Many people confuse accounting with bookkeeping. Bookkeeping is a part of accounting, as it is the process of keeping records of each and every transaction your business makes. Meanwhile, accounting is an analysis of your company’s financial status. It is important because it allows you to predict how your finances will look in the future. A ledger is an entry book where transactions are recorded and it is used to keep track of the business’s debits, credits, assets, liabilities, profits and losses. While some people choose to keep a ledger by hand, most businesses nowadays use some kind of computer software. Finally, a balance sheet is a financial statement that shows where your business stands at a given time. If your business is doing well, your assets will equal or exceed your liabilities.
Using the Cash Accounting Method
There are two schools of thought when it comes to accounting methods. One way to keep track of your business’s income is to record expenses whenever an amount is actually paid out by you and income when a payment from a customer is actually received. For example, if you order inventory but do not actually pay for the merchandise until it arrives one week later, you would make the entry in your ledger when you make the payment and not when you placed the order. This method is fairly simple and allows you to have an accurate reflection of your cash on hand. However, it also skews the overall picture since it does not take any outstanding debts or payments into account.
Using the Accrual Accounting Method
The other option is to keep track of your business’s income and expenses as soon as the obligation is known, rather than when the actual payment is made or received. For example, if you ordered supplies for your business but will not pay for them until they are received, you would record the debit at the time of the order. Similarly, if a customer purchases something on credit, you would record it at the time of the sale rather than waiting for the payment to come in. Unlike the cash accounting method, the accrual method allows you to see the big picture when it comes to your profits. Conversely, it makes it harder to see how much cash you have on hand at any given time. If your business maintains an inventory of goods that you sell to your customers, the Internal Revenue Service requires you to use the accrual method for the sales of your inventory.
The Importance of Balance Sheets
A balance sheet is essentially a snapshot of your business’s finances at a particular point in time. The sheet will list your company’s assets including cash, inventory and accounts receivable. It will also detail your liabilities, such as accounts payable and other outstanding expenses. The total of your assets minus the total of your liabilities is your business’s net worth or equity. Since the numbers on the balance sheet will vary from day to day, looking at how the balance sheet changes over time will allow you to analyze what is going right and what areas may need improvement.
Managing Your Cash
Understanding how cash flow works is an important aspect of any business. Poor cash management can lead to problems and possibly even the failure of your business. Your cash is the amount of money you have on hand or in your bank account. Cash flow is the movement of cash into and out of your business. Inflow is the cash you receive and outflow is any cash that you pay out. If your inflow is greater than your outflow, you have a positive cash flow. If your outflow exceeds your inflow, you have a negative cash flow. No business will be able to last very long if it does not have enough cash to meet its needs. By being able to project your future cash flow, you can develop a strategy for making sure you always have enough cash on hand to operate your business.
Having a good accounting system in place is vital for any business. Understanding the basics of accounting can help you implement a system that will work for your company and will help you to keep your business afloat.
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