- About BCI
January 15th, 2015
If you’re a small business owner it’s important to know Financial Accounting Basics for accurate financial reporting. Without it, you have no way of knowing the financial health of your company, not to mention where to allocate funds and how much debt you owe to your creditors. Plus, if you get audited by the Internal Revenue Service (IRS), you’ll need to prove that your books are in order so you don’t have to close your business.
Whether you’re looking to brush up on some bookkeeping terms or you’re trying to find a better way to manage your finances, a fundamental understanding of Financial Accounting Basics will help you organize your books for success.
So what do we mean exactly by financial accounting? According to the New York State Society of Certified Public Accountants (NYSSCPA), accounting is the “recording and reporting of financial transactions, including the origination of the transaction, its recognition, processing, and summarization in the financial statements.” In short, basic accounting allows you to keep track of all your business transactions so you have a place (called the general ledger) to see a snapshot of your finances.
The accounting process is often explained as a “cycle” and includes eight steps.
A transaction occurs when a business engages in some sort of financial event. This includes any activity that uses a company’s financial resources, such as:
After a transaction has occurred, you must record the event in a journal, which is a complete list of all transactions. To do this, many business owners use a method called double-entry accounting whereby two accounts are affected with each transaction. For example, let’s say you own a small lemonade stand and a customer buys a drink for $3.50 using cash. Using double-entry accounting, this transaction involves a debit to the cash account and a credit to the sales account for $3.50.
Posting simply means transferring all of the debits and credits from the journal to the ledger. By definition, a ledger is a list of all the accounts used by your company. Examples include:
Using the account balances from the ledger, the next step in the accounting cycle is to calculate the trial balance by totaling all debits and credits. This is also done at the end of the accounting period and the purpose is to verify that the basic accounting equation (Assets = Liabilities + Stockholder’s Equity) is in balance. In other words, the trial balance validates that debits equal credits.
After calculating the trial balance, it’s not uncommon to find that your books are not in balance. If so it means there’s an error and you need to make “adjustments” to correct it, which are tracked in a worksheet. Errors can occur for a number of different reasons, but here some of the most common:
To correct an error, you first record an adjusting entry in the general journal and then post it to the ledger. This involves balancing the appropriate asset or liability account and updating the corresponding revenue or expense account.
Once you’ve recorded the adjustments, the next step is to prepare another trial balance called the “adjusted trial balance.” If your debits equal credits it generally means you have no errors, but this isn’t always true. For example, your books may have errors but still balance if you:
With the corrected account balances, you can now prepare your financial statements. These include the following:
In the last stage of the accounting cycle, you’re now ready to prepare the closing entries so you can start the next accounting period. This may include a post-trial balance to double check that your debits equal credits.
Using the eight steps in the accounting process, it’s easy to see how Financial Accounting Basics can help you make better business decisions. For more information about financial accounting, you can enroll in our Financial Accounting Fundamentals Program today and learn other ways to improve your books.