Being a business owner who enjoys number crunching doesn’t automatically make you an accounting expert. As an entrepreneur, mastering the accounting basics is crucial for saving time and money. Whether seeking a CPA in Ottawa or simply looking to deepen your financial understanding, there’s no ‘ideal’ time to start learning.
The article below serves as your practical guide, easing you into the essentials of business accounting. Upon completing this guide, you can manage your accounting needs or properly enlist a professional.
What Is Accounting?
Understanding or outsourcing accounting, including contexts like fiscal consolidation in Malta, is essential in business management. While many have encountered accounting in various contexts, such as work, media, and online forums, understanding its basics is another story.
Accounting is a combination of strategic and analytical work. It extends beyond simple bookkeeping or tax filing; it’s about understanding the implications of your financial records for various stakeholders, including regulatory bodies and tax officials.
Accountants do more than crunch numbers and organize receipts. Accounting involves a systematic process of collecting, analyzing, and reporting financial data, using these insights to articulate your business’s liquidity, financial health, and operational efficiency.
The journey into accounting begins with an introduction to its fundamental terms and concepts. Understanding these accounting terms and principles is the first step to managing your business finances effectively.
Basic Accounting Terms
You’ll find many accounting terms everywhere, no matter where you work. By understanding these, you’ll not only recognize them but also comprehend their application in practical accounting situations.
GAAP refers to ‘Generally Accepted Accounting Principles.’ This term in accounting and financial reporting refers to a set of widely followed rules and guidelines.
2. Fiscal Year
The fiscal year is the period used for accounting purposes. Different companies may have varying fiscal years. While some align their financial statements with the calendar year, others choose a timeframe matching the time accountants prepare their financial statements.
3. Accounts Payable and Accounts Receivable
A company’s accounts payable are its obligations to suppliers, customers, or bondholders. On a balance sheet, these are categorized under liabilities.
The company’s receivables represent the money that others owe it for goods and services it has provided. In the balance sheet, accounts receivable are listed under assets.
Assets are tangible and intangible resources owned by a company. Tangible assets are physical items like cash, real estate, and equipment. Intangible assets, on the other hand, refer to non-physical properties such as patents, trademarks, and copyrights.
Expenses are the various costs a company faces in its business operations. These expenditures, which might include machinery maintenance such as a DV Systems compressor, are essential for generating revenue. Expenses are categorized into the following types:
- Accrued expenses – These are costs that have been recorded but not yet paid, falling under accounts payable.
- Fixed expenses – Regular and predictable costs, like salaries, utilities, and rent.
- Operating expenses – Crucial outlays necessary for the business to run and earn revenue, including all fixed expenses.
- Variable expenses – Fluctuating costs based on the company’s production and performance, such as raw materials used.
Liabilities are the various debts and obligations a company is responsible for, covering both short-term and long-term commitments. These often include debts, loans, and taxes your business must pay.
7. Cost of Goods Sold (COGS)
Cost of Goods Sold, or Cost of Sales (COS), pertains to the production costs associated with your products and services. Lowering the COGS can be an effective strategy to boost profit without needing to increase sales. It is typically the initial expense listed on the Profit and Loss (P&L) Statement. Understanding your COGS is also essential for calculating your business’s gross margin.
In accounting terms, profit, often called the ‘bottom line,’ represents the difference between your business’s income and its combined expenses and Cost of Goods Sold (COGS).
Basic Accounting Principles
Accounting standards ensure that investors receive reliable financial statements, not swayed by inaccuracies. Having covered the basic terms, we now turn to the foundational accounting principles. Companies must adhere to these principles to ensure their financial reports are accurate and uniform.
1. Full Disclosure Principle
This principle mandates that financial statements should not withhold any significant information. These statements must accurately reflect the actual economic state of affairs in compliance with legal standards. Accountants often incorporate explanatory notes in their financial statements to adhere to this principle.
2. Historical Cost Principle
According to this principle, assets should be recorded at their purchase price at the time of acquisition. This initial cost is the foundation for all subsequent accounting records related to the asset, both during the acquisition and future accounting periods. Typically, if an asset is acquired without payment, it is not recorded under assets in financial statements.
3. Matching Principle
This principle dictates that an accountant should align expenses incurred in an accounting period with the revenues generated in that period. For example, if your business earns revenue from goods sold in a specific period, the COGS for those items should be accounted for in that same period.
This principle is not about directly linking expenses to specific revenues but is based on the accruals concept. It emphasizes recognizing and recording revenues and expenses as they are accrued, regardless of actual cash flow.
4. Objectivity Principle
The objectivity principle stipulates that accounting data should be absolute, verifiable, and free from the accountant’s personal biases. Accounting books must be supported by adequate evidence to ensure their reliability and credibility.
5. Revenue Recognition Principle
According to this principle, accountants must recognize revenue in an enterprise’s income statement when earned, regardless of when the cash is received. This principle is a crucial aspect of the accounting basics, laying the groundwork for understanding the nuances of financial reporting.