Whether you are starting out a new business or you already have one that is established, knowing basic accounting principles comes in handy to check your finances and monitor your business growth. Even if you employ a professional accountant to check your accounts, it would be safer if you have this knowledge to ensure that you have control of your business and no one plays around with numbers to try and steal from you.
You can begin by understanding what an invoice is all about. Check out this invoice template. Here are five basic accounting principles you should know.
Cash flow is vital for the operation of any business. Cash comes into the business when customers actually make payments, not when they make purchases. Too little cash flow can hamper the growth of the business as the company may lack money to buy inventory required to keep the business running. You need to have a plan that balances when your customers make payments and when you pay your vendors. You will have a good cash flow if you can have customers paying way before the vendors require you to settle your bills.
2. Fixed Expenses and Variables
Fixed expenses are weekly, monthly or yearly bills that remains relatively the same throughout the business period. These expenses can be rent, some utilities, and fixed wages or salaries. It is always good to check on these expenses to see if you can cut down on them and only pay for expenses that are required to run the business. These can include payments on transportation, the cost of inventory, commission for salespeople, employee wages, among others. By minimizing costs, you can maximize profits.
3. Expenses and Revenues
All businesses have expenses and revenues. When you buy goods to sell later, those are expenses. When you make sales, then you get your revenue. To realize a profit, your revenue should always exceed your expenses. Always ensure that you record any expenditure incurred in the course of producing a good or giving a service, then check the total revenue. The difference is your profit and shows you whether your business is growing. The trick is to reduce spending on expenses as much as you can to increase your profit margin.
4. Double-Entry
This is the most basic and most important accounting principle. All financial statements in accounting have this principle as their underlying guideline. The underlying principle is that for each transaction, there must be an equal opposite effect in another one or two different accounts. In a balance sheet, this principle underlines that assets are always equal to equity and liabilities. In ledger accounts, the sum of all debit transactions is always equal to that of the credit transactions. It is a very vital principle in identifying any errors or omissions that may arise in your business.
5. Net and Gross Profit Margins
Net profit is the profit realized after all expenses including operating expenses have been subtracted from the net sales. Gross margin profit is what is realized after subtracting the cost of goods, but before subtracting the cost of operations.
