Accounting Basics for Small Business Owners By a CPA

Author:

LYFE Accounting

Keywords:

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as warren buffett says accounting is the language of business he and other savvy business owners use accounting to make investment decisions to grow the businesses they choose to invest in but interestingly enough many small businesses often neglect their accounting until tax time or don't do it at all 9 out of 10 small businesses that fail fail due to financial mismanagement of their company their financial mismanagement may result in their failure to make decisions to grow their business meet financial obligations like paying their employees or rent miss tax deductions that can save the money or fail to pay their taxes altogether look i get it as a cpa that studies and practices accounting i know accounting is not the most exciting thing in the world and it's probably not why you decided to go into business for yourself in the first place if you're watching this you probably have a good product or service that you're very passionate about and i'm sure your product will delight customers and beat the competition however eventually you will be faced with the reality of accounting and it's best that you're prepared for it now so you don't suffer the consequences later [Music] hi my name is sherman with life accounting a full service accounting firm that helps small businesses grow and manage their finances in this episode i'm going to simplify the accounting basics for small business owners by the end of this episode you will know the what why and how of accounting also if you're new to our channel then please subscribe so you don't miss out on future videos that can help your business grow and manage your finances also if you extract any value at all from this video then please help me out by hitting the like button below with that said let's begin what is accounting like really what does accounting really mean by definition accounting is the process of recording reporting interpreting and analyzing financial information these words recording reporting interpreting and analyzing are very important and i'm going to break down each component of this definition in just a moment here but first let's discuss why accounting is even important or a thing in the first place to understand why accounting is important it is best to look at a very simple example let's say you own a cleaning company we'll call it the house cleaning company let's say you charge 100 to clean one person's house and that includes vacuuming carpet cleaning window wiping and so on and at that time let's say you just started your business so you decide to do everything yourself in the beginning fast forward two years later and all of a sudden your business is booming your phones are ringing off the hooks your schedule is completely full for the week and you don't have time to do anything from sales customer service or even delivering the cleaning services and so on now you're stressed you don't know what to do logically this is a good problem to have your business is growing and perhaps you just need to hire some people to help you out at this point so you decide to do this and now you need to make some very tough decisions for one who do you hire first how much do you pay that person how can you ensure that there's enough work for that person to do and most importantly how much can you afford to spend to hire that person and how much can you afford to spend to keep expanding your business at the same time now there are a few things that will help you in making decisions like this such as knowing your profit margin knowing how much cash you have available and knowing your current financial obligations which includes debt payments and your expenses if these things are absent then you are unable to make informed decisions to grow and scale your business and if you make the wrong decisions it can be detrimental to your business for example what would happen if you hired someone but they did not have any projects to work on now you're wasting money on that person or what would happen if your customers don't pay you on time and you don't have enough cash to pay your vendors now you can't afford to operate your business or lastly what does it take to expand your business how much can you afford to spend in marketing or service improvements whatever you decide to do there will likely be financial implications in other words it will cost money and if you do not understand how money is currently flowing in and out of your business you risk making ill-advised decisions that can cause your business to fail you also risk tax consequences by missing business deductions that can save you money on your tax bill now you can save yourself from these financial headaches by having a reliable accounting system in place from the very beginning so let's discuss the accounting process that you need to deploy in order to accomplish this earlier we broke down the accounting process into four simple steps recording reporting interpreting and analyzing which are all very important so let's go over these steps the first part of the accounting process is to record all the transactions that occur in your business every time a transaction occurs you must record it now there are five major transaction types that you must know these five transaction types are revenue expenses assets liabilities and one of my favorites equity now it's important that you understand what these five transaction types are because it will determine how your reports are organized and influence how you interpret your business finance here's a very easy to understand breakdown revenue is what you make from selling your products or services it is the value customers pay in exchange for your products or services for example when a customer paid the cleaning company for its cleaning services their payment represents revenue now revenues also commonly referred to as sales expenses on the other hand are cost incurred to run your business in the cleaning example my expenses would be the cost to hire a contractor and the cleaning supplies used when those services are provided now let's move on to assets assets are resources that are owned by the company with a measurable future value for example if i owned an expensive cleaning device such as a carpet cleaner then this will be an asset in my business anything that you own that is used to generate future value is technically considered an asset now liabilities on the other hand are what the company owes to creditors for example if i took out a loan to pay for my expensive cleaning device then i would also have a liability to pay that loan back later in this scenario i would gain an asset the cleaning device and a liability the loan equity is the degree of ownership in your business your equity is the difference between your assets and your liabilities or in other words equity is the difference between