Accounting Basics

In my experience, a lot of small businesses just starting out believe that accounting is a matter of just watching the checkbook. As long as nothing bounces, business is good. But, more and more small business owners are realizing the importance of understanding accounting and the critical role it plays in the success of their business. Good accounting is needed to make successful and profitable decisions. Accounting is known as the language of business. So, whether you want to or not, it is important that you learn this “second” language and understand some of the basic terms to help you make those important decisions.

Definitions of Basic Terms

As with learning any language, the best place to start is by learning the basics. The more you learn the more you will understand as you delve deeper into your business’ finances. Fortunately, once you get the basics down there really isn’t any need to learn in-depth ratios or extremely difficult reports or tables, unless, of course, you are going into some kind of financial analytical field.

To get you started, the following is a list of basic terms (the backbone of accounting, if you will):

Assets are simply what you own (i.e. checking account balances, cash, accounts receivables, inventory, furniture, fixtures, equipment, vehicles, buildings, land, goodwill, etc…).

Liabilities are what you owe (i.e. payroll liabilities, accounts payable, loans, credit card balances, etc…).

Equity is investment and equity from the company’s owners, or partners (owner contributions, owner draws, stock, paid in capital, retained earnings, etc…).

The first three accounts are found on your balance sheet.

Income is what the business sales. This could be products, or services. It is generally referred to as revenue.

Cost of Goods Sold is used to track how much a particular product or service cost, and what type of margins the business is making on them. Businesses can choose to use these type of accounts, or not. I recommend using a cost of goods sold account for businesses who sale higher volumes of products.

Expenses are accounts that are used for administrative and overhead costs to a business (i.e. telephone, rent, payroll, travel, etc…). Too many expense accounts can be cumbersome to maintain, while too few keep the business from knowing where its money is going.

Net Income, also referred to as Net Profit, is not an account, but rather an amount that comes from subtracting your expenses and cost of good sold from your income. The saying “in the black” comes from whether this amount is positive (in the black) or negative (in the red).

The basics of accounting is a good place to start learning this critical language for your business. Remember, knowledge is power and the correct application of knowledge is wisdom. Be wise with your business!