Accounting is the language of business and all entrepreneurs should be familiar with this
Accounting is the language of Business. The Accounting Records truly tell us the story of Business. Many entrepreneurs with a Non-Accounting academic background get confused by the Accounting terminology. Here’s a humble effort to clear some of the fuss around the Jargon. Let us dig deep and dive in the Accounting world.
The First and foremost thing one has to understand is that Accounting is always done from the point of view of a Business i.e., The Business is considered separate from that of the owners or investors. [Entity Concept]
This is the reason why the Business treats the amount invested by the owners as its CAPITAL. The initial investment into a Business is termed as Capital.
The Accounting Equation:
The Accounting equation is the most fundamental concept of Accounting.
Assets = Liabilities + Owners Equity – Which can also be written as,
Assets – Liabilities = Owners Equity
Owner’s Equity is what is left after repaying the liabilities.
Basic Accounting Fundamentals:
Just remember that debits always go in the left column, and credits always go in the right column of an Account. Every Debit has a corresponding Credit. This is known as Double Entry System. Suppose you buy an Asset in Cash, The Asset A/c will be debited while the Cash A/c is credited correspondingly. (Asset Portfolio increases – Cash decreases)
3 Golden Rules of Accounting:
- Personal Accounts – Debit The Receiver, Credit The Giver
When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited.
- Real Accounts – Debit What Comes In, Credit What Goes Out
Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
- Nominal Accounts – Debit All Expenses And Losses, Credit All Incomes And Gains
The capital of the company is a liability to the company. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance.
Cash and Cash Alone:
Only those transactions that are capable of being expressed in terms of money are considered in Financial Accounting. Therefore, your core team of employees might be your biggest Asset, but you cannot account them as your Assets.
Accrual Basis of Accounting:
All the companies are required to Account their transactions on the Accrual basis. Under this, Revenues are reported as and when they are earned, not when the money is received. Similar is the case with expenses which are reported when they are incurred, not when the money is paid. For example, A sale on credit is regarded as a sale and the Revenue is recognized even though the cash hasn’t been received yet. However, the party from whom the Balance is due is recorded as a ‘Debtor’ in the Balance Sheet.
FS’s comprise of three statements:
- Income Statement or Profit and Loss Statement :
It shows the Revenues earned and Expenses incurred by the company during the period. The difference between the revenues and expenses is often referred to as the BOTTOM LINE which is labeled as either Profit (Excess of Revenue over Expenditure) or Loss (Excess of Expenditure over Revenue)
- Balance Sheet:
It can be described as a ‘Snapshot’ of the company’s financial position at a point in time. It projects what a company owns (Asset) as well as what it owes to other parties (Liabilities) as on that specific date.
This provides vital information to the banker and enables him to determine whether or not a Company qualifies for additional credit or loans. It is also of immense interest to the current investors and potential investors.
A frequently used analogy is that the Balance Sheet is like a Photograph, while the income statement is more akin to a Video.
- Cash Flow Statement:
As Adi Godrej famously said, “Sales is vanity, profit is sanity, cash is reality”
The CFS does exactly what it sounds like: It reports a company’s cash inflows and outflows over an accounting period. All the cash flows are separated into one of the three categories:
- Cash flow from Operation Activities
- Cash flow from Investing Activities and
- Cash flow from Financing Activities