Accounting Guide
Accounting is the organized method of keeping track of a business's financial information. It includes tasks like recording transactions, creating financial statements, and ensuring taxes are paid correctly. This guide can help you understand some of the basics of accounting and terms that are essential for understanding the principles and practices of financial reporting and management.
What is Accounting?
Accounting is a systematic process of recording, classifying, summarizing, and reporting financial transactions and activities. It involves the collection and organization of financial data to provide insights that aid in decision-making, compliance with regulations, and financial planning. It serves as a vital function in evaluating a company’s performance, managing resources, and ensuring accountability and transparency in financial practices.
Accounting Basics
Accounting basics refer to the fundamental principles and concepts that guide the recording, analysis, and reporting of financial information. Understanding these essentials is crucial for anyone involved in managing a business, whether small or large. Key topics include the accounting equation, which emphasizes the relationship between assets, liabilities, and equity, as well as the importance of double-entry bookkeeping, where every transaction impacts at least two accounts. Familiarity with financial statements, such as the income statement, balance sheet, and cash flow statement, is also essential, as these documents provide valuable insights into a company's financial health. By grasping these accounting basics, individuals can make informed decisions, ensure compliance with regulations, and contribute to their organization’s financial success.
Key Financial Documents
Key financial documents in accounting play a crucial role in tracking the financial health of a business. Here are some essential reports and documents to know.
Balance Sheet
The balance sheet provides a snapshot of a company's financial position at a specific point in time. It lists total assets, liabilities, and equity to show what the company owns and owes.
Income Statement
Also known as the profit and loss statement, the income statement outlines the company’s revenues and expenses over a specific period. This document helps assess operational performance and profitability.
Cash Flow Statement
The cash flow statement details the cash inflows and outflows from operating, investing, and financing activities. It helps businesses understand their liquidity and cash management.
Accounts Receivable Aging Report
This report categorizes accounts receivable based on the length of time an invoice has been outstanding. It helps businesses manage collections and assess credit risk.
Accounts Payable Aging Report
Similar to the receivable aging report, this document lists amounts due to suppliers and categorizes them by the length of time invoices have been outstanding, aiding in cash flow management.
Bank Reconciliation Statement
This document compares the company's records with the bank's records to identify any discrepancies. It helps ensure that all transactions are accounted for and provides an overall view of cash management.
These key financial documents not only facilitate accurate record-keeping but also provide valuable insights to business owners and stakeholders for better financial decision-making!
Essential Accounting Terms
Understanding essential accounting terms is crucial for effective financial management and decision-making. Familiarity with these terms can significantly enhance one’s ability to interpret financial statements and engage in strategic planning. Here are some essential terms to know:
A
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An accounting period defines the length of time covered by a financial statement or operation. Depending on the business, commonly used accounting periods include fiscal years, calendar years, and quarters, which divide the calendar year into three-month periods. Some organizations also use monthly periods.
➜ Each accounting period covers one complete accounting cycle.
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Accounts Payable is an account in the General Ledger used to track money a company owes to vendors.
➜ Shown as a Liability on the company’s Balance Sheet.
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Accounts Receivable is an account in the General Ledger used to track money owed to a business by its customers or other debtors. It is generally in the form of invoices created by a business and delivered to the customer for payment within an agreed time frame.
➜ Shown as an Asset on the company’s Balance Sheet.
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Records revenues and expenses when they are incurred, regardless of when the payment was received or processed.
➜ Accounts Receivable and Accounts Payable accounts are affected.
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These show the length of time an Invoice (Account Receivable) or a Bill (Account Payable) has been outstanding.
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Resources a company owns that are expected to provide future economic benefits. This includes items like Cash, Accounts Receivable, Investments, Stocks and Equipment.
➜ Shown on the company’s Balance Sheet.
B
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A financial statement summarizing a company's Assets (what it owns), Liabilities (what it owes), and Equity (owner's stake) at a specific point in time.
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A Bill is received from a vendor when they are owed money that will be paid at a later date.
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Burn rate is amount of money a company spends each month and measures how quickly a company is depleting its cash reserves.
C
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Capital refers to the funds or resources invested in a business by its owner(s).
➜ Shown as Equity on the Balance Sheet.
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Cash Basis Accounting records income and expenses when payment is received and processed.
➜ Cash accounts are affected.
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Tracks the actual movement of Cash into and out of a business over a period of time.
➜ Recorded in the Cash Flow Statement.
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A list accounts and subaccounts in a company’s General Ledger to summarize money movement from a company’s financial statements.
➜ A Chart of Accounts includes Assets, Liabilities, Equity, Revenue, Cost of Goods Sold and Expenses.
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A phrase signifying an accountant finalizing all accounting records in an accounting period. It is to protect transactions in previous periods from being changed and can show if anything has been changed after the books were closed.
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Direct costs associated with producing the goods or services sold by a business.
➜ (Starting Inventory + Purchases) - Ending Inventory = COGS.
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Credits are accounting entries that increase a Liability, Revenue or Equity account and decrease the balance of an Asset, Loss or Expense account.
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A Credit Memo is a sales form that acknowledges what is owed to the customer.
