14 December 2019

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Accounting Basics: An Essential Know How for Entrepreneurs

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Entrepreneurs usually spend a vital time developing their product line and fostering their client base. Accounting is also as important as this and without which your business will never reach its full potential. A proper book keeping, is essential to avoid the risks of many tax and legal issues, cash flow crunches, and would even miss out many growth opportunities.

The benefits of accounting are two fold - In the first place, it provides the entrepreneur with a valuable tool for assessing and analysing his business performance. This enables him/her to track the strengths and weaknesses of business, which in turn could improve the bottom line. Secondly, a proper recording of the receipts and expenditures of day to day business is vital for the annual tax filings and other legal compilation. It will also be required by the banks and financial institutions if you are applying for a small business loan.

Even though most of the accountings are carried out by accountants; either staff or hired, an entrepreneur should be aware of accounting basics, at least to keep the scores. This knowledge not only helps him/her to assess the business movements figuratively, but also to talk about accounting needs with employees and bankers authoritatively.

The basics mentioned below will help you to understand some of the confusing jargon you would often encounter in business accounting.

All businesses should maintain their records in a ledger, which is a simple record of sales, receipts and expenses. The transferring of individual receipts and expenditures to a ledger is called posting.

How often you post to your ledger depends on the volume of receipts and expenditures in your business. Many businesses find it necessary to make postings on a daily basis. However, you should plan to update your ledger on a daily, weekly or at least a monthly basis. Drawing up your ledger is fairly simple to do especially if you are using accounting software.

A Ledger Keeping or a Book Keeping is kept with an objective to summarize financial transactions into usable forms which structure the financial information about a business or an individual. Once you have posted your transactions to a ledger, you can begin the compilation of financial reports for your business.

Types of Book Keeping (Book Keeping Systems)

There are two major types of book keeping: Single Entry System and Double Entry System.

Single Entry System: Single-entry system is an "informal" record keeping system.  In this system, each income and expenses are noted as entries. It is much like a cheque book register and focuses on the business' profit and loss statement. Cash registers’ receipts are an example of this method of record keeping. It makes more sense to an average entrepreneur due to its sheer simplicity.

While the single entry system may be acceptable for tax purposes, it does not provide the financial information needed to report the financial affairs of a business. Also, this method further requires reconciliation through bank statements.

Double Entry System: The double-entry system is a complete and accurate accounting system. It is a self-balancing entry, works on the principal that a business transaction consists of an exchange of one thing for another. Every time an entry is made on the expense side (debits), another entry called an offsetting entry is made on the income side (credits) of the ledger. In short, for every plus there must be a corresponding minus. The end goal is a balanced or zero sum sheet. This system may appear confusing to a beginner.

These are the two methods of book recording. Following a single entry or a double entry method, books can be maintained by an accrual basis accounting or a cash basis accounting depending on the nature of the business.

Accrual Basis: Here you match the revenue with expenses regardless the cash physically collected or not collected. For example, you sell a product to a customer and he pays you for it after a credit period of 30 days.

The sale will be recorded in the books on the day it is made.  When the actual money comes in the "accounts receivable" it is then turned into cash. Or, if you incur an expense today, but you are making the payment next month only, the expense will be recognised today itself. If you're in manufacturing or dealing with inventory, the accrual basis would be suffice. Many large businesses and corporates use this method.

Cash Basis: Cash basis accounting on the contrary records the income at the time of receiving cash and expenses at the time they are actually paid. In short, this model actually records a cheque when it is posted or the date a deposit is made. Most SME’s use this method because it is simpler and is easier to understand.

Consulting with your account is the best option to ensure you are accurately recording your transactions in a way that is simple yet adequately addresses your business requirements.

Now let us have a look into the basic records need to be kept by a small business and further move to the major financial statements involved in a business.

The basic records (ledger ) to be kept in a small business are :

Revenue and Expense Ledger- Revenue and Expense Ledger keeps track of how much money is going out, where it is going, and how much is coming in. This is used by most small businesses and a single entry accounting is usually made to record the receipts and expenditures.

Cash Expenditures Ledger- Cash spent for your business needs are to be accounted, if you want to record all business expenses in a given year. There are at least two ways to do this: writing yourself reimbursable cheques or keeping a petty cash record.

