If you ever needed an accounting basics cheat sheet, you’re in the right place.
Accounting is an essential part of any business operation. However, getting involved and up to speed on what you need to know can be a bit daunting. We put together this article as a sort of starting point. This way, you can have at least a base understanding, like an accounting basics cheat sheet. We will cover financial statements, accounting concepts, types of accounts, accounting systems, ratios and metrics, and a little more.
Why Is Accounting Important for My Business?
The importance of accounting can be expressed in a threefold manner.
Financial Management – Any business needs to be able to track their revenue and expenses. How much money do you have available to run your business? Are you spending wisely? Do you need to adjust your pricing based on manufacturing, distribution, and other costs? Accounting is a means to organize how you manage your money so that you can answer the above questions and make better money moves.
Financial Compliance – Legal businesses have to submit to tax law and regulations. Accounting makes sure that you are accomplishing your money management in compliance with the law. Your accountant and team of bookkeepers ensure you have all the information and papers you need to file your taxes on time.
Financial Transparency – Organized books mean financials you can show to potential business partners, investors, and government authorities. For the investor side of things, well-kept financials are a signal that a business might be worth investing in.
What Are the Key Financial Statements
Financial Statements are records that show an overview of the financial standing of a company. These formal documents reveal key information about the performance and health of a business and inform future decisions. The three main statements are the balance sheet, income statement, and cash flow statement.
First on our financial accounting basics cheat sheet is the balance sheet. A balance sheet reveals at any specific point in time the assets, liabilities, and shareholders’ equity of a company. It gives you an idea of your current and potential financial health by revealing what a company owns (assets) and what a company still owes to an entity (liabilities and equity). It’s called a balance sheet because the assets must be equal to the liabilities and equity. Balance sheet ratios are formulas that use data gleaned from this statement to further asses your finances.
This is commonly referred to as a profit and loss (P&L) statement. This summarizes the expenses and revenue of a business within a set period (monthly, quarterly, annually). As the name suggests, it is used to determine the profitability of a business and how spending and income has changed over time. It tracks revenue, expenses, one-time gains, one-time losses, net income and more. Using this in tandem with other statements, companies can plan different strategies for cutting expenses or increasing efforts to generate revenue.
Cash Flow Statement
Your cash flow statements show the movement or “flow” of cash and cash equivalents in and out of a company over a period of time. Cash equivalents are anything you can convert to cash easily, and with a low risk of value changes. Cash flow out refers to money going out of a business. Note that cash can flow in from operating, financing (investors), and investing (investments made by the company) activities. These three activities make up the three parts of this statement.
This statement reveals:
- How much cash the company has on hand
- How well it can fund its operations
- How well it can pay off its debts
What Are the Fundamental Accounting Concepts?
Next on our accounting 101 cheat sheet, we’ll discuss some accounting principles.
These are the two methods of accounting and are based on when revenue or expenses are recorded in your books.
Cash Basis – Amounts are recorded the minute you get paid or make a payment.
Accrual Basis – This is like a credit system. Amounts are recorded the minute you receive a bill or issue an invoice to a client even if you haven’t received the the money yet.
Matching Principle: Recognizing Revenue and Expenses
If your business uses the accrual accounting method, you will want to understand at least the basics of the matching principle. It states that a business needs to match all revenues and expenses that occurred within the same time period and are related to each other. This means that you need to match an expense, for example, to the time period where it happened instead of when you actually paid the invoice for it.
Going Concern Assumption: Long-Term Business Viability
Going concern is an accounting term that refers to businesses that are evaluated to continue being operational within the next year and beyond. You can engage an auditor to do this. The auditor will determine whether any substantial doubt exists that your business will keep running.
A business is typically considered a going concern if it can
- Pay its debts and other obligations like loans
- Generate revenue
- Maintain good credit
- Manage its assets wisely in order to remain upward trending
Materiality Principle: Significance of Financial Information
Materiality in accounting is another way of talking about the relative size of an amount. The general idea is to regard a relatively large amount as material. A relatively small amount, then, is immaterial, or insignificant. Take note that you need the professional opinion of a certified accountant or auditor here. They will know how to judge whether an amount you are looking at is material or not. This is because the same amount can be material for a small company with a relatively low net income, but not matter much for a large corporation.
The materiality principle involves a business actually violating a certain other accounting principle. This comes into play if the amount that you’re looking at is so small that no one can be misled by the financial statements. In other words, this principle states that your accountant must follow the generally accepted accounting practices in your city or state. However, they can disregard these practices when an entry would not make any difference. This is to allow for skipping a certain procedure that would otherwise be very costly or too difficult.
Consistency Principle: Maintaining Uniformity in Reporting
This principle states that the same accounting practices and methods used in the creation and evaluation of financial statements remain the same between periods. This allows for more consistent financial reporting and comparative analysis. You are allowed to change to a more preferred or more effective method given that you state the change and benefit of the change clearly.
Conservatism Principle: Prudence in Financial Reporting
The Conservatism Principle in accounting is otherwise known as accounting constraint. This principle exists to guide an accountant when they are not sure which decision to make when they have two or more possibilities.
