In this article, I am going to quickly take you through the basics of accounting, and in a way help you learn basic accounting in less than five minutes of reading.
Obviously, this article is basic small business accounting, and there are many advanced things that I will not be covering and there are accounting principles that may contradict what I’m about to teach you. Accounting is basically debits and credits, that’s all accounting is.
It’s creating debits or credits or recording the financial transactions of a business using debits and credits. These debits and credits are always equal, so if you have one thousand dollars worth of debit entries, then you will also need to have one thousand dollars worth of credit entries.
So, debit entries consist of assets and expenses. Credit entries consists of liabilities and sales. Assets are things you own, such as equipment, property, stock, that is things that you own. Liabilities are things that you owe, things like loans, money you owe to people.
So, if bank accounts are in a negative balance, then it’s a liability. The cash and the bank account is something that you own. A bank account is an asset, equipment is an asset, debtors money that people owe to you, vehicles that you own – not vehicles that you have a lease contract with – they are vehicles that you own.
Liability examples however bank accounts, are in a negative balance like in an overdraft, that is cash that you owe to the bank. A loan is something that you owe, creditors that’s cash to suppliers that is something that you owe. These are liability examples.
Expense examples are power, rates, wages, rent, fuel. Say you have a payment for rent which is five hundred dollars. What’s the debit and what’s the credit? Well expenses are debit entries think of the debit think the credit debits are assets and expenses. Credits are sales and liabilities expenses are debit entries. So the $500 for the expense of rent will be a debit entry.
It then needs a corresponding credit of the same amount, so $500 if the cash is coming out of the bank account to pay for this rent. We would credit the bank account, so debit, expense, credit the bank account.
Another way to look at this, is that the bank account is an asset account. To bring the value of an asset account down, you need to credit it. Think about it an asset account is debit you debit an asset account to increase its value credit will bring the value down to making cash come out of the bank account or recording cash out to the bank account.
So a sale of a product. If you’re selling something, what are sales? Well, they are credits. We sold something for $200. sales are credits credit sales $200 you would quit it sales account $200 if the money goes into the bank account you need the corresponding debit so debit bank account $200 if they paid in cash you would debit cash account $200 you are increasing the value of the asset which is a debit and sales are credits quit it debit $200 balances.
Another example is a bank loan of $10,000 or liabilities they are things that you owe. So, you owe the bank $10,000 credit. The $10,000 is money that we owe, and it’s a liability, or it’s a credit. So, we receive a bank loan and we record ten thousand as a credit. Then we debit $10,000 into the bank account, if the money is going to the bank account which it likely is, we are therefore increasing the value of the asset which is a debit, by $10,000.
We have all of these accounts, and all these accounts will build up running balances as we post these transactions. The list of these accounts and their balances is called the chart of accounts. We use this information or the accounts and the totals and the accounts to create a profit and loss statement and a balance sheet.
A P&L statement tells you how much profit a small business has made or how much of a loss a business has made. We get the totals from their sales accounts, then we get the totals from the expense accounts, and we deduct the expense totals from the sales totals that gives us a profit or loss. Hopefully a profit and a big nice one!
A balance sheet, is the totals of the assets. We get the totals of the liabilities and we put them on a sheet. it gives us a figure that figure tells us the financial position of the business or it’s used to analyse the strength of the small business.