There are a few basic things you need to understand to make setting up your accounting system as easy as pie (trust me, it’s not as hard as you think). Accounting is based on 5 basic account types: assets, liabilities, equity, income and expenses. If these accounts are the skeleton for your accounting system debits and credits are the backbone if you can understand how debits and credits work and you’ll understand the whole system:
Ok? Ok! Now let’s have a quick look at the Accounting Equation which is based on the 5 account types:
Assets – Liabilities = Equity + (Income – Expenses)
Resources owned by a business which have future economic value that can be measured and can be expressed in monetary value such as cash, investments, inventory, buildings, equipment, and so forth.
A business’s legal debts or obligations, arising out of past or current transactions, owed to lenders and suppliers, i.e. accounts payable or debt.
Can be viewed as a business’s “net worth.” It represents what is left over after you subtract your liabilities from your assets, so in short it is the assets you own without any debt.
Assets, liabilities and equity are known as the Balance-Sheet Accounts, and they simply track the value of the things you own and owe. The income and expense accounts allow you to change the value of these accounts, and this is very important:
So, let’s have a more in-depth look at income and expense accounts – keeping track of how much money you receive and how much you spend is ultimately and arguably the most important function of an accounting system:
Refers to the payment you receive for your time, services you provide, or investments. In short income is a company’s remaining revenues after all expenses and taxes have been paid. Most forms of income are also subject to taxation. Tax regulations differ from country to country, but by categorising your income and expenses (i.e. office supplies, entertainment and donations) you can optimize your accounts and in doing so, increase your profit margins.
Refers to the money you spend to purchase goods or services provided by someone else. Typical expense accounts include salaries and wages, telephone bills, electricity and so forth. Businesses generally incur the same expenses on a monthly basis, so once the expense accounts are established it usually won’t vary that much. It is also a good idea to consult your local tax regulations before setting up your expense accounts as their might be certain categories you have to take into consideration.
Each of the above accounts contains sub-accounts (categories) defined by different transactions for example your income account could encompass income derived from services delivered, income derived from products sold, investment income and other income. This is where online accounting software like saasu, waveapps or xero can come in handy allowing you to track and report on each of your accounts to make sure you keep your cashflow in check!