Basic Accounting Skills Every Business Owner Should Know
Having basic accounting skills is vital to your business.
Accounting is the universal language of business.
Every business decision is related to the transactions and financial results of that business.
Half of all companies fail before the first 5 years. The overarching reason why is due to poor financial management.
As a business owner, you have to use the information accounting provides to make the best possible decision for your company.
If you want to know which accounting skills are most important for your business, keep reading.
What Is Accounting?
The first step to sharpening your accounting skills is developing an understanding of what exactly it is. Most people understand that accounting involves numbers. That’s reason enough for some to stray away from it completely. However, accounting is an area of your business that you shouldn’t ignore.
Accounting is a set of rules for the documentation of financial transactions used to analyze and present financial information.
With good accounting, you are able to measure the success and future profitability of your business.
A Certified Public Accountant (CPA) is considered the most qualified individual to report and analyze the financial information of a company. They earn their status only after passing a CPA examination and meeting other educational and experience requirements.
However, gaining a familiarity with some basic accounting terminology and skills is essential to the management of your business’ finances. Not only that, but you’ll be empowered with the knowledge you’ve gained which will help you to have a more in-depth, strategic conversation with your CPA.
Where there is knowledge, there is power. Power to succeed and grow your business.
The role of an accountant
The primary objective of an accountant is to present financial statements using Generally Accepted Accounting Principles (GAAP) to non-experts with interests in your business.
These statements are essential for the decision making of your business.
Board members, stakeholders, potential investors and creditors are all interested in the financial health of your business which is presented in its financial statements.
Why Is Accounting Important for Small Business?
Your business generates thousands of transactions over its lifetime. This fact makes it necessary to organize and categorize this information, i.e. accounting.
Accounting helps with the organization of financial information, but it makes it possible for decision-makers to implement the best strategy.
Accounting is also fundamental to the determination of growth forecasts and other performance metrics for your business.
There is a lot more to accounting than sheer number crunching. Accounting narrates the story of your business to investors and executives through the use of numbers.
Great accounting can help you steer your business clear of murky waters where there are ineffective controls over business expenditures or other facets of your financial situation.
Technological advancements of today’s world makes it even easier and cheaper for small businesses to obtain accounting solutions.
As a result, small companies now need to take advantage of readily available accounting solutions in order to compete with the other businesses that do.
Economic Entity Assumption
One of the first accounting skills you should understand is the economic entity assumption.
Economic entity assumption is the concept that separates the transactional data of a business from those of its owners due to legal and economic reasons.
It serves to ensure that no gray area exists between the records of transactional data and the financial records of the owners and partners of the business.
It also requires that the business bank account is separated from the personal or other bank accounts of the business owners and partners.
Depending on your business structure, the economic entity assumption is more of a mandate than a general concept. For example, those who operate a limited liability company (LLC), is legally required to keep personal and business finances separate.
By deploying economic entity assumption, you can remain certain that the proper documentation of transactional data does not collide with your personal financial information. It ensures that every analysis and forecast generated by the use of your financial statements is based on financial data that has been generated solely through the agency of the business.
Organization is one of the few accounting skills every business owner should have, especially when it comes to their business finances.
Your business accumulates hundreds, if not, thousands of transactions a month and it is your responsibility to keep up with them all.
Most organizational principles are plain and simplistic. You can easily start becoming more organized with your business finances. Here’s how.
One organization principle is to limit cash transactions as much as possible. There is little to no paper trail with cash transactions which makes it difficult to organize and categorize transactions. If possible, it would be better to pay and receive cash using credit cards, checks or bank transfers. In this way, you don’t necessarily have to memorize what a transaction was for, but instead rely on the information on the bank statement.
Another organization principle that is an important to developing your accounting skills is being timely in recording your financial information.
The only way you can effectively make business decisions is if you have updated financial information. If your bookkeeping is behind 6 months, it would be no use to you to consider that information in making a decision today. Even financial information from 2 months ago may paint a different story of your business today.
You should consistently seek to have accounting information that is no more than 1 month old. That way, the information you base your decisions on is always relevant.
All in all, the organization of your business should revolve around the adherence to routines that guarantee the optimal use of your accounting information.
