A Guide to Accounting Basics for Small Business

Small business owners need to know accounting basics to make sound financial decisions for their businesses. The accounting process starts by posting financial transactions and generating reports that help business owners understand the financial health of their companies and plan for the future.

While it is possible to rely on others to do the accounting work for you, it is essential to understand the concepts to ask the right questions and get the information you need. This guide will explore the key accounting knowledge that all small business owners should know.

Why are the basics of accounting so essential?

There are a few key reasons why accounting basics are essential for small business owners. First, tracking your income and expenses is the only way to know whether you’re making a profit. Second, sound accounting practices can help you save money on taxes. Finally, understanding your financial position can help you make better business decisions.

Basic Financial Accounting Equation

The financial accounting equation is a fundamental accounting principle that states that the total assets of a company must equal the total liabilities plus the shareholders’ equity. This equation is used to track changes in a company’s financial position.

You can break the accounting equation into three parts: assets, liabilities, and equity. We will look at each section in more detail.

The accounting equation is always balanced, meaning the total assets must equal the total liabilities plus the shareholders’ equity. It ensures that a company is accounting correctly and that assets are not counted more than once.

Assets

Assets are anything that a company owns and can use to generate revenue.

Assets are divided between current and long-term assets on the balance sheet. Current assets are those that can be turned into cash within one year, while long-term assets are those that cannot convert to cash within one year.

Current assets

Current assets are those that can turn into cash within one year. They are divided into four categories: cash, accounts receivable, inventory, and prepaid expenses.

Cash is the most liquid asset and can easily convert into cash. Accounts receivable are amounts owed to the company by its customers. Inventory is any goods that a company has on hand that it plans to sell in the future. Prepaid expenses are expenses paid in advance, such as insurance premiums or rent.

Long Term Assets

Long-term assets include property, plant and equipment, which cannot easily convert back into cash if a company needs the money urgently. Examples of long-term assets would consist of buildings and machinery, or even intangible items such as patents or trademarks.

Liabilities

Liabilities are amounts that a company owes to others. They are divided into two categories: current liabilities and long-term liabilities.

Current Liabilities

Current liabilities are those that need to be paid within one year.

Common examples of current liabilities include accounts payable, short-term loans, and wages payable.

Long Term Liabilities

Long-term liabilities are amounts a company owes to others that cannot easily convert back into cash if a company needs the money urgently. Examples include buildings or machinery; intangible items such as patents or trademarks can also be considered long-term liabilities if they cannot liquidate quickly for cash.

Equity

Equity is the third part of the accounting equation, and it represents the portion of the company’s assets that its owners or shareholders own.

Equity includes owners’ investments, shareholders’ investments and retained earnings (income from running the company).

Double Entry Bookkeeping

One of the basic accounting procedures is double entry bookkeeping and looking at debits and credits. The easiest way to complete it is by using accounting software.

Double entry creates at least two accounting entries for each transaction. The debits and the credits are always equal. These entries are posted to the general ledger.

Once all the transactions are posted, the financial statements are produced.

Single Entry Bookkeeping

Single-entry bookkeeping is, in its simplest form, of recording business transactions and makes it easier to produce accounting records. The transaction is posted to either an income account or an expenditure account.

Only the self-employed can use it in the UK, but it is easier to understand and run.

We have a free Excel cash book download to complete single-entry bookkeeping.

Contra in Accounting

Contra is an account in accounting that is used to offset another account. This can be done to reduce the gross amount on a balance sheet. For example, a contra-accumulated depreciation account can be used to offset a fixed asset. It will help keep track of the net amount of the fixed asset.

Bookkeeping Basics

Completing everyday transactions is part of the bookkeeping basics. Bookkeeping basics covers all the record-keeping of credit control, sales invoicing, reconciling bank accounts, writing cheques, posting receipts, producing profit and loss accounts, and maintaining the balance sheet.

Every small business must complete its bookkeeping basics to produce accurate accounting reports regularly.

Types of accounting records

There are two types of accounts that make up accounting basics – financial statements and management accounts.

Company Financial Accounts basics

Every limited liability company must produce a set of accounts at the end of its financial year. These consist of a profit and loss account, balance sheet, cash flow statement, trial balance, and cash-flow forecast called the financial statements.

Every company in the UK has to submit these accounts to Companies House, as specified in the Companies Act. These accounts become publicly accessible records and can be accessed by anyone for a small fee.

These Financial Accounts will need to be completed by Accountants with a report from the Directors and the Accountant. Small companies can produce abbreviated accounts. Check with your accountant about the reports you must submit for your small business.

Your financial reports will enable investors to look at your company’s performance. The bank may also require a copy to help secure overdrafts or small business loans.

Here is a brief overview of the basic accounting reports:

Balance Sheet

The company’s balance sheet is one of the most critical accounting reports. It shows a company’s financial position at a specific point in time. It is divided into three sections – assets, liabilities and equity.

The balance sheet provides a snapshot of a company’s financial position and can be used to track trends over time. It is also used to calculate ratios, which can be used to measure a company’s performance.

Profit and Loss (Income Statement)

The profit and loss statement, also known as the income statement, shows a company’s income and expenses over a specific period. It could be over a month, quarter or year.

