Accounting Concepts that Everyone Should Know

accountingconceptsAccounting is important to anyone that deals with money. Although you may think accounting is a topic reserved for business owners, the truth is that just about anyone can benefit from a basic understanding of accounting. At the personal level, accounting principles allow you to create a budget and gain a true understanding of where your money goes. If you’re interested in getting a better grasp on your personal finances, consider checking out Life Happens – a course designed to teach you more about personal accounting principles.

From a business perspective, accounting is an essential skill required at every level of business from the sole proprietorship to the large multinational corporation. The Small Biz Doers’ Guide to Small Biz Accounting teaches you basic accounting concepts and advanced techniques for creating a functional accounting system.

The Basics of Accounting

Accounting is based on a set of rules known as the Generally Accepted Accounting Principles (GAAP). These rules are designed to regulate accounting and make most accounting tasks universal. This means that if you create a report (for personal or business use), any accountant in the world should be able to understand the accounting principles and techniques used to factor the numbers within your statement.

Probably the most important accounting concept you need to understand is known as the Accounting Cycle. This is a fancy way of saying that every event creates a transaction. In its most basic form, this means that when you pay your electric bill (for instance), a check is written. When you write the check, you record the transaction in your checkbook. All this information is accessible via your monthly bank statements.

Introductory Financial Accounting does an excellent job of explaining the basics of GAAP and the Accounting Cycle.

Accounting Journals are used extensively in the business world. In your personal finances, you also have accounting journals. Probably the best example is your checkbook ledger where you keep track of checks you have written so you can balance your accounts at the end of the month.

In business, there are multiple accounting journals that track everything from cash disbursements to payroll to purchases. A journal is a simply a way to keep track of transactions and can be used as an accurate representation of current financial health.

Financial statements are another important aspect of accounting. Although there are literally thousands of financial statements used in the business world, the three most important and widely used include the Income Statement, Balance Sheet, and the Statement of Cash Flows. Each of these statements serves a specific purpose and is relied on heavily for daily tasks and future financial planning.

The Income Statement, sometimes known as a Profit & Loss Statement, shows the profitability of a company during a specific time interval. Income statements are also useful in managing personal finances and are often used by financial planners when helping to create budgets and investment plans for clients. This statement shows revenues, expenses, gains, and losses. In other words, the Income Statement is a quick snapshot of overall business health and profitability during a given period (which could be a day, a week, a quarter, etc.).

Balance Sheets are extremely important in both personal and business accounting. A Balance Sheet reports a company’s (or individual’s) assets, liabilities, and stockholders’ equity at a specific point in time. Unlike the Income Statement (which shows a specific period of time), the Balance Sheet shows information at a specific moment in time. This information could change five minutes later; an important thing to remember when creating or looking at a Balance Sheet.

Finally, the Statement of Cash Flows shows how your cash changes during the specified time period. Most of the information on this financial statement comes directly from the Balance Sheets and Income Statements previously mentioned. In terms of personal accounting, this type of statement is useful because it shows you exactly where your cash is going on a monthly basis. This includes expenses, income, and investing activities as applicable.

Accounting Software

Technology allows you to leverage the power of proper accounting concepts without having to understand exactly how some of the more complex components work. In other words, accounting software hides many of the calculations required to monitor your finances successfully.

If you are small business owner, QuickBooks is one of the most popular accounting solutions available. It is specifically designed for small to medium-sized businesses and provides full accounting functionality as well as a host of other features including inventory management.

There are also numerous programs available for personal finance that work in a similar way. These programs can even sync information from your bank account automatically to generate reports that clearly show your income, expenses, and overall cash flow.

One aspect of using accounting software properly is known as the Chart of Accounts. A Chart of Accounts is used in practically every accounting software as a way to quickly add or remove various expenses or income generating activities. For instance, you might have your bank account, your credit card, your mortgage, and your car payment as accounts within this chart.

Simply put, the Chart of Accounts is a listing of everything you spend money on in a given month and any sources of income you have during that same time period. If you decide to use accounting software, make sure you carefully create your Chart of Accounts to accurately reflect the accounts you use most frequently.

You can learn more about using QuickBooks for small business accounting in Quickbooks Training – Bookkeeping Made Easy.

Whether you decide to use accounting software or do it the old-fashioned way, everyone can benefit from having at least a basic understanding of accounting. The concepts learned can be applied in your personal financial life as well as in any business ventures you attempt in the future. Even in the corporate world, your boss will appreciate your understanding of basic accounting principles as they relate to daily operations.

Unfortunately, too many people have little to no understanding of accounting basics. This is evidenced by record-setting credit card debt per household and increased bankruptcy filings each year. Do not become one of these statistics – learn basic accounting concepts and apply them to protect the financial health of your business and your family.