A Beginner’s Guide to Accounting Basics

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Boring. I know.

Accounting is the process of reporting, analyzing, and communicating financial information about an individual or an entity (organization). In the simplest terms, it refers to how a business records its financial information.

Accounting Activities:

• recording financial transactions
• collecting financial data
• compiling records, reports, statements
• preparing and filing tax returns

Why Should We Need to Know Accounting?

Not only finance and accounting professionals need to be familiar with accounting’s role in business (and for entrepreneurs) but accounting also is a critical business skill for all professionals.

Whether you’re running your own business and need to prepare financial records to get a loan from your local bank, someone trying to better understand and your organization’s financial decision-making processes, or just someone who wants to make sense of your own personal finances, understanding basic accounting provides many benefits.

If you can grasp some of the basics in accounting, you will be able to:

• Investments—You will understand financial statements published by the companies you’re investing in.
• Budget—You will have the knowledge to improve your own budget, perhaps even purchase software such as QuickBooks to track your financial history and project your financial future.
• Entrepreneur—If you own a business or plan to become an entrepreneur, basic accounting principles are crucial. They allow you to manage costs, cash flow, invoices, vendors, and payroll, contributing to your company’s success.
• Consistency and accuracy—Familiarizing yourself with accounting concepts ensures more consistent, accurate, and reliable financial records for your business.
• Financial standards—Understanding accounting helps you grasp the Generally Accepted Accounting Principles (GAAP) followed by publicly traded companies and many small businesses. Compliance with these standards is essential for financial transparency and credibility.
• Skills—Your own career marketability is enhanced by accounting understanding, regardless of what field of endeavor you have chosen. Accounting is the universal language of financial health, providing valuable insights and practical skills.

Accounting Principles:

As with any field of study, accounting has its own vocabulary, rules, assumptions, and principles. Here are the main accounting terms to understand, along with a (very) brief description of what they mean:

• Accruals—Most of us work on a cash basis, cash coming in, cash going out. But we may have earned or may owe an amount that at month end hasn’t clicked the cash register just yet. So, these are estimates that will involve cash in or out after the end of the month.
• Consistency—This simply means the methods you choose for accounting (cash or accrual for example) should remain unchanged. Knowing this will keep us out of trouble with the Internal Revenue Service!
• Going concern—Refers to our expectation that we are going to stay in business. If outside experts (auditors) come to a different conclusion, we become concerned because what that implies is that we might run out of cash to keep going.
• Conservatism—While more complicated than this, it means we recognize all the expenses and liabilities, but delay recognizing revenue and profits if there is a question whether they’re earned or will be received.
• Economic entity assumption—If you have a business, and maybe another gig or side hustle, you keep them separated in terms of financial records.
• Materiality—Minor amounts can be missed or even ignored, but amounts that make a difference and matter more, should all be included and reflected in the financial statements.
• Matching—Accrual accounting seeks to match revenue and expenses in the same period, regardless of whether the cash involved has been received or used.
• Accounting equation—Simplicity is: Assets = Liabilities plus Owner’s Equity]. For every debit, that amount must be reflected in an equal amount in credit(s). Double-entry bookkeeping is quite simple at the basic level.
• Accounting period—Most often, the “month” is the accounting period, along with calendar year for financial statement reporting purposes.

The Basic Financial Statements Are These:

• Income statement: a financial statement that shows the revenue, expenses, and net income or loss of a business.
• Balance sheet: an accounting report that shows the financial position of a business by recording the assets, liabilities, and owners’ equity (net worth) of a company.
• Statement of cash flow: summarizes the amount of cash and cash equivalents entering and leaving a company.

Below is a fictional statement of cash flow. I have chosen two different methods: the direct (a way of preparing the cash flow statement where only cash receipts and payments are considered), and the other is indirect (a way to generate a cash flow statement by adjusting net income with differences from non-cash transactions).

Statement of Cash Flow: Direct Method

(Source: Excel file: Cash Flow; prepared by Rodd Mann; for illustrative purposes only)

Statement of Cash Flow: Indirect Method

(Source: Excel file: Cash Flow; prepared by Rodd Mann; for illustrative purposes only)

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