What accounting concepts should small business owners know?
It’s not your intention to go into business to become an accountant and so why would you need to be aware of the accounting principles? Understanding the basic accounting concepts will help you make better forecasts about your company’s future, based on the past trends in costs and sales. This will enable you to make better financial choices over the long term.
Knowing the fundamental accounting principles can assist you in the making fast and informed decisions about your operations daily. This can save you time and money, two of the most important assets as a business owner. If you’re employing the software for business accounts, it’s essential to understand the basics of these ideas. Also, knowing accounting principles can help you have productive conversations with your financial advisors while making plans for your business’s future. These are the most crucial accounting concepts you have to understand.
Table of ContentsToggle
If you’re seeking to learn accounting basics, This is an essential one. You can employ two major accounting techniques cash basis accounting or accrual basis. Many small-scale businesses begin using cash basis accounting. However, financial statements based on accrual will give you a greater understanding of your company’s financial condition than cash basis financial statements. In addition, the Generally Accepted Accounting Principles, also known as GAAP, which are required for public companies, requires them to employ accrual accounting.
Accrual basis financial statements correspond to expenditures and income to periods during which they were paid for. However, cash-based statements only show the income and expenses when they are paid or received.
Let’s suppose you invoice the customer for services rendered on March 15 and give the customer thirty days to settle the bill. If the customer is reliable, the payment is due on April 15 or perhaps just a few days sooner.
In the case of financial statements based on accrual, the income is reported in March due to increased sales and a rise in the number of accounts payable. The income will not be reported until April when it reaches an account in your banking institution for financial statements based on cash.
In the same way, suppose you were required to reimburse a subcontractor to complete the work for which you invoiced the client. The subcontractor invoiced your account on March 31 for services they provided in the month and provided you with an additional 45 days in which to settle the bill. This means that you’ll have to be able to pay them by May 15.
In your accrual-based balance sheets, this cost will be reported in Marchthe same month that you invoiced your client. In your cash-based financial statements, the expense won’t be reflected until the month of May.
The ability to correlate expenditures and income with the time period during the period they are made can assist you in identifying the trends and expenses in your company. This is why accrual-based financial statements are more beneficial than cash-based financial statements for management.
The second accounting concept is very similar to that of the initial. The concept of consistency states that once you have decided on one accounting method, it is best to stick with the same method for all subsequent financial reports. This lets the company precisely compare the performance of various accounting time periods. This allows the company to compare performance across different accounting periods accurately. Internal Revenue Service also requires consistency in accounting for small-business taxes. If you opt for an accounting method and then decide to alter it, you need IRS approval.
According to the conservation principle, revenue and expenses are treated differently. Businesses should only recognize revenue when they have a reasonable chance the revenue will eventually be recognized, such as a purchase receipt or a signed invoice. But, companies should recognize expenses earlier if there’s a good chance that they’ll be incurred. This is in favour of more prudent financial statements. It’s more beneficial for cash flow reasons to underestimate your expenses more than your earnings.
This is among the most important principles for small business owners to avoid the commingling of personal and business finances. Financial statements for business should show only business-related transactions. For example, you must avoid putting personal expenses onto a credit card. If you don’t adhere to this rule, it could complicate your bookkeeping online. It could put you in legal trouble in the case of a corporation or a limited liability business. In these cases, you’ll be able to keep your limited liability insurance only by separating personal and business financial accounts.
This is a fairly simple concept and means that companies should keep track of any financial transactions that might influence the business’s decisions. Even if there are the recording of minor transactions, the concept is to provide a complete analysis of the company. In reality, accounting software allows you to track every single transaction since it instantly integrates with your accounts at banks and credit cards.
The “Matching” concept “matching” concept says that you must simultaneously keep track of the expenses and revenue associated with revenue. This is so that you observe any causal connection between purchases and income. For example, you give a commission to a salesperson for sale you track in March. The commission must record in March.
There is a fundamental accounting formula that will assist you to keep track of the following transactions:
Assets = liabilities + owner’s equity
The formula suggests that assets are located to the left of the equation and are debited. The same way assets appear to the left of the general ledger. For instance, if you get cash, your account for cash is debited through the accounting program you use. The owner’s equity and liabilities are to the right of the equation and are credited. In the same way, these items are to the right of the general ledger. For instance, if the company issues shares of common stock, this amount would be credited to the owner’s equity account.
“Accounting period” is the last concept to be understood. In this sense, only the financial records related to the period in question should be included. To grasp this, it is first necessary to know those three statements of financials that are essential to a business, such as the profit and loss statement and the balance sheet and statement for cash flow.
The knowledge you gain from these accounting fundamentals can help you succeed in your business. There is no need for advanced accounting expertise to manage your company. But having the basic principles of accounting (and buying some helpful accounting books) can assist you in reviewing your financial statements and transactions with more certainty. The added value you receive from conversations with your financial advisers will make an effort to grasp these concepts worth the effort, too. If you’re in search of accounting knowledge to understand and implement these ideas, you should try Vancouver Bookkeepers.