Financial Accounting Basics
A Few Basics: Where To Start With Bookkeeping If Numbers Aren’t Your Thing
Some people are great with numbers. Others showcase their other talents while bookkeeping remains a mystery. Wherever you fall on that spectrum, at Clear Accounting, numbers are our thing and we’re here to help with all things accounting. Whether you’re a small business owner, individual filing your taxes, or anyone else who might not know where to being with their bookkeeping and accounting, here’s some info on the basics to get you started.
Terms to Know
- Accounts Receivable: As the name suggests, accounts receivable refers to the amount of capital another party owes you. For example, if another company has bought something from you with payments in installments or if you have monthly recurring services, these would both be examples of accounts receivable because they refer to the amount of money another party owes you.
- Accruals: The accounting process takes time, and not all transactions can be fully completed immediately. That’s where accruals come in. Accruals refer to transactions that have been made but not yet fulfilled. This can mean expenses that have been incurred but not paid in full or sales transactions that have happened but have not been billed.
- Accrual Based Accounting: This accounting method takes when expenses are incurred and when payment is actually fulfilled into account. This method allows companies to be more flexible with their bookkeeping as there are various rules as to when payments will be fulfilled during the accounting period.
- Assets: In short, assets are what you own. They include all property, equipment, cash, and intangibles such as copyrights, brands, and trademarks.
- Balance Sheet: A balance sheet is a document that details your company’s overall finances. This includes assets, liabilities, and overall equity.
- Cash Basis Accounting: Cash basis accounting is another accounting method that’s great for small businesses and startups. This accounting method details when payments are sent and received, unlike accrual based accounting.
- Depreciation: The car you bought in 2008 probably isn’t as shiny and new now as it was when you bought it. That’s a result of depreciation. Assets lose their value over time, and that needs to be reflected in your record keeping, especially on your taxes.
- Equity: This refers to the overall amount of money put into a company by its various owners, and the cumulative net incomes earned over the life of the company.
- Fiscal Year: A fiscal year is the specific amount of time a company uses for its accounting period. While some companies follow the calendar year with their bookkeeping, some do not. For example, many schools will follow a fiscal year that starts in August and ends the following July because of how the school calendar falls.
- Forecasting: Forecasting is a technique where you use how your company has performed historically to predict how they will perform in the future. Though not perfectly accurate, this is a good way to get a big picture idea of how your company’s future finances.
- Liabilities: liabilities are everything your company owes. This includes everything from employee salaries, to rent, to a wide variety of other expenses.
- Profit and Loss Statement: A Profit and Loss statement is a financial report, which details expenses, earnings, and net profits over time.
- Revenue: Revenue increases all income a company has made without taking expenses into account.
Forms to Have:
Now you know the basic terms. Unfortunately, that’s not all you need to know in terms of basic accounting knowledge. Bookkeeping of all kinds comes with a lot of paperwork and forms to fill out. To get started there, here are a few forms to know about including where to find them and what their purpose is.
W4 Form: If you’ve ever had a new job, you’ve probably filled out a W4 form. This form shows employers how much federal income tax needs to be withheld from your paycheck. Withholding means that there is a certain amount of your paycheck that gets taken taken out and sent to the government. Its crucial to fill out this form correctly to avoid additional payments later on in the year and so the correct amount is withheld.
I9 Forms: The purpose of an I9 form is to verify employees identities and their authorization to work in America. All employees must fill out these forms to work legally in this country, whether or not they are a citizen. If employees are not U.S. citizens, they must include some form of documentation showing their eligibility to work in this country such as a work visa or work permit.
W2 Forms: W2 forms are also crucial for small business bookkeeping. If you make more than $600 in a year from a single employer, even as a freelancer or non full time employee, you must fill out this form. The IRS says this form must be filled out for all employees for whom:
- Income, social security, or Medicare tax was withheld.
- Income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4, Employee’s Withholding Allowance Certificate.
1099-MISC Form: As the name states, the 1099-MISC Form essentially takes care of all income that falls into the “miscellaneous” category. This can include income, other forms of payment, bonuses, and a wide variety of other payments. These forms are especially common for independent contractors, as they often have less uniform payment structures that can vary from client to client.
Copies of invoices, receipts and other financial records: financial recording keeping is the bread and butter of all accounting. Without thorough records of purchases and expenses, you may be missing out on deductions as well as giving your business a wider margin for error. Making quick copies of all of these documents or tracking them digitally is an easy way to make sure you don’t fall behind on these transactions and your day to day record keeping does not slip through the cracks.
Accounting Formulas Small Business Owners Should Know
1. Assets=Liabilities + Equity
If you remember one accounting formula from your college accounting class, it’s probably this one. “The Accounting Equation” as it’s often called dictates:
- Your assets, the accumulation of all of your company’s capital including cash, property, equipment and other beneficial things your company owns that will bring you value over your business’ lifespan.
- Are a sum of your liabilities: liabilities are the things your company owes. That can include debt, employee salaries, rent, taxes, and any other monetary and capital value that your business must spend in order to stay afloat.
- Plus Your Equity: which is the value of however much of the company you actually own.
This basic accounting formula is a tool to figure out what you own minus what you owe, and draw conclusions accordingly.
2. Debt to Equity Ratio
Debt-to-Equity Ratio = Total Liabilities / Total Equity
This formula will help you to figure out how sustainable your business is at its current standing. It illustrates the amount of your business’ funding that comes from other sources such as investors and loans, compared to the amount of profits that come from your business operations.
To use this formula, you’ll need to know:
Your total liabilities: in other words, everything you owe to other parties. This includes loans, rent payments, payments for capital you have purchased on credit and any other sort of payment you owe.
Your total equity: which is the sum total of your company’s worth, and how much the owner of the company you actually own and how much belongs to other stockholders.
A “good ratio” depends on what stage your business is in and what your goals are. A good rule of thumb is that if your debt to equity ratio is too high, that means you owe a lot more than you own, and this can be a red flag for many investors. Overtime, this ratio should go down as your company starts to earn more and owe less.
3. Net Income
This is a simple formula, but it’s an important one to keep in mind. This formula details that all of your company’s expenses subtracted from your total revenue equals your net income. If your company is generating a ton of revenue that’s great, however if you are spending three times that much to generate sales, your business will end up in the red. It’s important to keep your expenses in check and monitor both your spending and earning.
4. Profit Margin:
Profit Margin= Net income/ Sales
As stated above, your net income is the difference when you subtract expenses from revenue. Sales is the amount of total sales your company has made. The dividend of these two numbers will give you your profit margin, or the amount of money you are making from sales. If this number is high, that’s a great sign for your company’s financial health because it means your sales are highly profitable. If this number is low, however, that’s a red flag, and you may need to reevaluate your sales model.
5. Break Even Point
Break-even volume=fixed cost /sales price –variable cost per unit
This handy formula essentially tells you how much product you need to sell before you break even (and from there, how much more you need to sell to make a profit). This formula takes a few variables into account:
- Fixed cost: Your recurring business expenses, or the price it takes to keep your business running. These costs include employee salaries, rent, equipment etc.
- Sales price: How much it costs to purchase one unit of your product or service
- Variable cost per unit: the cost of how much it makes to create each unit
What to do if you don’t know where to start
With this outline of basic accounting, you’ll have a better idea of how these factors impact your business. If credits and debits still mystify you, have no fear. From basic bookkeeping to contract CEOs and so much more, at Clear Accounting, we are at your service and are happy to help with a variety of bookkeeping needs. To learn more about our services or to talk to one of our experts, visit our website today!