Accounting basics: terms, statements & steps to get started
Running a business involves more than having a good product or service. Successfully managing your finances is critical and entrepreneurs can’t afford to ignore the accounting details.
When making any business decision, it’s critical to consider your finances. Crunching the numbers is essential to helping a business thrive, so understanding the basics of accounting should be a fundamental part of your business acumen.
Below, we discuss accounting basics when running a business in Australia, key financial statements, and the tools you can use to simplify your process and help you succeed.
What is business accounting?
Business accounting involves regular tracking, analysis, and understanding of a business's finances. Entrepreneurs can use accounting information to track their financial obligations, helping them make decisions for a stronger, more sustainable operation.
A necessary component for running a business is comprehending the basics of business accounting, but that doesn’t replace the need for good, independent accounting advice from an accountant or bookkeeper. Plus, you should also engage a qualified tax practitioner when it comes to accounting for tax purposes.
Why is accounting important?
Accounting is important not only to make sure you’re spending within your budget but because entrepreneurs often need to report their earnings to stakeholders to inspire confidence in their venture.
Investors will want to know the status of businesses in which they’re investing; they’ll want to keep tabs on if the operation generates a profit, and how the value is increasing. Additionally, creditors will need to know if the company they’re loaning money to generates enough profit to repay their loan.
Reporting good numbers helps you maintain positive relationships with your stakeholders, while the ability to report regularly and accurately on your business activity also makes it easier to maintain compliance with any relevant tax legislation.
Understanding accounting basics means coming to grips with some key terms to describe the various concepts involved.
Once you’re familiar with accounting, you’ll understand and recognise words like revenue, expenses, balance sheets, assets, liabilities, income statements, and more.
Chart of accounts
Accounts can be kept updated by recording your finances regularly, with your key accounts summarised under a chart of accounts.
Your key business accounts will fall into the following categories:
assets – assets are items that are acquired or purchased but not immediately consumed. Accounts receivable and inventory are examples of assets
liabilities – liabilities are business obligations that are intended to be paid at a later date. For example, accounts payable or loans payable
equity – you can figure out equity by calculating your assets minus liabilities
revenue – revenue is the amount you earn from selling goods or services to customers
expenses – expenses are the total amount of assets acquired during a period, for example, rent or wages.
Key financial statements
Financial statements can come in various forms to show different financial perspectives of your business and its activities.
Below are the types of financial statements you would become familiar with when running a business:
shows a company’s profits and losses
sales income, retained earnings, interest income.
shows your assets and liabilities and equity accounts
a financial snapshot of a particular point in time
provides insight into a company’s financial position showing what is owned and what is owed
assets, liabilities, equity.
Profit and Loss (P&L) statement
summary of business income less expenses within a specific time frame.
tracks business performance and breaks it down into categories
income, cost of goods sold, expenses.
summary of the amount of money coming in and leaving a company
operating expenses, investing activities, financing expenses.
compare and match your bank statements to your accounting records.
Basic accounting terms
Thoroughly understanding your business means understanding your finances and many terms you’ll use when talking about your business relate to finance.
The following list of terms covers all the major terms you might use for describing the flow of money in and out of your business.
Essentially refers to the money a business owes its suppliers, creditors, or vendors. Accounts payable show as a liability on an organisation’s balance sheet. Accounts payable is similar to an IOU to an outside business.
Accounts receivable is the opposite of accounts payable and refers to what is owed to the business. Typically the money comes in the form of bills paid by customers for services or goods.
A period of time that you track financial information. In Australia, it’s often from 1 July to 30 June.
Credits and debits recorded, but not fulfilled. In other words, a transaction has occurred but money has not yet been exchanged.
A way of accounting that anticipates expenses and revenues by considering accounts receivable and payable. Cash-based accounting focuses mostly on present expenses and revenues; accrual-based accounting often more accurately represents the business’s financial position.
Items with economic value that the company has acquired to provide a future benefit. For example, assets are acquired to reduce expenses, improve sales, or generate cash flow. Assets are recorded on balance sheets.
Financial statements provide insight into a business’s assets, liabilities, and shareholders’ equity at a certain point in time. Balance sheets are helpful to evaluate a company’s financial worth.
