Simplified Accounting For New Business (no big deal to understand)

November 2, 2017 5:31 pm1 commentViews: 40

By : Alex Nordeen

ACCTG1Before you start your own business, it is mandatory to know about how accounting works. Accounting involves necessary tax payments, cash flow and expenses, payroll and financial reports. Accounting gives the financial summary about the performance of your business.  Contingent upon the size of the company, accounting will be have to be carried out. You need these primary conditions to start with your accounting and they are as follows :

a)    Opening a bank account

b)    Making a list of creditors

c)     Making a list of items you own in the company

If you have all these things, your accounting work is half done.  The next stage is how you use all these information and create your balance sheet. But before that, you have to choose your accounting method.  There are basically two methods on which accounting is based :

1)    The Cash Method – This method is most common for a small business. In this method, you count income when you actually receive the payment and your expenses are counted when you make the payment.

2)    The Accrual Method – In this method, the company counts income when a sale is made, regardless of whether the company actually receives the payment or not. Similarly, the expenses are noted or recorded when they occur and not when they are paid. This method is usually practiced by big businesses.

Once you have decided your accounting method, the next step is to understand the balance sheet.  It keeps accountability of all your income and it figures out how your business is running. Your balance sheet will include three main sections : a) Assets b) Liabilities c) Stockholders or Owner’s Equity.

a)   ASSETS :  Cash, Petty Cash, Account Receivable, Prepaid Insurance, Land, Goodwill, Equipment, Bond etc.

b)   Liabilities :  Account Payable, Interest Payable, Salaries Payable, Bonds Payable, Loans Payable etc.

c)   Owner’s Equity or Stockholders:  Owner’s Equity includes your Capital and Retained Earnings. This is also the difference between the total assets and the total liabilities.

To understand how the balance sheet is prepared, here is an illustration of a small business transaction. For example, you started your business with an Owner’s Equity of $20,000 Cash. That would be Cash of $20,000 to your Asset account and Capital of $20,000 to your Owner’s Equity Account.

Transaction-1

Then, you bought a vehicle for $15,000 for your business transportation, and you have paid that amount through check. Two accounts are involved here : Cash and VehicleRemember, the amount you pay will go to a credit account and the amount you receive will go to debit account.  So you have paid $15,000 for vehicle through check ; thus, Cash account will recorded as credit account. And since you received the vehicle, the price value of the vehicle will be recorded as debit account.

Account Name Debit Credit
Vehicle $15,000      -
Cash - $15,000

[Fig-1]

The common equation for accounting is, Assets = Liabilities + Stockholders/Owner’s Equity

Assets Liabilities
Cash $5,000 Owner’s Equity $20,000
Vehicle $15,000       –
Total $20,000 Total $20,000

[Fig-2]

In fig-2, in the first table, the cash amount is depleted from $20,000 to $5,000 as you paid $15,000 for your vehicle. The Cash account decreased but at the same time you bought a Vehicle for $15,000 which will balance your Assets and your Owner’s Equity with the same amount of $20,000.

Debits_&_Credits

Transaction-2

Let’s assume that you have received $20 check from a customer for your product, it will debit the Cash account – but we know the rule, it should balance the credit side, as well.  The credit side will be the amount you earned or your Service Revenue account which is an income statement account.

Account Name Debit Credit
Cash $20
Service Revenue - $20

Transaction-3

Now, your business is doing well, and you have received another order for $300, but your customer asked to pay that amount after a week. The customer asked you to submit an invoice of $300 on credit. As we have discussed in transaction-2, any amount that is earned and not received will go to Service Revenue – thus, Service Revenue account will your credit account. For this deal, you have received cash payment and you just issued an invoice to the customer. A bill or invoice issued to the customer for payment in a given time frame will be recorded as Accounts Receivable account, which will be your debit account.

Account Name Debit Credit
Account Receivable 300 -
Service Revenue - 300

Transaction-4

Now, there is another expense transaction -when you got the above order for the product, you hired a person to deliver the product and promised to pay him $50.  Any expense will go to debit account.  While you owe money to someone for the purchase of product or service which was not paid immediately, it will be recorded as Account Payable on the credit side.BS-1

Account Name Debit Credit
Temporary Expense 50 -
Account Payable - 50

Before preparing a balance sheet for the above transactions, let us calculate your Net Income. Net Income is computed by deducting the expenses from the gross profit.  In this example, your service revenues are $300 and $20, thus, your gross profit is $320. Deducting $50 expense from it, your net profit is $270 : $320 – $50 = $270.

Gross Profit $  320    (Total service revenue )
Expense  -    50    ( Payable to delivery person)
Net Income $  270
                                                                 BALANCE SHEET                               

Assets

Amount

 

Liabilities & Owner’s Equity

Amount

Cash $  5,020 Account Payable $       50
Vehicle $ 15,000 Capital $ 20,000
Account Receivable $      300 Retained Earnings/           Net Income $      270 
Total Assets $20,320   Total Liabilities $20,320

Please note that the balance sheet has equal amounts on both sides. If you know the basic principle of debits and credits in Accounting, then it is no big deal to do business accounting.  There are few rules you have to follow for debits and credits as shown in the table below :

Debits and Credits of Accounts :

                       Debit                           Credit
Increase in asset accounts Decrease in asset accounts
Increase in expense accounts Decrease in expense accounts
Decrease in liability accounts Increase in liability accounts
Decrease in equity accounts Increase in equity accounts
Decrease in revenue accounts Increase in revenue accounts

Once you get familiar with this basic accounting, you can also understand the more advanced accounting procedures like budget and taxation.  Accounting will be a lot easier to understand and implement for your new business.

Alex Nordeen is a Technical Writer who has evolved over years of teaching Accounting, JAVA, PHP, &  SQL while working in the IT (Information Technology) field.  After documenting hundreds of technical processes and teaching others how to duplicate results, technical writing and training became his next logical career path. Alex has personally edited the Accounting tutorials created by an Amazon veteran in Guru99.com.

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