D
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Debits are accounting entries that increase an Asset, Loss or Expense account and decrease a Liability, Revenue or Equity account.
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Used to record money going into a company’s business bank account.
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The systematic reduction in the value of an asset over time.
➜ Recorded as an Expense on the Income Statement.
➜ Accumulated Depreciation (the total Depreciation over an Asset’s lifetime) is recorded as a contra Asset on the Balance Sheet.
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An accounting concept that states that every transaction has an equal and opposite effect in at least two different accounts. This ensures that every transaction has two sides: a Debit and a Credit, and that the accounting equation (Assets = Liabilities + Equity) always remains balanced.
➜ Recorded twice in the General Ledger.
E
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An Estimate is a sales form provided to a potential customer with a detailed breakdown of what your client proposes to deliver, along with the costs. It essentially serves as a quote or a proposal for the products/services.
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Equity, also known as Shareholder Equity, Owner's Equity, or Net Worth, refers to the difference between the value of the company’s Assets and Liabilities.
➜ The core accounting equation is Assets = Liabilities + Equity
➜ Shown on the Balance Sheet.
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The costs incurred by a business while trying to generate revenue.
F
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Expenses that remain constant regardless of the level of production or sales within a specific timeframe.
➜ Examples are Rent, Salary, Property Taxes, Insurance and Depreciation.
G
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A General Ledger is a record of all financial transactions for a company, organized into accounts.
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A set of standard rules and guidelines followed by accountants in the United States to ensure consistency and comparability in financial reporting. It's a central point for tracking all financial activity, acting as a master record of a company's financial data.
➜ The General Ledger is the source for preparing financial statements like the Balance Sheet, Income Statement, and Cash Flow Statement.
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Gross income is the total revenue generated by a business, or the total pre-tax earnings for an individual, before any deductions or expenses are subtracted.
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The definition of Gross Profit is total Revenue minus the Cost of Goods Sold (COGS).
➜ Gross income = Total revenue – COGS
I
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An Income Statement, also known as a Profit and Loss Statement (P&L) or Statement of Operations, is a financial report that summarizes a company's Revenue, Cost of Good Sold, Expenses, gains, and losses over a specific period. It provides insight into a company's profitability and operational efficiency.
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Products that a company plans to purchase and sell and which they want to track quantities on hand.
➜ Shown on the Balance Sheet.
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An Invoice is a sales form issued to a customer to request payment for products or services provided. It’s a formal sales transaction record and outlines the payment terms, including the amount due, payment due date and any applicable discounts or terms.
J
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A Journal Entry records a financial transaction in a business’s accounting books. It documents the date, accounts affected (debits and credits), amounts involved and a description of the transaction.
➜ Records Debits and Credits to accounts in the General Ledger.
L
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The debts and obligations a company owes to others. This includes Accounts Payable, Loans and Taxes.
➜ Shown on the Balance Sheet.
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Liquidity refers to how easily a business can convert its assets into cash.
If a business can easily turn an asset into cash, then it is a Liquid Asset. They are essential for short-term (due within one year) financial needs and maintaining cash flow.
➜ Cash, short-term investments and Accounts Receivable are examples of Liquid Assets.
N
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Net Profit, aka Net Income or Net Earnings, refers to the money a business has after covering all its operational and financial obligations.
➜ Net Profit = Total Revenue - Total Expenses
➜ Shown in the Income Statement.
➜ Contributes to the Equity section of the Balance Sheet under Retained Earnings.
O
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Term that describes any indirect costs required to continue business operations that are not directly linked to a company's products or services.
➜ Examples include Insurance, Administrative Costs, Rent and Utilities.
P
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The process of tracking and recording money paid to employees. It also includes the records of deductions like taxes and benefits the employee receives.
➜ Affects the Income Statement and the Balance Sheet.
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A Profit and Loss Statement (P&L) is an Income Statement that reports a company's financial performance over a specific period. It shows Revenues, Expenses, and Net Income (or Loss) over a specific period, showing results of a company’s profitability and operational efficiency.
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Purchases are the exchange of money for Inventory or Goods during an accounting period.
R
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The verification process that compares a company’s financial information to external sources and confirms that they match. This ensures the accounting activity reflects what’s really happened in terms of Income, Expenses, and other movements and Cash adjustments.
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Return on Investment (ROI) is a financial ratio used to measure the profitability of an investment by comparing the Net Profit (or Gain) generated from an investment against its cost.
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The total income a business generates from selling goods or services.
S
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A Sales Receipt is a sales form used to record a sale when payment for a product or service is made.
U
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Undeposited Funds, aka Payments to Deposit, are funds that haven’t been deposited in the bank yet.
➜ Once the funds are deposited, they're transferred from the Undeposited Funds account to the appropriate bank account as part of the bank reconciliation process.
V
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Expenses that change in direct proportion to the level of activity or production volume.
➜ Examples include raw materials, hourly wages, utilities and credit card processing fees.
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Accounting Articles
Want to learn more information about any accounting terms and how they apply? Here is a list of some of the blog articles that we have published to help you learn more about any accounting terms, documents and procedures.
Here are some essential terms to know:
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