Inventory Records- Inventory records will enable you to prevent pilferage, keep inventory holdings to a minimum, and track the buying trends among the other things.

For example, if you sell a large number of small ticket items as in a stationary store, you might need to use a computer system to track inventory by having a POS (point of sale) inventory system. If you sell larger ticket items you may be able to do it yourself on papers. The important inventory information you need to capture is: date of purchase, number of items purchased, purchase price, date of selling and selling price.

Accounts Receivable Records- If you provide products or services for which people pay for you at a later date, your accounts receivable records keep a track of what is owed to you.

You can monitor accounts receivable using copies of all invoices sent out or by keeping an accounts receivable record. The information you need to capture includes invoice date, invoice number, invoice amount, terms, date paid, amount paid, and the name of the entity being billed.

Many software programs are available to help you which can save hours of time and create professional-looking invoices.

Accounts Payable Records- Accounts payable records are debts owed by your company for goods and services. Keeping a track of what you owe and when it is due will enable you to establish a good credit and a hold onto your money.

Depending on the nature of your business, there may be other areas in which you need to retain supporting documentation like – deposit slips, receipt books, credit card charge slips, cheque book registers, cancelled cheques / bounced cheques register , business information records. Also you need to keep in your office / shop  all tax receipts and records, deeds, lease agreements, license, permits, financial statements, insurance records etc  and most importantltly- the employee records and asset documentation (for calculating depreciation).

The Three Major Financial Statements

Financial Statements are accounting reports prepared periodically to inform the owner, creditors, and other related people about the financial condition and operating results of the business. They stand as one of the most essential components of business information in communicating to outside agencies.

The three basic financial statements are Balance Sheet, Profit and Loss Account and Cash Flow Statement.

  • Balance sheet

The balance sheet is an itemisation of a business assets (cash, inventories, accounts receivables, etc.) and liabilities (loans, debts, accounts payable). If done properly, a good balance sheet will provide an accurate snapshot of where you stand.

The order of a balance sheet is from the most liquid to the least liquid. In other   words, the first item under “assets” is cash, because cash is the most liquid asset. After cash, comes receivables, representing the money owed you from customers. When you receive the money it is turned into cash. Next in assets comes "inventories." Following current assets are property and equipment that are typically carried at cost.

You may also notice "depreciation" on a balance sheet. Depreciation is a non-cash expense and is an attempt to record that assets go down in value over time.

The reason this particular financial statement is called a "balance sheet" is that assets are always equal to your liabilities and owners’ equity. This is a double entry bookkeeping, and is done in almost every business.

When bankers look at a financial statement, they check the financial ratios. Ratios indicate the financial strength of a business on handling repayment of loans. Your ratio will be your current assets divided by current liabilities. If your current assets are less than your current liabilities, a red flag will be held because it indicates a risk of insolvency during the present year. Different industries will have different levels of ratios. You can compare your ratios with others in your industry to see how your business is performing.

  • Profit and Loss Account (Income and Expenditure Statement)

This statement unlike the balance sheet covers a period of time, usually a month or a quarter. Usually year-to-date figures are presented in it to show how the business is doing during the current accounting year. The income statement and the balance sheet are often clubbed together. In non profitable organisations such as clubs, societies and charities, Profit and Loss Account is substituted with an Income and Expenditure Statement.

  • Cash-flow Statement

Cash flow control is a method of projecting the future needs for cash of your business. It is an income statement covering future periods of time that has been changed to show only cash: cash coming in and cash going out and the balance of cash at the end of designated periods of time. This is a great tool because you can predict future needs for cash before the needs arises.

There is also one more important document The Capital Statement, which is a report summarising all the changes occurred in an owner's equity during a specific period.

A company in its development stage must follow generally accepted accounting principles in their preparation of financial statements. Usually accountants have three levels of statements: certified, reviewed and compiled. For most start ups, the compiled type will work, that is, your accountant prepares the financial statement with a letter stating that the numbers are based on the information you have given him.

The general guidelines here outline what you must take care of and ideas on how to keep your books in an orderly manner. But before making any decisions regarding bookkeeping, check with your accountant because bookkeeping needs vary dramatically from business to business.

 

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