Basic concepts of Financial Accounting
-Dr.
Lalit Kumar Setia*
Accounting
— often called the language of business — is the process of recording,
classifying, reporting and analyzing financial data. And while the accounting
requirements of every business vary, all organizations need a way to keep track
of their money. Unfortunately, there's very little that's intuitive about
accounting. Many small businesses hire accountants to set up and keep their
books. Other companies use accounting software like QuickBooks, CheckMark
Multi-Ledger and M.Y.O.B. Accounting and keep their accounting functions in
house.
It's All about Balance
Using
a system of debits and credits, called double-entry accounting, accountants use
a general ledger to track money as it flows in and out of a business. They
record each financial transaction on a balance sheet, which provides a snapshot
of a business's financial condition. Accountants record every financial
transaction in a way that keeps the following equation balanced:
Assets
= Liabilities + Owner's Equity (Capital)
The Accounting Cycle
Accounting
is based on the periodic reporting of financial data. The basic accounting
cycle includes:
Ø Recording
business transactions. Businesses keep a daily record of transactions in sales
journals, cash-receipt journals or cash-disbursement journals.
Ø Making
adjustments to the general ledger. General-ledger adjustments let businesses
account for items that don't get recorded in daily journals, such as bad debts,
and accrued interest or taxes. By adjusting entries, businesses can match
revenues with expenses within each accounting period.
Ø Closing
the books. After all revenues and expenses are accounted for, any net profit
gets posted in the owners' equity account. Revenue and expense accounts are
always brought to a zero balance before a new accounting cycle begins.
Ø Preparing
financial statements. At the end of a period, businesses prepare financial
reports — income statements, statements of capital, balance sheets, cash-flow
statements and other reports — that summarize all of the financial activity for
that period.
The Importance of Financial Statements
At
the end of a period — either annually or more frequently, depending on the
length of a business's accounting cycle — accountants create financial
statements that show the financial health (or decline) of a business. Many
people inside and outside a company use the information found in financial
statements. Business owners and managers use the data in financial statements
to chart the course of their companies, project revenues and expenses, monitor
cash flow, keep tabs on costs and plan for the future. Present and
prospective employees also want to see their employers' financial performance.
Stockholders and investors closely examine financial statements to check a
company's performance. They want to compare a business's financial statements
with those of other companies to guide their investment choices. Bankers look
at a company's most recent financial statements when they make lending
decisions. Financial statements also make it easier to for accountants to
prepare tax returns and report financial information to the Internal Revenue
Service. In fact, so many business partners, investors, and other interested
parties rely on your these documents that it's important to get a handle on all
the common
financial reports your business will be expected to produce.
*Copyright © 2018 Dr. Lalit Kumar. All rights
reserved.