The profit and loss statement is used to track a company’s profitability. It can be used to compare different periods to see if the company is making a profit or loss.

It is also used to calculate ratios, which are used to measure a company’s performance.

The income statement shows the revenue, cost of sales, expense account, gross profit and net profit for an accounting period.

Cash Flow Forecast Statement

The above cash flows template is available for free download.

The cash flow statement is a report that shows how much cash a company expects to have for an accounting period of a month, quarter or year.

The cash flow statement tracks a company’s liquidity – how easily it can access cash to meet its obligations. It can be used to compare different periods to see if the company has enough cash to meet its needs.

Trial Balance

There is also a trial balance that accountants and bookkeepers use to check business records. The trial balance lists all the general ledger codes and the debits and credits in one report. It makes it easier to reconcile financial year-end accounts. It shows the balance of all the income and expense accounts, assets, liabilities and equity all in one report.

The basics of self-employed financial accounts

If you are self-employed, you will still need to produce accounting records once per year, although these need not be as comprehensive as company accounts. You will use this information to complete your self-assessment tax return.

If you are self-employed, setting your financial year-end to the 6th of April is worthwhile, in line with the nominal tax year. It makes it much easier to complete your tax return and save money using an external accountant or bookkeeper to maintain your accounts.

Management Accounts basics

Do you know from your financial reports how much money your small business will have in the bank in six months? You should have a rough idea. If not, how can you budget for staff, premises and other outgoings?

The tools that give you this information are management accounts.

Management accounts are reports which help you make decisions in running your business. Cash-flow statements and forecasts, stock reports, fixed asset registers, and purchasing processes – are all tools that help you keep your finger on the pulse of your business.

Every business is different and requires different reports, depending on the size and type of company. Some companies produce these accounts monthly; others present some reports weekly – or even daily.

Accounting Software and Free Accounting Software

While using a software package to handle your accounting basics is not required, modern software packages streamline the whole accounting system. It will generate financial reports at a touch of a button for the reporting period required and significantly reduce the amount of time spent on bookkeeping.

Accounting software helps you keep track of accounts receivable, accounts payable, time tracking, expenses and inventory. They help speed up posting business financial transactions by using bank feeds, bank rules and automatically posting scanned transactions.

Many packages are available to help your small business, from free software you can download from the internet to major financial systems costing millions of pounds.

Look at our accounting software review section for information on the most popular accounting packages available, including free software downloads.

The most popular accounting software packages include FreshBooks, Xero and QuickBooks.

When setting up your accounts software, it is essential to ensure that you have a chart of accounts that work for your business. It sets up all the Nominal codes and is the basis of the financial statements.

8 Steps of the Accounting Cycle

The 8 steps of the accounting cycle are the process that companies use, from processing transactions to producing a trial balance, making adjustments, preparing the financial statements and closing the year-end.

We look at each step in detail and explain the accounting cycle.

Accounting Ratios

Various people use accounting financial ratios to see how well a business performs. Business owners will use profitability ratios, while lenders and investors will use ratios to see if they can pay their debts.

In the section on accounting ratios, we look at a few examples. We provide several accounting calculators, including simplified expenses, gross profit, net profit cost of goods sold and Flat rate Vat.

The figures for accounting ratios are taken from the balance sheet or income statement (profit and loss).

Basic Accounting Terms

To understand accounting better, it’s essential to know these basic accounting terms such as accounts payable, assets, liabilities, debits, credits, cash flows, net income and income statement.

We have produced a comprehensive list of accounting terms with a brief explanation and a link for further details.

Accounting Basics Courses

If you want to learn more about the basics of accounting, it may be worth looking into an accounting course; these can either be completed at home in your spare time or a part-time college course. You can learn anything from the basics to becoming a fully qualified accountant.

All the accounting bodies run courses, which generally start in September. The Open University also runs a Certificate in Accounting, a one-year course.

If you are looking into a course because you work in accounting and want to learn more, it may be worth asking your employer to fund the course.

Accounting Regulating Bodies

If you are looking for an accountant to complete your accounting basics regularly or year-end figures, it is worth checking the accountant qualifications you use. All accountants should belong to one of the main regulatory bodies.

The are a few places worth checking to find a good accountant. If you use accounting software, there is usually a list of providers. Asking other small business owners for recommendations or checking on the internet and looking at reviews.

Accounting Period

An accounting period is a specific time frame used when preparing financial statements. The most common accounting periods are monthly, quarterly and annual.

The accounting period will be stated in the company’s accounting system and used to calculate all the financial ratios and figures. All the business transactions will be posted to the accounting system before generating reports.

Generally Accepted Accounting Principles

Generally accepted accounting principles (GAAP) are accounting rules companies must follow when preparing their financial statements.

The main aim of GAAP is to ensure that all companies present their financial information in a comparable way. An accountant can guide you with accounting principles and reporting financial information required to Companies House.

Accounting Basics – History

We have produced a short introduction to accounting history, explaining how it started and who first invented the double-entry system.

Basic Accounting Summary

Accounting is the process of recording, classifying, and summarising business transactions to provide helpful information in making business decisions. Accounting aims to ensure that financial information is accurate and reliable.

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