The principle directs them to choose the alternative that is objective when considering:
- lower profits
- lesser asset amount
- greater liability amount
This isn’t about choosing the least profitable option. An accountant should record a transaction in a way that seems fair.
What Are Double-Entry Accounting Systems?
Next up on our beginner accounting basics cheat sheet, let’s talk a little bit about double-entry accounting.
Debits and Credits: Understanding the Accounting Equation
In double-entry accounting, transactions are recorded in terms of debits and credits.
Debits – An accountant records a debit as an increase in an asset and expense account. It represents money coming into an account.
Credits – An accountant records a credit as an increase in a liability, revenue, or equity accounts. It represents money going out of an account.
Financial transactions affect at least two accounts. Recording a debit in one account means recording it as a credit in a different, applicable account. For example, crediting an asset account and recording it as a debit in an expense account when making a business expense.
T-Accounts: Visualizing Transactions and Account Balances
An accountant or bookkeeper typically records debits and credits in what is known as a T-account. T-accounts are also known as ledger accounts named after the visual representation of how bookkeeping entries are recorded. At the top of the “T” is the name of the account. Debits are typically recorded on the left and credits on the right.
General Ledger: Recording and Summarizing Transactions
On this accounting basics cheat sheet, the general ledger is probably one of the most important things to remember. This is THE book when talking about bookkeeping. You would record here all your transaction records and descriptions, also known as journal entries. This contains all your accounts and sub-accounts.
You would also record your debits and credits here. Total debits and credits must always equal the same. This is where we get the term “balancing your books”.
What Are the Types of Accounts?
There are five main types of accounts.
Asset Accounts: Tracking Resources and Investments
These are resources that add value to your company. Assets can be tangible or intangible. Cash is the most common asset but this can include other things such as property, equipment, intellectual property, trademarks, and others. Asset accounts include your bank account and your Accounts Receivable.
Liability Accounts: Recording Debts and Obligations
Liabilities refer to amounts or obligations you owe to another entity. This can be in the form of loans or invoices. Liability accounts include tax accounts and Accounts Payable.
Equity Accounts: Capturing Ownership and Retained Earnings
Equity refers to the amount of capital invested by an owner or owned by a shareholder. In bookkeeping, this also refers to the amount the remains after subtracting liabilities from assets. These accounts typically increase with investments like when someone purchases stock in the company. Two types of equity include common and preferred stock. Equity accounts include Retained Earnings and Common Stock.
Revenue Accounts: Documenting Income and Sales
Revenue refers to your income or earnings in a given period. Any money brought in is recorded in the revenue account. Your revenue account is credited when your bank account is debited. Revenue accounts include Sales accounts from websites or in-store sales.
Expense Accounts: Noting Costs and Expenditures
Expenses refer to any purchases made or costs incurred for business operations. This can be spending on equipment, property, or expenses involved in the manufacturing of a product. Expense accounts include COGS (Cost of Goods Sold), Repairs and maintenance, Payroll, and Utilities.
What Are the Basic Accounting Ratios and Metrics?
This last section of our accounting basic cheat sheet will cover a few accounting ratios and metrics to track.
Profitability Ratios: Assessing Profit Margin and Return on Investment
An accountant or bookkeeper would use profitability ratios to assess the ability of your business to generate earnings. This ratio would be assessed as relative to the revenue, operating costs, and balance sheet assets of the business. It should also account for shareholders’ equity over time, considering data from a determined point in time.
This class of financial metrics is one of the most popular in financial analysis. Profitability ratios can show you your business’s health and financial performance. They are amazing comparison tools, but you should not rely on them in isolation. Look at them side by side with efficiency ratios, for example, which show you how well your business generates income by way of its assets and not after-cost profits.
Liquidity Ratios: Analyzing Cash and Working Capital
In general, liquidity refers to how easy it would be for you to convert an asset into cash. Liquidity ratio refers to a company’s ability to pay short-term or current debts and other obligations out of its liquid assets. These liquidity ratios include current ratio, quick ratio, and days sales outstanding.
Solvency Ratios: Evaluating Long-Term Debt and Financial Stability
Solvency ratios, on the other hand, refer to a company’s ability to pay off long-term debts and other obligations. Investors typically look at this ratio when determining which companies are less risky to fund. These solvency ratios include the equity ratio, the debt-to-equity ratio,the debt-to-assets ratio, and the interest coverage ratio. A good solvency ratio holds more value in the long-term.
What Is EcomBalance?
EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
- Monthly Finance Meeting Agenda
- 9 Steps to Master Your Ecommerce Bookkeeping Checklist
- The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
- What Is a Profit and Loss Statement?
- How to Read & Interpret a Cash Flow Statement
- How to Read a Balance Sheet & Truly Understand It
Conclusion on Accounting Basics Cheat Sheet
Armed with this accounting basic cheat sheet, you now have a steppingstone toward greater financial literacy. Check out more of our articles on the EcomBalance blog if you want to learn more about bookkeeping, accounting, and related topics.