When starting a business, whether online or traditional, it is imperative to learn the fundamentals of financial accounting. You cannot expect your business to grow if you don’t know how to read the numbers or metrics and how to interpret these. Yes, there are automated tools you can use to keep track of your business’ performance or sales.
But without a basic grasp of financial accounting, your business will not last for the next five to ten years or so. Point is, understand financial accounting. You don’t have to learn the advanced features. You only need to learn the key points and apply them to your business.
Fortunately, in this article, we will show you how to Achieve Finance and the basic details you should know about financial accounting. Read on.
Financial Accounting in Layman’s Term
Experts define financial accounting as the process of preparing financial statements for a business or enterprise. There are three critical financial statements involved, namely, income statement, balance sheet, and cash flow statements. These are meant to report the current financial standing of the company and to portray how it’s been performing over time.
Financial accounting also provides stock market investors, business collaborators, creditors, and other interested parties, baselines when making crucial decisions. That is because it tells whether a business is making money or going bankrupt. These people also rely on financial accountants to make sure that these statements are accurate and understandable.
Simplifying Financial Statements
As mentioned in the previous paragraphs, the three fundamental financial statements are the balance sheet, income statement, and cash flow statements. All three accounts the same daily transactions in a business but each presents the results or factors quite differently.
- Income Statement. The income statement shows operational results. With the use of this statement, you can determine if a company is either generating income or loss during the financial duration. It also presents the revenue, expenses, gains, and losses of a company. Stock market investors typically assess this statement before deciding to buy, hold, or sell their stocks.
- Balance Sheet. The balance sheet is like a diagnosis platform of any business. That’s because it presents the business’s health since it started operating to the specific date of the balance sheet. In other words, it manifests a company’s financial standing. The balance sheet also contains a business’s assets (cash, inventory, and other resources), liabilities (factors or funds draining the assets), and equity (the difference between assets and liabilities). The equity, by the way, shows the owner’s overall investment in the company.
- Statement of Cash Flows. The cash flow statement shows how a business is generating and spending its cash. Investors and prospect lenders assess this information to determine whether the company has enough cash flow to meet dividends or repay loans. Warren Buffet, the world’s most significant investor, always speaks about cash flow study when deciding on a large stock purchase.
Basic Financial Accounting Terms and Definitions
Financial accounting is full of jargon. If you are studying this field for the first time, you can feel overwhelmed or lost with the technicalities. But don’t worry, you don’t have to learn or memorize everything. Here are just some of the key terms and definitions you should know so you can properly execute financial accounting.
Financial Accounting Information Users
These are the people or companies that see accounting transactions organized and relayed into financial statements before making educated decisions. Such decisions include whether to buy stocks from blue chips or loan money to a company.
Features of Financial Information
Financial accounting information should be:
- Relevant – The information directly portrays the facts you’re trying to assess or understand.
- Reliable – You can trust the information to drive you in the right direction.
- Comparable – Clients can determine differences and similarities between the companies they are assessing.
- Consistent – A company applies the same accounting approach for the same types of related transactions.
Standard Accounting Principles (GAAP)
These are generally accepted rules which financial accounts must consider when doing accounting transactions and preparing financial statements. Financial accountants cannot just guess numbers on the balance sheet, income statement, or cash flow statements. In other words, a company should have a level playing field so that people reading the reports can come up with comparisons.
Certified Public Accountant (CPA)
That is the professional license given to certified accountants. Once an undergraduate passes the board exam, he/she automatically earns such title and eligibility. Of courses, an undergraduate must take a certain number of accounting and business-related courses and then complete the Uniform Certified Public Accountant exam. The AICPA writes and scores the said test.
Chart of Accounts
It refers to the list of all accounts put in place to manage a company’s accounting transactions. It usually starts with 1000 (assets) and proceeds to 9000 (miscellaneous gains and losses). The accounts are numbered in sequence.
It records all financial transactions occurring within a company during an accounting cycle. A chart of account number gives this order.
Companies use this method to systematically transition an asset’s cost from the balance sheet to the income statement during the asset’s useful duration. There are three methods used for depreciation, namely, straight-line, declining balance, and sum-of-the-year-digits methods. Another technique, units-of-production, considers the actual physical usage of a fixed asset.
Equity of Stockholders
In every company, especially blue-chip, there are claims of specific individuals or separate companies. Financial jargon refers to these as stockholders’ equity. It has three primary components namely; paid-in capital (amount of investment of a shareholder in a company), treasury stock ( stock of a company which it buys back from other shareholders or investors), and retained earnings (total net income or loss of a company from its opening to the date on the balance sheet).
If a business or a person files a lawsuit on a company, that company incurs a liability called contingency. Other factors, such as internal issues and natural calamities, can lead to such loss.
Also called mergers and acquisitions, the business combination is all about putting two or more businesses together. When McDonald’s buys 50 percent of Starbucks, for example, that is a case of business merging. It comes in two forms, namely: asset acquisition and stock acquisition.