Grasping accounting 101 basics is vital to the very survival and well being of every organization.
Understanding accounting principles is even necessary to fulfill many legal requirements including paying taxes.
But what is accounting in the first place? This is the record keeping, measurement and revelation of the finances of an organization which enables managers, investors, tax authorities and anybody with access to the information to understand the financial well being of the organization they are dealing with. It also enables those with the authority to make pertinent decisions about how resources will be allocated at the said entity.
Take away accounting from a business and what you will have is somebody walking around blindfolded because managers will not be able to assess and make decisions without knowing what is really going on and the “numbers” produced by accounting will always tell you that. Accounting 101 basics is the minimum you need to know as a business owner.
An income statement is one of the key tools used in financial accounting 101.
It is also referred to as a profit and loss statement or earnings statement. This is a financial report that shows exactly how the revenue (money coming in from sales) flows through the organization to ultimately produce a net income which is arrived at after deducting all costs and expenses. The main function of the income statement is to show the health of a company and reveal whether it made money or is operating at a loss of money.
Non profit making organizations like charities will usually produce a statement of activities rather than an income statement. This financial report will show funding sources versus the expenditure.
There is usually a lot of confusion between an income statement and a balance sheet. Understanding the difference will enable anybody to grasp financial accounting 101 much better. An income statement will cover a certain period of time, usually a year while a balance sheet will capture the position of the company in a single moment of time. In other words the financial position at a certain date.
A balance sheet will show a summary of financial balances with key vital numbers namely the assets, liabilities and the shareholding or equity as of a certain date (when this financial report was generated). First will be assets listed and then liabilities. The difference between them is what is called the company net worth. You will often hear people referring to a balance sheet as the “snapshot of a company’s financial position”.
To understand cash flow better it is important to look at the human body which cannot survive without blood flowing through the body. In the same way a business or organization will not be able to stay “alive” or afloat or in business without a healthy cash flow. A business can be profitable but still fail because it is cash starved or there are problems with liquidity which could mean that despite the profits on paper, clients are not paying and the money is not coming in. Cash flow, as the name suggests is actually the movement of money in and out of a business.