Why do you need Accounting?

How do you know how your business is doing? I mean do you really know how your business is doing? Is there enough cash in your account? Will it be enough to get you through the next year, month, or week? Are you able to turn credit sales into cash? Is the debt you have for the business working as hard as it needs to in order to grow your business? What do we owe for taxes? These are the questions that can be answered by understanding what accounting is and how it works.

Balancing Act—Examining the Balance Sheet

The Balance Sheet is basically what you own or are owed (assets) minus what you owe (liabilities) with the leftover being your net worth of the business (owner’s equity). The bread and butter of how your company is structured is found on your balance sheet. For analysis, you can compare your balance sheet now to last year’s your balance sheet and see what’s changed. Has cash on hand gone up or down?  Have liabilities gone up? All these questions are the beginning of financial analysis, or the art/science of seeing how a business is performing. If you’re a small business owner, you really, really want to pay attention to your balance sheet. Any wide fluctuations from a previous period should make you question what’s going on. Also, there are two lines in the owner’s equity section, one is Retained Earnings and the other is Current Earnings. The Current Earnings are what you've made or lost this year and should match your year-to-date total on the Income Statement, and the Retained Earnings are your net income or loss from prior years. Pretty cool, right? It all interacts in a big circle.

Easy (In)come, easy go—How much did we make on our Income Statement?

The Income Statement is a much easier statement to grasp than the Balance Sheet. For one, it makes perfect sense. We had $10 million in sales; the inventory we sold cost us $2 million; there were $5 million of expenses, so we had a net income of $3 million. Pretty intuitive, right? It is, and one great way to use your Income Statement is to see how well your business is performing against a budget you (hopefully) wrote before the beginning of the fiscal year. If you don’t have a budget, make one J Life will improve drastically for you, because you will be able to see line by line how much you think you would make and spend based on your income and expense history, versus what’s going on now. If there’s a wide variance (good or bad), it’s time to start digging.

Hmm, my checkbook is thinner—The Statement of Cash Flows

Probably the hardest statement to understand is the Statement of Cash Flows. It doesn't help that there are a couple of different ways of putting the darn thing together, either. So, in short, the Statement of Cash Flows takes your accrual-basis books and makes it like it was on cash-basis. If your books are cash-basis (most small businesses are), then your income statement is like a statement of cash flows. But, for you accrual folks out there (that is, most of the world), there are three basic transaction categories that all transactions fall into, Operations, Financing, and Investing. Operations is what your business normally does. If you sell boxes, then the cash generated from the selling of boxes is an Operating activity. Say you need to sell stock in your business to take it to the next level. The cash generated from selling stock and paying your stockholders dividends is a Financing activity since you’re—you guessed it—financing your business. Also paying interest on debt falls into the Financing activities. The last category on the Statement of Cash Flows is the Investing activity section. This is where you put cash laid out for things like investments in equipment and building for your business. Also you would put cash generated by investments that you've parked your business capital in like stocks or bonds. The awesome thing about that Statement of Cash Flows is that at the very bottom you have cash at the beginning of the period, and cash at the end of the period, with the difference being all the pluses and minuses of each line in the Statement. Pretty cool, right?