Accounting tasks can be tedious and confusing, but this Business Kitz blog will walk you through some basics of accounting and reading financial statements to help!
What is accounting?
Accounting is the recording, measurement, processing, and presenting of financial information. It is known as ‘the language of business’ as it is used to communicate the financial transactions of a business. The rules that govern accounting principles depend on the circumstances but may follow Generally Accepted Accounting Principles (GAAP), International Financial Reporting Standards (IFRS), or Australian Accounting Standards Board (AASB).
Why is accounting important?
The accounting of financial information provides the following benefits:
- Bookkeeping of income and expenses
- Improves business decision-making
- Tracking of tax liabilities and deductions
- Lends confidence to investors about business performance
- Ensures compliance with regulations and law
- Assists in business evaluation
Financial accounting records transactions and the nature of the items on the financial statements. There are three main financial statements: profit and loss (income), balance sheet, and cash flow statement.
What is included in an income statement?
The income statement is responsible for tracking the revenues, cost of goods sold (COGS), and operating and tax expenses of the business. The statement covers a period of time, such as a quarter or annual period. It generally follows the following format:
- Revenues: the income generated by product or service sales
- COGS: the cost of raw materials to produce the product (there is often no expense for service businesses)
- Operating expenses: the expenses affiliated with operations (wages, leases, marketing, insurance, legal fees, etc.)
- Interest & Taxes: the expense of interest on a loan and taxes
- Net Income: the profitability of a business as defined by revenues minus expenses
What is included in a balance sheet?
The balance sheet displays the assets and liabilities of a business at a specified point in time. All assets and liabilities are broken down into current and non-current forms. The term ‘current’ refers to items that may be short-term, such as assets or liabilities that may be liquidated or paid within 12 months. Therefore, ‘non-current’ are assets or liabilities which are likely to be on the balance sheet for over 12 months.
Current Assets (cash, receivables, inventory, etc.)
Non-current Assets (property, plant, equipment)
Current Liabilities (payables, short-term debt, leases)
Non-current Liabilities (long-term loans, leases)
Equity (total assets – total liabilities)
What is included in a cash flow statement?
The cash flow statement is the final statement, tracking the movement of cash within the business over a period of time. The cash flow statement exists because the income statement includes non-cash expenses, which is an accounting entry rather than a payment from the business. An income statement also does not include any capital expenditures, which is payment for property or equipment. This means that the net earnings on an income statement may not be the best estimate of cash flow in the business. The cash flow statement adjusts for these and shows the way cash is received and spent in a business. There are a few ways to calculate a cash flow statement, for example:
Cash from Operating Activities
- Add: Net Income
- Add: Non-cash expenses (depreciation, amortization, etc.)
- Add/Less: Adjust for change in net working capital (inventory, receivables, payables, etc.)
Cash from Investing Activities
- Less: Capital expenditures (property, plant, equipment)
- Add/Less: Proceeds from investments
Cash from Financing Activities
- Add: Proceeds from share issuance
- Add: Proceeds from debt issuance
- Less: Payment of debt
- Less: Payment of dividends
The sum of the changes in the cash flow statement will display the flow of cash within the business. This can be viewed by the change in cash on the balance sheet.
What is Managerial Accounting?
This form of accounting is similar to financial accounting but is designed to provide valuable information which assists management make decisions about business management. This may include budgeting, forecasting, project management, and other tasks.
What is Cost Accounting?
Cost accounting uses financial data to assist businesses to make decisions about costs. This technique assesses all fixed and variable costs associated with a product. This is a form of managerial accounting, as it is used internally to make decisions about cost efficiency in the business.
What is Tax Accounting?
This section of accounting deals with assessing the taxable income of individuals, businesses, and other entities. In a business, an accountant must consider the income and expenditure of the entity along with other accounting treatments to calculate the taxable income. An individual may be assessed based on employment income, investment gains, and deductible items.
Accounting is a necessity for businesses and individuals alike. You should always consult with a professional about any accounting or financial matters. However, having an understanding of accounting standards and tax laws can help you improve your business.
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