Beginner’s Guide on Accounting for Small Businesses
Accounting is a process of keeping records of the financial transactions of a company. The accounting process includes summarising, analysing and reporting the transactions to regulators and tax collection authorities. Accounting plays an essential role in businesses and could help them save money and improve performance when things are tough financially. By maintaining the books regularly, you can find ways to improve business performance financially while avoiding fraud and keeping on the right side of tax authorities.
Because of improvements in technology, it is easier than ever before for business owners to have control over their accounting responsibilities in real-time for far lower costs than it was ever possible before.
Essential Principles Of Accounting
There are the essentials of accounting that small businesses need to be familiar with.
Basic Accounting Terms
The basic accounting terms include.
- Assets: Anything that the business owns
- Liabilities: debts that a business owes to its creditors.
- The owner’s equity shows the owner’s investment in the business in shares or capital.
- Income: money that is earned by a company from selling goods or services.
- Expense: amounts spent by businesses on goods, services and items.
Double Vs Single Entry Accounting
Each recorded transaction affects at least two accounts in double-entry bookkeeping, while only income and expenses are recorded in single-entry bookkeeping. You will get a limited view of your business finances in single-entry bookkeeping because there are many more transactions involved in a business other than just expenses and income.
Basic Accounting Equation
The basic accounting equation is.
Assets = liabilities + owner’s equity
Owner’s equity = assets – liabilities
The most important aspect of this equation is that it should be balanced out. If both sides are not equal, this means that there is something wrong with your calculations.
Understanding Debits And Credits
Debits are the transactions that give rise to assets or expenses and decrease the liabilities of the company. On the other hand, credits give rise to liabilities and reduce assets or expenses. It is important to remember that debit transactions always come on the left side and credit transactions on the right side in a T-Account.
A journal entry is used to record a business transaction and organise accounts affected by that transaction. These entries are made in general ledger accounts. In accounting, all transactions are recorded with an entry in the journal in chronological order.
Chart Of Accounts
Chart of accountants is a method of organising and grouping similar transactions into a specific category or accounts. There are six categories available in the chart of accounts.
- Cost Of Goods Sold (COGS)
These categories are subdivided into specific accounts such as cash, notes payable and office supplies. Creating and categorising proper accounts is essential for accurate accounting reports because the chart of accounts correlates with the general ledger. It records every transaction of the business and is a fundamental part of creating accounting reports.
Cash Vs Accrual Accounting
Cash and accrual accounting are the methods through which you can record your business transactions. Cash accounting records a transaction when the product or service is paid for, while under accrual accounting, you record transactions when they are incurred even though they are not paid for. Accrual accounting is often more used by businesses and applies to every business size or type. People choose accrual accounting because it gives a clearer picture of a company’s actual profit and loss.
Accounts Payable and Accounts Receivable
A transaction when the business sells goods and services but the buyer hasn’t paid yet will be treated under accounts receivables. On the other hand, a transaction when the company buys goods or services but hasn’t paid for them yet will be considered accounts payable. These terms will help you in understanding how to record income and expenses correctly.
Assets having a long life span, i.e. more than a year, are considered fixed assets. e.g. property, equipment etc., while current assets have a short life span, i.e. less than a year. It’s vital to remember the difference between fixed assets and current assets because the taxation treatment for fixed assets is different. As assets having a long life span are not used in a single fiscal year, they have to undergo a depreciation process.
Depreciation is a way of calculating how much life of a fixed asset is left so you can compensate for only the amount that has been used.
What Are The Basic Accounting Reports
Accounting reports help the business understand their financial health, track records, change current business practices and make informed decisions about the future. Professional accountants in London can also help you make these reports accurately as they will have expert knowledge and skills in the accounting field. The essential accounting reports include.
Profit And Loss Statement
This report, sometimes known as an income statement, is used to calculate the annual net profit of your business by subtracting the COGS from the total business income less the fixed costs. In addition, it will help you in filing multiple tax forms.
It records financial transactions of all accounts in correlation with the chart of accounts. It includes asset, liability, expense, income and equity accounts. This report is an excellent source of maintaining available vital records and analysing transactions in detail.
A trial balance is a summary list of all the accounts found within the chart of accounts. In your trial balance, the totals of debits should be equal to the sums of credits, and if they don’t, there might be some mistake in your calculations or a chance of fraud or error. Therefore, businesses should prepare this report periodically to make sure everything is balanced and looks right.
The balance sheet extracts the information from the trial balance and show’s company assets, liabilities and equity at a certain time. This report is often helpful for businesses when they are applying for loans and other sources of finance.
Statement Of Cash Flows
This report is like a general ledger specific to cash; it shows all the transactions affecting cash accounts. Therefore, this report is helpful when you need to see your money on hand or where you are investing cash.
An audit trail documents all business transactions and their details, such as who made the transaction, when the transaction was incurred, etc. It is often helpful for preparing a tax audit and is sometimes known as an Audit log or Audit History.
Accounts Receivable Ageing Summary
This report shows what customers owe you and how late they are in making their payments. You want to stay updated with this report regularly so that you can get in touch with late customers asking for money.
Accounts Payable Ageing Summary
This report demonstrates what the business owes to its suppliers and vendors. In addition, it shows the details of how old each payment is, so you need to look regularly to ensure that you paid all your bills within the due date and avoid interest or late fee charges.
How Accounting Can Add Value To Your Small Business
Doing effective accounting can add value to your small business in the form of.
Better Cash Flow And Financial Management
You can tell how much your business is earning and have enough cash to cover expenses with accurate accounting. It will help you analyse your business’s financial position and uncover those areas where you need improvement.
Business owners are required to report essential information to investors and other stakeholders. An effective accounting system helps you in increasing data accuracy and improve communication with your stakeholders.
You can track your firm’s financial records and evaluate its performance. You can analyse your past results and make comparisons to know whether your firm is improving or not. It will help plan an effective strategy for the future, resulting in low costs and high profits.
Effective Tax Preparation
With proper bookkeeping and accounting solutions, you can save time by recording all the transactions as they are incurred and determine the taxes payable in advance.
Tracking of Profitability
You can track your business profitability and improve earnings in the future. Profitability measures can help you in estimating how much your business is earning. Some profitability ratios include.
- Gross profit margin
- Profit margin
- Return on assets ratio
- Return on equity
- Return on capital employed
Small businesses need to have in-depth accounting knowledge for running their business operation smoothly; however, with the increase in technology, integrated cloud accounting software are nowadays used by small businesses for running their accounting operations much more easily than before. Accounting software can help automate the calculation of sales tax or VAT returns, generate financial statements and tax computations.
It is always advisable to use a state of the art cloud accounting software for business accounting needs, big or small. It is also noted that successful and scalable businesses tend to hire experts to set up their financial systems from the foundational level and outsource their accounting services and tax services to professional accounting experts to better focus on the growth and development of their business.