By Alex Nordeen – Re-Blogged From https://www.guru99.com
Accounting is no big deal to understand, for a new business
Before you start your own business, it is mandatory to know about how accounting works. Accounting involves necessary tax payments, cash flow and expenses, manage payroll and producing financial reports. Accounting gives a summary about the performance of your business. Regardless of the size of the company, accounting will be done. You need a few things to start with your accounting and that is
- Opening a bank account
- Making a list of creditors
- Making a list of items you own in the company
If you have all these things, your accounting work is half done. The next stage is how you use all this information in your balance sheet. But before that, you have to choose the accounting method. There are basically two methods, on which accounting is based.
- The Cash Method: This method is most common in small businesses. In this method, you count income when you actually receive the payment, and your expenses are counted when you do the payment.
- The Accrual Method: In this method, the company counts income when a sale is made, regardless of whether or not the company actually received the payment. Similarly, the expenses are noted or recorded when they occur and not when they are paid. This method is usually practiced in big business.
Once you have decided your accounting method the next step is to understand the balance sheet. It keeps the accountability of all your income. Only through a balance sheet you can figure out how your business is running. Your balance sheet will include main three things a) Assets b) liabilities c) Stockholders or Owner’s Equity.
- ASSETS: Cash, Petty Cash, Account receivable, Prepaid insurance, Land, Goodwill, Equipment, Bond etc.
- Liabilities: Account payable, Interest payable, Salary payable, Bonds payable, Loan payable etc.
- Owner’s Equity or Stockholders: Owner’s Equity is the difference between the asset amount and the liability amount.
To understand how a balance sheet is prepared, we have shown an Illustration of small business transaction over here.
For example, you have bought a vehicle for $15000 for your business transportation, and you have paid that amount through check. Here two accounts are involved Cash and Vehicle. The amount you pay will go in a credit account and the amount you receive will go in a debit account. Here we have paid $15000 for vehicle through check, so the cash account will go in credit, and we have received the vehicle, so the price value of the vehicle will go in debit account.
The common equation for accounting is, Assets = Liabilities + Stockholders
In fig-2, in first table, the cash amount is depleted from $20,000 to $5000 as you paid $15,000 for your vehicle, so the Asset decreased, but at the same time you bought a vehicle for $15,000 which will balance the Assets and the total remains same as $20,000.
Let’s assume that you have received a $20 check from a customer for your product, and we will debit the account ‘CASH.’ But we have a rule: we have to balance the credit side, as well. The second side or the credit side will be a ‘SERVICE REVENUE’; it is an income statement account. The amount $20 is the amount we ‘earned’ and not what we received, so it will go in Credit side.
Now, your business is doing well, and you have received another order for $300, but your customer asked to pay that amount after a week. The customer tells you to submit an invoice for $300, and they will make the payment after one week. As we have discussed in transaction-2, any amount that is earned and not received will go in Service Revenue, so one account will be a ‘Service Revenues’, which will be our credit account. For this deal, we haven’t received the cash, and an invoice is generated to the customer. Any bill or invoice generated to the customer for payment in a given time frame will go in ‘Account Receivable’, which will be our debit account.
Now, there is another transaction that we missed, while we got an order for $300 for the product, we had hired a person to deliver the product, and we paid him $50. Any expense will go in debit account. While the company owes money to someone for the purchase of product or service, which was not paid immediately will go in account payable. ‘Account Payable’ would go in the credit side.
Now, before we prepare a balance sheet for our transaction, we will calculate our net income. Net income is something that we get by deducting an expense from our gross profit. Here our gross profit is $300 and also we got a check for $20, and deducting a $50 expense from it, we will get net profit. $320- $50= $270
|Gross Profit||$ 320 (Total business revenue )|
|Expense||– 50 ( Paid to delivery person)|
|Net Profit||$ 270|
|Assets||Amount||Liabilities & Owner’s Equity||Amount|
|Cash||$ 5,020||Liabilities/ Account Payable||$50|
|Vehicle||$ 15,000||Common Equity||$ 20,000|
|Account Receivable||$ 300||Retained earning||+ $ 270|
|Total Assets||$20,320||Total Liabilities||$20,320|
Now, in the balance sheet you have balanced the both sides. If you know which amount will go on which side, it is easy to do business accounting.
Before you start with balancing the accounts, there are few rules you have to follow for credit and debit accounts, as shown in below table.
Debits and Credits of accounts
|Increase in asset accounts||Decrease in assets accounts|
|Increase in expense accounts||Decrease in expense accounts|
|Decrease in liability accounts||Increase in liability accounts|
|Decrease in equity accounts||Increase in equity accounts|
|Decrease in revenue accounts||Increase in revenue accounts|
If you get familiarized with these basics of accounting, then to use accounting for taxation will be easier to understand and implement for your business.