Businesses in Australia registered for GST or have employees that lodge activity statements regularly with the ATO, which involve GST, PAYG, or other necessary information.
Refers to an organisation’s financial assets. For example, capital could mean funds in bank accounts or funds from financing. Working capital specifically refers to liquid capital for day-to-day expenses.
The money that comes in and goes out of a business. Cashflow refers to the sum of money a business generates from operations, financing, and investments.
Closing the books
Refers to accounting for the entirety of financial transactions for a particular period of time. “Closing the books” is an older phrase that refers to when accountants physically took handwritten notes in ledger books to record transactions.
Cost of goods sold
The cost of total goods sold by a company, also known as COGS, includes the costs of generating goods and services, materials, labor but excludes indirect costs like distribution.
Credits typically go on the right side of a balance sheet; debits should equal credits to keep an account in balance and good standing.
Opposite of credit and goes on the left side of an account. Debits increase expenses and asset accounts and decrease equity and liabilities.
An accounting method used to determine the value of tangible assets which continuously depreciate.
Refers to the time period that your finances are tracked over a year. Most businesses in Australia record from 1 July to 30 June.
General ledgers are where all your information comes together from inventory, sales, cash in, and cash out. General ledgers are used by accountants to record financial transactions and have information that helps companies prepare financial reports and analyze their economic prosperity and financial health over time.
The profit a business makes after considering the costs of supplying services or creating and selling goods. Accountants calculate the gross profit by subtracting the costs from the revenue. Looking at gross profit helps analysts determine a company’s efficiency and health.
Read this next: Break-even analysis: Definition, calculations, examples, pros & cons
GST stands for Good and Services Tax. GST is a broad-based tax amounting to 10% on most items, services, and other goods sold in Australia.
A company’s raw materials used to make products, works-in-progress, and the products themselves are referred to as inventory, and they appear on a balance sheet. Generally, businesses want to avoid keeping large amounts of inventory for prolonged periods due to the mere risk of storage costs and obsolescence.
A business transaction can be recorded as a journal entry in a company’s general ledger. A journal entry could include the date of entry, account information, debit, credit, and a description of the transaction.
A liability is when a company owes another entity money. Liabilities can be short-term and be settled in under a year, or be long-term, taking over a year to resolve. They might be settled by payment or transferring services or goods. Types of liabilities might include mortgages, loans, accrued expenses, or accounts payable.
Liquidity refers to how simply a business would be able to convert assets into cash. Cash, the most liquid asset, can convert easily into other assets.
The amount of money a business earns after taking away taxes and deductions from gross income. Often referred to as the bottom line, and is the last item you’ll see in an income statement. Net income is important because it helps shareholders and investors determine a company’s financial standing.
The ongoing costs of running a company are called overheads. Knowing your overheads is important to figure out what you should charge for services or goods to be profitable.
The total amount of money a business pays its employees during a specific amount of time. Social security, Medicare, distributing payments, and hours worked over weekends all need to be included for payroll.
A qualified expert in taxation. They are specially trained to prepare and lodge income tax returns, company tax returns and manage payments. How someone qualified to be a tax agent will depend on their tax jurisdiction.
A statement of how much income an individual earns and expenses they’ve claimed as a deduction.
Read this next: Tax deductions: 18 things you didn’t know you could claim
Getting started with accounting (a basic checklist)
The hardest part of any task is getting started, so here’s a shortlist of what’s important.
1. Create and link a business bank account
When starting a business you’ll first need to decide where to keep your money.
Even if you’re not legally required to have a separate business bank account, it makes good sense to set one up.
Keeping your business and personal finances separated makes accounting easier for you in the long run. Separation also helps when you decide to bring on an accountant or bookkeeper.
Read this next: What’s the difference between a sole trader and a company?
2. Create a chart of accounts
Your accounting system will need a chart of accounts, as this acts as the heart of your financial system, keeping all your accounts organised in your general ledger.
Likewise, all your transaction entries should be kept in your general ledger for recordkeeping’s sake.
Before recording any financial transactions, create a chart of accounts to keep you organised from the beginning. Small businesses often start out doing these tasks with spreadsheets, whereas getting started with online accounting software is even easier.