One of the most essential accounting skills to have relates to bookkeeping. Bookkeeping is the process of assembling the building blocks of the financial and accounting data of a business. It revolves around the record-keeping of transactional data.
For your business to remain afloat, it must habituate accurate and constantly updated bookkeeping records. If it fails to do so, you will lose track of crucial data, which could lead to miscalculations and bad decision making.
The first step for an excellent bookkeeping practice is to gather source documents for all of your business’ transactions. That implies the collection of every relevant information for every executed transaction. These source documents provide the initial inputs for your bookkeeping.
The next step is to convert the bookkeeping records into analysis-ready financial statements. The most common statements generated are the balance sheet, income statement and cash flow statement. Together, theses 3 statements paint a comprehensive view of the performance of your company.
Note that these records must be consistently updated.
How to Read the 3 Basic Financial Statements
The three main financial statements, income statement, balance sheet and cash flow statement are statements which you should acquaint with to develop some accounting skills.
There are 4 main measures of income on the income statement.
The 4 main measures of income are the gross income, which is the figure resulting from the subtraction of cost of goods and depreciation from the sales figures; the operating income, which is the result of the subtraction of the fixed expenses from the gross income; pre-tax income, which represents the company’s financial records bar interest paid on debt as well as other charges not directly incurred from the core operations of the business; the net income, which is the value left when income taxes have been deducted from the pre-tax income.
From these 4 measures of income, you can easily arrive at the company’s profitability.
The balance sheet shows the value of your company’s assets, liabilities, and equity.
The balance sheet must always balance. Meaning assets should equal liabilities plus equity.
Assets on the balance sheet are listed in order liquidity. With cash being the most liquid asset there is, it is always listed first on the balance sheet. Listed after are other current assets or assets that are expected to be converted to cash within a year.
Assets that are converted after a year are considered long term assets.
Liabilities are also recorded in a similar fashion. Current liabilities are those expected to be satisfied within a year. Long-term liabilities are those expected to be satisfied beyond a year.
The equity section of the balance sheet, also known as net equity, contains records of retained earnings, equity held by common shareholders, etc.
Cash flow Statement
The cash flow statement records the inflow and outflow of your company’s cash.
There are 3 sections to this statement: operating, investing, and financing.
Operating cash flow activities shows the cash flow from your company’s core operations.
Investing cash flow shows the cash flow from investing into assets like new equipment.
Financing cash flow shows the cash flow from borrowing and repaying loans or receiving and paying back cash invested by investors.
From the complete cash flow statement, you can see if your company is running with a positive or negative cash flow.
Cash Flow Management
Your accounting skills would not be complete without understanding cash flow management. Cash flow management revolves around the monitoring of the inflow and outflow of cash. It is fundamental to growth analyses and forecast, as well as to the survival of the enterprise. Poor cash flow management can wind down the enterprise, leading to debt defaults.
A profitable company does not always equate to positive cash flows. This is a common misconception that stems from the idea that revenue means cash collection. You could have millions of dollars in sales but have zero cash on hand. This is a prime example of poor cash flow management.
Your accounting skills must include budgeting for your business.
At every stage of the business growth, budgeting and forecasting remain a vital aspect of business management. It plays a decisive role in cash flow management.
When creating a budget, it’s advisable to include some level of flexibility for favorable or unfavorable variances in your budget. Higher than expected revenues does not necessarily mean you should be spending more.
Make sure to use your prior period accounting data to help you create a budget. These estimates should be guesses but rather well-informed predictions of what and where you plan to spend your resources.
Update your budget periodically. As your business grows, you will need to allocate resources differently. Whether you believe semi-annual, annual or another interval is better for your business, it is important to take the time to review the outcome of your budget and adjust where needed.
Day-to-day accounting practices entail more than sheer number crunching. But instead has the power to narrate the story of your business using figures as it unfolds by the day.
It can project a glimmer of hope as it draws up a positive balance sheet with an increasing asset base or the documentation of profits and losses via the income statement can also present the financial wellbeing of your business.
As the owner of your business, you have your hand in every part of your business. Accounting should not be any different. While the concepts and technical aspects of accounting can be quite daunting, understanding key concepts and acquiring certain accounting skills can help you take your business to the next level. It allows you the opportunity to have that deeper conversation with your CPA that will completely unlock the door of possibilities for your business.