what you own and what you owe now the most fundamental part of accounting is recording and categorizing each transaction that comes into your business into one of these categories now there are quick and easy ways to do this by syncing your business bank account to a bookkeeping system and classifying your transactions within that bookkeeping system this whole process is called bookkeeping so to learn more about bookkeeping then check out our video on bookkeeping 101 where we break this all the way down for small businesses now let's move on to the second major component of accounting reporting once your bookkeeping is complete you will be able to prepare financial reports that depict the financial health of your business now there are three major accounting reports that every business should be familiar with number one your income statement number two your balance sheet and number three your cash flow statement let's start off by talking about your income statement your income statement is where you can find your total revenues expenses and most importantly your profit your income statement tells you if your business is growing or slowing and if your business is in the green or not which refers to if your business operations are profitable now you can review your income statement in two formats on a cash basis or on an accrual basis cash basis simply means that you recognize revenue and expenses in your business based on when money is exchanged for example let's say that you paid one hundred dollars to reserve my cleaning service but i don't deliver the cleaning service to you until next month well under cash basis accounting the revenue would be recognized the moment you paid me not when i delivered the service accrual basis on the other hand means that you recognize revenue and expenses based on when the exchange of services is complete or in other words once the service is delivered under accrual based accounting revenue must be earned by exchanging the product or service it completely ignores the cash transaction now to learn more about the differences between this and which one is more appropriate for you please check out our video on accrual versus cash basis accounting now let's discuss your balance sheet your balance sheet shows which assets the company owns the liabilities it owes and the equity that belongs to the owners the balance sheet helps you understand your company's liquidity and its ability to meet its financial obligations for example if my cleaning company has twenty thousand dollars in assets but fifteen thousand dollars of those assets are not liquid maybe it's in equipment for example then that would mean i only have five thousand dollars in liquid assets which we can call cash now this could mean trouble if my expenses begin to exceed the amount of liquid assets or cash that i have in my bank even worse if my cleaning company has a high debt to equity ratio it can indicate that my business is over leveraged and could have issues paying my liabilities if a downturn occurred in my business as you can see your balance sheet can give you a clear indication of the financial health of your business finally let's discuss the cash flow statement now the cash flow statement digs deeper into the cash position of your company it details all the cash outflows and inflows on a consistent basis for example you may have debt payments and expense payments but both of these transaction types show up on different reports your debt standing is reflected on your balance sheet while your expenses are reflected on your income statement the cash flow statement shows the total amount of cash leaving your business regardless of if it's an expense or a liability this statement helps you understand the total outflow of cash each month which enables you to make healthy decisions about future projects that require cash as you can see these reports can give you a good idea of what's really happening in your business knowing this financial information can help you make future decisions to grow your business now let's move on to the third step of the accounting process interpreting and analyzing unfortunately financial reporting means absolutely nothing if you cannot interpret them and there are many ways to slice and dice through your financial reports to derive certain information in many cases you can apply ratios to certain pieces of your financial statements to interpret what's really happening in your business for example on your income statement you can find out your profit margin by simply dividing your net profit by sales you can also find out your return on advertising spend by dividing your advertising expenses by your sales revenue on the balance sheet you can find out how liquid your company is by using the current ratio which divides your current assets by your current liabilities you can also find out how quickly your customers are paying you by using something called the accounts receivable turnover method which divides your sales on your income statement by your accounts receivable on your balance sheet which is the money that people owe you as you can see there are several ways to interpret and analyze your financial statements and to be honest there are hundreds of ways to analyze your financial statements i know this because of all of the years and exams i had to take the learning to get the best interpretation of your financial statements you may need to invest into some financial education courses or consult your cpa now we'd be happy to help you with this process through our bookkeeping tax planning or our cpa and cfo services anyway let's summarize this video so you can walk away with the accounting basics for your business we started this episode by defining accounting remember accounting is simply the process of recording reporting interpreting and analyzing financial information then we discuss why accounting is important accounting is so important because it helps you make decisions to grow your business and it prevents the financial mismanagement that can result in financial stress headache or even the closure of your business finally we broke down each element of accounting recording transactions financial statement reporting and how to interpret and analyze financial information while there are many ways to report and analyze your finances there is only one way to get started you must start recording and categorizing every single transaction that occurs in your business to pull any report or to conduct any analysis you must first have a bookkeeping system in place with that said i truly hope you found this video useful and interesting if you did please go ahead and give this video a thumbs up or comment below with any questions that you have also don't forget to subscribe to our channel so you don't miss out on other accounting content we're putting out to help you grow your business and manage your finances that's it for today folks until next time take care you