they attract depreciation a bookkeeper can carry out this task but generally it falls to the accountant. It involves monthly and most certainly annual writing down the value of an asset using the same method in which a percentage is used to reduce the value either by straight line or decreasing value depreciation. Once a method has been chosen it must be used every time depreciation is carried out

Gaines and Losses

Gains and Losses arise from the sale of assets. These transactions are recorded as journal entries and the NBV will be used to calculate the loss or gain in the accounts. The figure for the loss or gain is recorded in the profit and loss account, as well as other journals in the balance sheet assets section.

Preparing Financial Reports

Accurate and useful reports enable a business to know its financials status and identify areas of overspending, reduction in profit etc.

Cash Flow Statement

The cash flow statement refers to the inflow and outflow of cash over a period of time.

Cash inflows from borrowing money and from additional investment of money by its owners, these are called financing activitiesbookkeeping.

Cash Inflows from making sales and cash outflows for expense – these are called operating activities

Cash Outflows for making investments in new assets such as machinery, vehicles and buildings. Cash inflows from making sales on assets that are no longer needed, these are called investment activities