Running a business consists of understanding a lot of principles, laws, and of course, knowledge in that industry. But what most business owners don’t realize is that having knowledge regarding finances is necessary. The honest reality is that most business owners don’t find accounting that desirable. It is easier to hire a professional and never worry about it. Often, having very little to no knowledge regarding the finances of your business can result in experiencing a nightmare during tax season, or even taking a major loss that could have been prevented. Usually, business owners are unable to afford an accountant in the beginning stages of business development. For that matter, it’s wise for business owners to be enlightened with a few accounting principles that every business owner should know:
CASH FLOW
Cash flow is cash that comes in and goes out of the company account. It is very important to have a positive balance of cash flow as it is the oil to keep the operation running and effective. Positive cash flow is when a company’s ending balance is higher than the balance at the beginning of the period. Below are a few tips in keeping the cash flow positive and the business thriving:
- Sell more goods, services, and assets.
- Reduce costs of expenses but increase the selling price.
- Collect money faster than you pay out.
Cash flow is not the same thing as sales revenue or profit. Revenue is the gross earnings received from the company’s services or sales transactions not including other interest on investments or assets. When you add the total revenue plus other income sources and deduct the expenses, you will see your profit earned.
PROFIT AND LOSS STATEMENT
A Profit and Loss statement will show the business owner how the revenue developed into net income which is the net amount of revenue, expenses, gains, and losses. The document will list the expenses like the cost of sales, salaries, and bills deducted from the company’s income. Here are some things to remember about the P&L statement:
- The report is usually prepared on a yearly basis.
- Used to prepare for tax time.
- Used as a proof of income or requested when applying for a loan.
The P&L statement comes in handy when the owner is interested in expanding the business, applying for a loan or making decisions that will grow the company.
CASH vs. ACCRUAL ACCOUNTING
The thin line between cash and accrual is the timing of when revenue and expenses are recorded. The cash method, which is generally used by small business owners and sole proprietors, records the revenue and expenses after the transaction is complete. The accrual basis method is to record revenue and expenses that are expected whether the transaction is complete or not. Many business owners and accountants find that the cash method is better when it comes to tracking cash flow. Both methods are useful; however, it is important to know which method works best for the financial wellness of your company.
Bottom line: Business owners cannot be totally dependent upon the accountant. After all, your company is YOUR baby. You are solely responsible for the development and growth of your business. Small business owners may also consider affordable accounting software that will assist in bookkeeping. If hiring an accountant makes more sense, ask the accountant to teach some basic accounting principles when possible. Poor management can lead to a failed business. It is when we fully understand our financial position, we can make wiser decisions that will give our company security and success.