What Business Owners Need to Know About Accounting
I came across a Forbes article today based on a podcast: “Do Business Owners Need to Know Accounting”? I think this is a great question to discuss and today I will go over the aspects of accounting that I feel all business owners should know. It is critical to at least have a basic understanding of certain aspects in accounting in order to make timely and positively impactful business decisions.
Business owners are probably familiar with the most commonly used financial statement: the Profit and Loss Statement. This statement not only tells you whether you are in the black or not, but it also tells a story of why your bottom-line number is what it is.
It’s important to understand what each account’s purpose is and what can make that specific revenue or expense account change. You cannot estimate future amounts without this foundation so this is a great first step in educating yourself for when it’s time to create a budget or forecast.
The second most commonly used financial statement is the Balance Sheet, although it’s not as commonly used by business owners in particular. The balance sheet is “a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time.” This financial statement tells a different story than the Profit and Loss Statement.
The key point for business owners to understand about the Balance Sheet is that it does not affect your bottom line (unless you’re looking at depreciable assets, but that’s a tax related topic). In working with clients, it is typical for business owners to expect a cash exchange to show up in their Profit and Loss, as this seems to be the only report that most ever look at. This is not always the case. Writing a check to yourself in place of a salary? That will likely go on the balance sheet as an Owner Distribution, not an expense.
Cash versus Accrual Method
Simply put, the cash method of accounting is recognizing transactions as the actual cash exchange occurs. Writing a check in December 2016 that is for January 2017 rent? You recognize the rent expense in December, when the exchange occurred. Typically, every transaction is recognized in one single month.
The accrual method can be a little more complex for those unfamiliar with accounting. This method entails recording transactions to match actual usage, which can be spread to more than just one month. In the rent check example above, you would record a bill in December 2016 and this is when you would see the expense. The bill creates a balance in your accounts payable (on the balance sheet). When the bill is paid, you offset the accounts payable and there is no affect to your Profit and Loss in January 2017. There is an advantage to using this method though: it more accurately reflects the story of how your business is doing, plus it can be easier to track upcoming bills to be paid and invoices waiting for payment from customers.
You Have an Accountant
If for no other reason, it’s important to have a basic understanding of accounting so that you know what your accountant is doing! This is your business, and you are ultimately responsible for it financially. If there ever is a transaction or account balance that looks off to you or you aren’t sure what the implication is behind it, ASK YOUR ACCOUNTANT! There should never be any hesitation on his or her part to do so and a good accountant will willingly continue to explain something until you both feel confident that you understand what is being questioned.
If you have a specific accounting question you’d like answered, comment below or email me at firstname.lastname@example.org to have it featured in a future blog.