Accounting Basics

accounting basicsLike so many other fields that involve the crunching of numbers and the use of complex mathematical algorithms, accounting is seen by many as a dull and listless job that, unfortunately, is also a necessary evil for every business on the planet. However, while accounting and the things it helps us keep track of (finances, taxes, fundraising, and more) may strike many people as little more than a huge hassle, it can actually be a fascinating pursuit for those who truly understand how it works. In addition to the bountiful rewards and savings that a good accountant can bring to a business or even an individual, accounting can help you understand how business and money in general work. Suffice to say that there is a reason Udemy offers a course called “Learn Accounting. Understand Business.” In many ways, those two statements are one and the same.

The Branches of Accounting 

Before you can start to understand the basics of accounting, you need to realize just how many branches the accounting industry contains. A simple search on Udemy will yield numerous courses on “Introductory Financial Accounting,” but while financial accounting is the type of accounting that most people know, it is only one branch in a much broader industry.

Still, financial accountants are the types of accountants that most of us will deal with in our day-to-day professional lives, so it is perfectly worth knowing what they do (or better yet, understanding the art of their work so that you can do it yourself). Financial accounting is the form of this field most often seen in business. Professionals working in financial accounting positions are generally there to help businesses keep track of their finances, including their revenues, expenses, profits, and losses. These benchmarks of a company’s finances are compiled into reports by financial accountants, documents that are in turn used by corporate board members, shareholders, customers, and more to determine precisely how the business in question is performing.

While financial accountants are the types of professionals that most people think of when they consider the field of accounting, other types of accountants are just as pervasive. Tax or insurance auditors, for instance, are types of accountants who are sent by the government or by independent firms to look at a company’s finances for inaccuracies or inconsistences. Tax auditors are not to be confused with tax accountants, however, who are professionals that use their knowledge of money and IRS tax laws to help businesses and individuals legally minimize their annual payments to state or federal governments. If you have ever sought professional assistance in preparing your income tax return, you have worked with a tax accountant.

There are numerous other branches of accounting as well, though none of them are encountered as frequently as those listed above. These include fund accountants, who help non-profit organizations manage their resources, or forensic accountants, who help to manage financial matters in court cases involving divorce, bankruptcy, and the like.

For the purposes of this blog, however, we will mostly be focusing on financial accounting for businesses.

Understanding What Financial Accountants Do 

Before you jump into Udemy’s “Accounting Skills for Managers” course and start learning how to manage the money for your own business, you will want to have a basic understanding of what accountants do and of the terminology they use to do it. This primer will help you to dispense with misconceptions you have had about accounting previously, as well as to establish new definitions in your head.

The first misconception you will want to erase from your memory is that accountants are little more than people who keep the books for a business, as this is not the case. Certainly, bookkeeping – or the recording of business transactions – is a part of accounting. However, it is not the full scope of what accountants do or why they are an integral part of your business. In fact, most bookkeeping – from keeping track of sales to paying the company bills – is now automated by smart accounting software, and yet accountants have not been put out of work.

On the contrary, the software that executes the bulk of bookkeeping tasks these days was designed by accountants to carry out the sort of mathematical calculations that they used to do on paper. In other words, the software exists to make the lives of accountants easier, not to replace them.

Still, understanding what bookkeeper software does (and what it keeps track of) is important if you wish to learn about the basics of accounting. In the simplest of terms, bookkeeping software keeps track of various different accounts that have an economic impact on a business. Bookkeeping software generally maintains hundreds or even thousands of different accounts for different businesses. It’s easiest to understand how these accounts work if you think of them in terms of big general categories like “company budget” and “sales.”

Things become more complicated when you consider that most companies will split their accounts into so many different categories. For instance, items purchased using the company budget could be new permanent assets for the business, like furniture or computers used in the offices. However, furniture or computer purchases for another business might be made to replenish the sales inventory. Depending on what a company’s plan is for the purchase in question, the transaction behind could impact entirely different accounts. This fact is true of any transaction ever completed by a company, and it is essentially up to the accountant to determine which categories each transaction falls under and which accounts that transaction affects.

Regardless of all of this messy gray area, however, most accounts actually look remarkably clean because they only use four or five columns. For each transaction, the accountant (or the bookkeeping software) records the date, the affected account, a brief description of the transaction (e.g. “purchased computers for inventory”), and the sum of money credited or debited to that account.

Balancing the Company Accounts

Throughout a month, an accountant will keep track of a business’s transactions in the manner described above: by tracking debits and credits in different accounts by date. At the end of the month (which is usually the end of the accounting period), the accountant will go through each of the company’s accounts, add up the credits and debits, and balance the accounts. This act is called “balancing” because the debit and credit columns should ultimately be equivalent for any given accounting period.

The question among most accounting novices, of course, is why the accounts should balance at all. After all, shouldn’t there be some months where a business spends more than it makes? Or vice versa? While the answer to that question is, admittedly, “yes,” it doesn’t really have anything to do with this particular stage of accounting. While accounting does help a business to track its revenues or losses, the act of balancing the accounts is merely meant to make sure that all transactions have been applied to every necessary account.

Which brings us to one of the golden rules of accounting: every transaction a business makes will be applied to at least two accounts. Let’s return for a moment to the previously described scenario involving computers purchased for a company’s sales inventory. If the company spent $5,000 on the shipment of computers in question, that amount would be debited from its inventory account, but it would also have to be credited to another company account for proper account balancing to take place.

As a result, a credit is applied to the “accounts payable” account, which essentially represents money that the company owes, whether to the vendor that it purchased the computers from or to a credit card company, bank, or some other lender. In other words, the accounts payable credit is a debt that the company has promised to pay on a short-term basis. This process can work in the other way when the company is owed money by a customer. If someone were to purchase one of the computers discussed in the above scenario, the value of the computer would be credited to the inventory account, as well as debited from the “accounts receivable” account. Once again, a contractual agreement would exist, this time between the company and the customer, that the debited amount would eventually be paid and the debt settled.

Additional Steps 

Once a company’s accounts are balanced between its debit and credit transactions, an accountant would go through a few additional steps before submitting his or her reports. These steps could include anything from calculating the depreciation of property or equipment value to determining the new financial balances of each and every account in the company’s books.

Ultimately, the accountant’s job is to deliver financial statements for company higher-ups to give a firm and accurate portrayal of the company’s finances. These reports must combine the sums and balances of every account, and can therefore be used to gauge company profits and losses for the month or accounting period at hand. These statements can help business owners with a range of different decisions and considerations, from determining whether or not they are capable of paying their bills on time to deciding whether or not current cash flows demand a cutback on certain business expenses. In essence, accounting gives business owners the informational tools they need to run their business in an effective and financially responsible fashion.

A Note on Consistency

Ever since the stock market crash of 1929 and the ensuing Great Depression, efforts have been made to standardize company accounting methods so that they match up with the financial statements and reports of other companies. These efforts have led to the creation of Generally Accepted Accounting Principals (GAAP), a set of rules and standards that every company (and therefore, every accountant) must play by.

For instance, shareholders could never know if one company was in a better financial position than another if both weren’t observing the same accounting principals, which is where GAAP comes into the picture. If you wish to become an accountant (or to carry out the accounting tasks for your own business), then you will need to formulate a thorough understanding of GAAP.

Conclusion 

Whether you want to save money on hiring an accountant for your business, or simply want to gain a better understanding of how finances work, learning the art of accounting can be an extremely valuable and rewarding thing to do. Of course, mastering accounting skills will also be a challenging task, but with the help of Udemy and its numerous “Accounting 101” courses, you should be able to balance accounts and organize company finances in no time!