Every business that incurs debt must keep accounting records to identify assets and liabilities as well as to decide how best to pay for goods and services provided.
External users of accounting information include tax authorities and lenders. Investors and prospective buyers also review a company’s accounting documents.
Accounting Methods
Accounting methods are a set of rules that dictate how a company records expenses and income on its financial statements, with choosing the ideal approach having lasting impacts on profitability and attracting debt financing or investors. Therefore, working with a professional accountant is key when selecting an accounting method for your company.
There are two primary accounting methods, known as cash and accrual accounting methods. With the cash method, revenue and expenses are only recorded once received or paid for; with accrual accounting you record income and expenses immediately regardless of when they arrive in your account. Accrual can make sense for small businesses that prefer keeping things simple or for companies whose profitability relies heavily on how quickly their goods or services are paid for; it’s more complex than cash accounting but produces more in-depth reports regarding a company’s finances.
Recording Transactions
Any transaction that affects the financial status of your business should be recorded – from purchases and sales, deposits and withdrawals, etc. This practice is known as bookkeeping and marks the start of accounting cycle.
Recording transactions involves identifying all parties involved and accounts involved with transactions before recording their dates, amounts and descriptions in an account ledger. This process typically uses cloud-based software systems and may even incorporate POS systems integrated with bank accounts to download daily statements for all accounts automatically. Most businesses utilize double-entry accounting which involves two transactions being recorded per each transaction: one credit entry and one debit entry for every transaction.
At the conclusion of each accounting period, a trial balance is created as part of an overall accounting overview to assess whether all accounts with their current balances match. It allows you to test if debits match credits in terms of total debits vs credits; any discrepancies identified must then be corrected before finally creating an accurate record that provides you with an overview of your company finances for informed business decisions.
Chart of Accounts
A chart of accounts (COA) is a listing of each account within a company’s general ledger. While its structure will depend on your industry sector, the COA should generally contain primary categories for assets, liabilities, shareholders’ equity and revenue/expenses with subcategories such as prepaid expenses, accounts receivable and inventory within each category. Each account should also feature its name, brief description and identification code/number for easy reference.
A chart of accounts (COA) allows you to organize all of your revenue, expenses, assets and liabilities into logical categories that will allow you to produce key financial reports like balance sheets and profit-and-loss statements. Be sure that your accounting software provides enough granularity as the COA sets the stage for all other forms of reporting.
Once your COA is established, allow it to remain for at least several years so you can observe trends over time and make accurate predictions and run effective reports to assist your business in growing.
Financial Statements
Financial statements are documents that provide an overview of a company’s operations and finances over a certain period of time. Prospective investors use them to assess a business, while companies can use them themselves to spot trends that indicate possible profitability issues in the near future.
The four primary financial statements include the balance sheet, income statement, cash flow statement and statement of retained earnings. They are prepared utilizing standard accounting frameworks so they may easily be compared between parties outside their organization.
Balance sheets of businesses show what assets and liabilities exist at any one point in time, while income statements provide an overview of revenues, gains, expenses and losses over a specified reporting period. A cash flow statement depicts cash inflows and outflows related to operating activities, investing activities and financing activities while the statement of retained earnings illustrates profit accumulation over time and its transfer into equity section of balance sheet as retained earnings.
