What is accounting?
Well, accounting is all about money to help people to make better decisions. In simple terms, the basics of accounting are recording all your incomes and expenses to use the past to make decisions for the future.
How do you do it?
The following are the four flavors of accounting:
- Financial Accounting
- Managerial Accounting
- Income taxes
This is done to record all your receipts of income and expenses. If you don’t start collecting these, then you can not do accounting.
When you start a business, start to organize your receipts and various other statements to make better decisions in the future. Bookkeeping is all about collecting information, and getting things recorded! Once you collect all the information, organize those records and categorize them.
You require this information to give to other people outside the organization to get them to invest in your business. The Lenders and investors are the key external people. Lenders and Investors need this information so that they understand whether you will be able to pay back or not.
All the details related to income, assets, obligations, resources, credit cards and cash are recorded so that proper data can be driven from it. They define the Assets and Liabilities of the business. Assets are ‘what you have’ and Liabilities are ‘what you owe. Keep note of all the transactions of your supplier, customers, employees, competitors, government agency, press, etc.
All your financial accounting can be summarized into three sheets of paper:
- Balance sheet
- Income statement
- Statement of cash flow
1. Balance sheet
It includes the money invested by the owners in the business or borrowing made for the business. This borrowing can be used as an investment in developing the business as well. The balance sheet is the list of resources and obligations of the business.
Assets = Liabilities + Equity
There are some limitations to the balance sheet as well i.e not all the things can be recorded in the balance sheet i.e. the aspects which give value to the business but don’t generate revenue or expense to the business are not recorded. For example, the number of customers increasing due to brand is never calculated.
2. Income statement
It’s how much money that business made in the period. This defines the revenue generated after we deduct the expenses i.e the net income. The balance sheet is the snapshot of what is going on right now while the income statement is the details of the period in time.
3. Statement of cash flow
There are three categories of cash flow
Operating activities: It includes income from the daily tasks
Investing activities: It includes the income from investing somewhere
Financial activities: It includes the occasional activities done to generate income
Of these, the operating activities are the crucial ones as it defines everything.
To make the right decision inside your business. Managerial accounting is detailed decisions made to make changes to the business internal to the organization.
Data used for making decisions. There are various managerial accounting examples like product or service costing, break-even analysis, budgeting
Product or costing: The decision made to determine the cost of the product or service the business provides
Break-even analysis: The decision made to avoid losing money
Budgeting: The parameter set to spend money on a particular activity
Income tax accounting
This is done to satisfy the legal obligations and to be compliant with the law.
We have a progressive tax system. Every country has a tax bracket. The first tax bracket is never taxed. One is charged tax after the first tax bracket. The government has set some tax deduction rules for gaining some deductions from the income tax applied which means that the government encourages people to spend their salary on essential things rather than spend it casually. Useful things like donating money, buying a house, etc.
Click on this link to get a detailed understanding of accounting.