As a young entrepreneur, you're probably focused on growing your business and making money. But if you’re not careful, you could end up spending your hard-earned money on things that will never help your business grow. One of the best ways to avoid this is by knowing exactly where every penny is going.
“You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business” - Warren Buffet
It is important that you understand the basics of accounting to get a better picture of where you stand financially and make smart decisions. In this article, we’ll go over 4 tips on what every young entrepreneur needs to know about accounting:
FIRST: What is Accounting?
Accounting is the art of recording, classifying, and summarizing financial transactions of a business for presentation in reports useful for management decision-making. Accounting helps businesses keep track of the money flowing in and out of their company so they can manage their finances and make decisions effectively.
Understanding accounting is crucial to the success of your business. Without proper accounting, you won’t understand how much money is coming into and going out of your business. This will help you make better financial decisions that can help you grow as a business owner.
What are the Basics of Accounting?
There are five basic accounting concepts that every entrepreneur should understand:
- Revenues: Revenues are the money that your business makes from selling products or services.
- Expenses: Expenses are the money your business spends on equipment, salaries and rent (etc.). You must keep track of all your expenses so that when it comes time to file taxes at the end of the year, you don't get surprised by a large bill!
- Assets: Assets are things owned by a company such as cash on hand, properties, equipment (machinery used in production) and inventory. These assets can be used to generate revenue for your business.
- Liabilities: Liabilities are the debts that a business has. They include accounts payable (money owed but not yet paid), such as money owed to suppliers or contractors.
- Equity: Equities are the assets minus the liabilities. Equity stands for what is left over from your debts that have been paid off. It could also be referred to as owner's equity.
What are the Basics of Financial Statements?
A financial statement is a report that provides an overview of a company's performance, which can help potential investors decide whether to invest in the company, as well as how much to invest. It includes the income statement, balance sheet and cash flow statement.
The income statement is also known as the profit and loss statement. This financial statement summarizes the income and expenses of a business over a period as well as its profitability.
It provides insights into how your business is doing, what revenue you are generating, what costs you have incurred and whether you are making money from your operations.
The Income Statement can be broken down into eight sections:
- Revenue - how much money you make
- Expenses - the costs of running your business
- Net Revenue - Revenue minus Revenue Related Expenses
- COGS (Cost of Goods Sold) - the total amount of money used to produce goods and services, which are then sold to customers
- Gross Profit - measure of the total sales revenue minus the cost of goods sold
- Operating Expenses- costs associated with keeping a business running on a day-to-day basis, including things like rent and utilities, supplies, and any employee wages.
- Operating Profit- a company's earnings before interest and tax.
- Net Profit - what’s left after all expenses are paid
A balance sheet is a financial statement that details a business's assets, liabilities and equity at a specific point in time (usually the end of a fiscal year). It is also used to provide a snapshot of its financial position.
- Asset - It is an item or resource that can be used to generate revenue
- Current Assets (Cash, Accounts Receivable, Inventory)
- Long-Term Assets (Equipment, Building, Land, Property)
- Liabilities - It is a claim on the company's assets by other firms and banks or people.
- Current Liabilities (Accounts Payable)
- Long-Term Liabilities
- Owner’s Equity (Total Assets – Total Liabilities)
Cash Flow Statement
The cash flow statement provides an overview of how much money came in and went out in a given period. By tracking your cash flow, you can see whether you're making enough money to stay afloat financially, whether it's time to take out another loan or ask investors for more capital investments. It includes:
- Cash Flow from Operating Activities (Change in Accounts Receivable, Inventory, Debt, and Depreciation)
- Cash Flow from Investing Activities (Change in Capital Expenditures and Investments)
- Cash Flow from Financing Activities (Change in Financing such as dividends paid and purchase of stock)
You must understand the cash flow of your business to make better decisions and find if there are any red flags that need immediate attention (like enormous amounts of debt).
The best thing you can do for yourself as a young entrepreneur is to learn accounting and to understand financial statements so that you can keep track of all your finances.
Not only will this help you avoid costly mistakes, but it’s also important for any young entrepreneur who wants to know how much money their company has in the bank and where it came from or went.
In short: if you don’t know where your money comes from or goes, then how can you possibly make good business decisions?
RELATED: How to Choose the Best Accountant for Your Business
Get Accounting Services You Can Afford
More than anything, developing your business requires your undivided attention. If your accounting duties are taking much of your time from your core activities, it’s time to get some help. One way is Outsourcing an Accountant.
This way they can take care of all your bookkeeping, auditing and accounting needs efficiently while leaving you with more time to do what matters most: growing your business. Talk with our financial experts now to learn which of our customized accounting services fits your requirements. Discover how you can succeed with outsourcing by getting a free copy of our guide Outsourcing: How to Make it Work.