"The process or work of keeping financial accounts." -Oxford Dictionaries
Accountants facilitate smooth businesses. Without their hard work, the complex tasks of managing and tracking transactions, filing tax liabilities, and ensuring legal compliances would be left in the hands of executives, who may not be well-versed in any of these processes.
Accounting is not a glamorous job. Yet it has high implications for a business and the economy at large. For many, the daily chores of an accountant are tedious, unimaginative, and merely dull. But without them, the global economy would just come falling down!
Key Accounting Terms
In order for you to understand the basics of accounting, you need to familiarize yourself with the golden rules of accounting and its basic terms. It helps you not only in the accounting profession, but also if you plan to start a business, or simply to manage your personal finance.
An asset is any resource owned by a business or an economic entity.
A company, as soon as it is set up, comes to own a significant number of assets. These are resources that have future value, implying those that can be liquidated against any legal currency.
There are two types of assets in any business:
- Short-term assets: These are highly liquid in nature and can be sold off in the market to realize money, usually within a year. Also called current assets, these include cash and cash equivalents, accounts or debtors receivables, prepaid expenses, and short-term investments.
- Long-term assets: These are fixed assets such as the company's office, plant, equipment, or long-term investments or patents. Also called non-current assets, these are reflected in the balance sheet at the price at which they were purchased and not at the current market rates.
A balance sheet is a glimpse or summary of the assets, liabilities, and the capital of a business at a particular point in time, detailing the income and expenditure flow over the preceding period.
It is called a balance sheet as it shows the company's assets and liabilities to be in balance. This can be explained using a simple formula:
Assets =Liabilities + Shareholders' Equity
In simple terms, this means that the company has to pay for all the things it owns or assets, using liabilities or issuing shareholders' equity. Liabilities simply reflect the sum of money (generally) that the company owes. Shareholders' equity, on the other hand, is the money attributable to a business' shareholders or owners.
To understand more, check out how a balance sheet looks like.
A ledger is a system of record-keeping of a company's financial data with debit and credit accounts validated by a trial balance, during the entire life of an operating company.
Balance sheets and income statement transactions are also factored into a general ledger to have a further understanding of a company's financial dealings.
Credits and Debits
The concepts of credit and debit in accounting are quite different from how a layman understands it. In double-entry bookkeeping, these are important concepts where accountants make use of them to keep track of all the business transactions.
Every single business transaction is either a credit or a debit flow, and an account ledger requires both. You will find the debits on the left and credits on the right of a balance sheet. The account where the money is coming from is credited on the right-hand side, and the money where the transaction is going is debited on the left-hand side.
Note that the left-hand and right-hand sides of such a balance sheet will always be equal to each other. And it is the job of the accountant to ensure that.
Bot debits and credits have their importance in company finance, especially in increasing certain types of accounts. A debit transaction is used to boost the following accounts:
- Dividends or draws or the regular sum of money the company pays to its shareholders.
- Expenses or the cost of business operations.
- Assets or everything that the company owns.
- Losses or the company's excess of expenses over its revenue.
Credit transactions on the other hand result in the following:
- Gains for a company.
- Income or the company's earnings.
- Revenues or the company's sum of profit and loss.
- Liabilities or the money owed by the company.
- Stockholders' Equity or money attributable to company stockholders.
A company's management rides on the information hidden in its revenue figures and annual sales.
Revenue can be defined as the total sum of money that flows into a company over a certain period of time. It is used to calculate net profits, which can either be positive (meaning the company has profited) or negative (meaning the company has incurred losses).
You may be interested in learning about a profit and loss account and its implications on business.
Keeping track of regular revenue reports, and recording relevant insights is a crucial role that an accountant plays in a business. This information drives important business strategies including new product launch, performance management, and cost controls.
Simply put, the wealth of a company, either in the form of money or other assets, constitutes its capital. The financial well-being of a business is hugely dependent on the proportion of its capital at any given point in time.
It is important here to make a distinction between money and capital. Money is used for transactions, has a more immediate purpose, and is highly liquid. In contrast, capital includes assets such as stocks or investments that have long-term implications for the company's future. In this regard, capital can be said to be more durable, and definitely more reliable for the company's sustenance. Capital can also be used to create money or capital in the future, and this is what makes it so important to accountancy and businesses at large.
Cash flow can be defined as the total amount of money flowing in and out of a business.
Positive cash flow is a desirable state for businesses as it indicates a higher closing balance than the opening balance. However, a note of caution is important here which says that higher cash flow is not synonymous to higher profits. It simply means that money flowing into the business at a particular point in time is greater than what is being spent. This scenario is not permanent and may change in the immediate future, and can also translate into losses.
There are ways to improve the cash flow of a business or corporation:
- Selling additional products or offering new services.
- Selling assets that are no longer needed by the company.
- Controlling costs and budgets.
- Ensure competitive pricing to keep the flow of cash consistent.
- Bringing in more equity.
What are the other key concepts of accounting?
Important Types of Accounting in a Business
In accountancy, there are several different types of accounting that have their uniqueness and significance in the world of finance. All of them are based on the Generally Accepted Accounting Principles (GAAP) in India. Of these, two are worth mentioning in the context of company finance.
What's more interesting is that you can now use accounting software for any type of accounting work.
Cost Accounting Definition
A cost accountant is tasked with the very important job of recording all the costs that a business incurs and furnish data to improve management. In essence, it is an internal process curated by companies in order to improve business and financial efficiency.
Since it is an internal process, cost accounting is not mandated by any law and does not have to comply with any legal statutes. It accounts for every single cost associated with the production, including fixed and variable costs. It is a variant of management accounting that concerns itself with analyzing cost patterns and data in each step of production. This helps in forecasting, cost controls, and performance management.
Financial Accounting Definition
The process of recording, summarizing, and reporting the innumerable transactions that result from business operations. Note that this is different from auditing in that it is a process held by internal employees, while the latter is more of an evaluation by external agencies.
Financial accountants prepare financial statements, including the balance sheet, income statement, and cash flow statement. These statements reflect the operating performance of a business over a period of time. These reports are drawn up at regular intervals, either monthly, quarterly, half-yearly or annually. Financial accountants are hired across sectors and all types of companies including big corporations as well as non-profits.
Find out what other responsibilities fall under the ambit of financial accounting.
The field of accounting is one of innumerable possibilities and great significance. It makes a great career choice if your passion lies in number crunching, data analysis, management, and entrepreneurship.