3. Identify your accounting method
After your chart of accounts is squared away, you’ll want to choose the accounting method you’ll use.
Many sole proprietors and freelancers opt for a cash accounting method, as it seems simpler. The cash accounting method doesn’t record accounts payable or receivable, and when you have no employees, that’s usually all that’s needed.
An accrual method is more suited for businesses that sell products and have employees. This method records income and revenue and tracks expenses when they occur instead of when money is transferred. The accrual strategy is useful for providing a more comprehensive and insightful financial picture, but it also makes managing cashflow a little more complex.
4. Enter and itemise all transactions
Gone are the days when it was necessary to categorise expenses by painstakingly looking through physical receipts. Apps, software, and cloud-based bookkeeping have changed the game and made organising expenses simpler and more streamlined.
While receipts are beginning to be considered a thing of the past, you should still be careful about ignoring, forgetting or disposing of them.
When it comes to business accounting basics, it’s always wise to be on the safe side. You’ll want to keep and organise your receipts, bills, invoices, bank statements, credit card statements, financial statements, tax returns and related documents in a safe manner.
Keep in mind, if you’re hoping to get tax deductions come the end of financial year, you need records of where you spent your money.
5. Research the tax obligations of your business type
Understanding your tax obligations is critical because by not complying, you could make a major legal mess for yourself. Seek out a thorough comprehension of the various taxes your business must comply with and keep meticulous records of all your transactions and financials. Setting aside money to pay your taxes ahead of time is wise, so you’re not caught out come tax season.
6. Comply with income, employment, and sales taxes
Bookkeeping is a constant task in business accounting and it should be happening daily. Life happens and sometimes you have to catch up, but regular bookkeeping does need to be done frequently and regularly to keep a close tab on your business’ performance.
Keeping an eye on how much revenue your company generates, where you’re hurting, and where you could afford to cut back, will help you turn a profit and keep your doors open in the long run.
By using accounting principles in combination with good bookkeeping practices, you’ll stay up to date with all sales, income, and employment tax laws so that you’re operating appropriately and in compliance with the law. And remember to hire an expert to help make any key decisions along the way.
7. Set up invoicing and payroll systems
As early as possible, get a head start on setting up your invoicing and payroll systems. Having a set procedure in place from the start should help you keep on top of operations, payments, and payroll.
Fortunately, there is software that can help in this department, like MYOB. MYOB automates many of the everyday tedious tasks for you, helping you stay organised and up-to-date.
Remember, employees and independent contractors fall into different classifications, which give different tax deductions—understanding how both works is critical to staying in compliance with tax and employment law.
8. Reconcile bank accounts each month
An important task in business accounting basics is to reconcile your accounts each month to keep an eye on your financials. A monthly check gives you a chance to catch and recognise any unusual transactions or identify fraudulent withdrawals or accounting mistakes. This may be particularly helpful if your company utilises more than one bank.
9. Consult with an accountant
Using a professional when necessary is paramount to success. Consulting with someone who has extensive experience managing money and providing business and financial advice will always be a wise choice. Whether or not you are educated on business finance, having a trusted advisor will help you take your business game to the next level.
Types of accounting professionals
Not all accounting professionals are the same, so be sure to understand a few key types of professions in this area will help you in choosing the right one for your needs.
Accountants help with your company’s financial needs, manage your taxes, prepare financial documents, offer you financial advice and guidance on business.
Bookkeepers help record daily financial transactions, oversee your banking, follow up overdue payments, administer payroll, and prepare financial documents.
Business activity statement (BAS) agent
A business activity statement agent will assist you in preparing and lodging your BAS to make sure it’s submitted properly. These are professionals who are registered specialists in their field.
Simplify your accounting with MYOB
If all of this financial speak is over your head, you’re not alone. Finances are full of complex details, so it makes sense to outsource this function of business entirely if you don’t have the time for it. Or, you could deploy a system like MYOB to automate daily tasks, so you can get back to focusing on the big picture.
MYOB is a single system that will automate simple yet often forgettable everyday tasks that you must do for your business to succeed. MYOB helps your business look professional and stay in good standing while remaining compliant with the laws and regulations necessary to do business in Australia. Start a 30-day FREE trial.
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