Understanding a few basic accounting principles will help you and your bookkeepers make informed decisions on a day-to-day basis. It will let you predict your company’s trends in future. Lastly, it will help you have fruitful conversations with your financial consultants. Here are the top accounting concepts useful to know for running your small business.
1. Accruals
There are two types of accounting methods – cash basis and accrual basis. Cash basis accounting documents reflect only those income and expenses that have been received or paid. On an accrual basis, on the other hand, expenses and income are recorded in the period they occur. For example, A customer’s due date to settle is 30 days after he has made the purchase.
On a cash basis, the income received wouldn’t appear until it has been received. On an accrual basis, the income will appear in the month these sales have been made. Using an accrual basis will let you identify the income and expenses more accurately.
2. Consistency
It means that after you choose one of the concepts mentioned above or the basis of recording transactions, you should stick to it. This will allow you to compare the performance of your company in different years and is a requirement to fill small business taxes.
3. Going concern
It is the assumption you make about your small business that it will operate in the near future. This assumption will let you defer some of your expenses in future accounting periods.
4. Conservation
In this concept, the revenue you generate and expenses you make are treated differently while recording transactions. You should recognize revenue when there is reasonable confidence that you will receive it in the near future. But, you should recognize expenses sooner. It is safer for your business to overestimate the costs than your income.
5. Economic Entity
You should treat your business as separate entities without mixing personal and business funds. You shouldn’t put personal expenses on your business cards. Doing so can result in legal liability, especially in cases of a LL Company where it is mandatory to separate business and personal domains.
6. Materiality
It would help if you only recorded those financial transactions which are material to the business. This also includes minor transactions. The idea is to record every transaction related to and indulges in your business.
7. Matching
In order to visualize a cause-and-effect relationship between expenses and incomes, you should record both of these at the same time. For example, if the commission is paid to a salesperson for sales made in the month of May, then record the commission in the month of May as well, as you would record the sales.
8. Accounting Equation
Keep the following equation in mind while recording transactions:
Assets = Owner’s Equity + Liabilities
Assets are debited and, the owner’s equity and liabilities are credited. For example, cash is an asset that, when received, will be debited. On the other hand, the owner’s equity or common stock, when issued, will be credited.
Summing up
To run your small business, you don’t need to have expert advanced accounting knowledge. But familiarizing yourself with these basic concepts will help you record, analyze and review transactions effortlessly.
