Importance of Accounting: Basic Financial Concepts to Know

Well, all businesses are concerned about revenues and costs.

Managers at companies small and large must understand how revenues and costs behave or risk losing control of the performance of their firms. Managers use accounting information to make decisions about research and development, budgeting, production planning, pricing, and the products or services to offer customers. Sometimes these decisions involve a trade-off.

Accounting systems are used to record economic events and transactions, such as sales and materials purchases, and process the data into information helpful to managers, sales representatives, production supervisors, and others.

Financial accounting focuses on reporting financial information to external parties such as investors, government agencies, banks, and suppliers based on Generally Accepted Accounting Principles (GAAP). The most important way financial accounting information affects managers’ decisions and actions are through compensation, which is often, in part, based on numbers of financial statements.

Basic Accounting Equation:

The basic accounting equation portrays two particulars of a company: its ownings and its owings. This equation is the base of the double-entry accounting concept. The mentioned equation is as follows:

Assets= Liabilities + Owner’s Equity

This equation shows that you can get assets by adding the liabilities and owner’s equity which is meaningful because companies acquire assets by using funds and liabilities and owner’s equity are the sources of this funding.

Here, liabilities appear before owner’s equity because the company has to pay the creditors before the company becomes bankrupt. For this reason, current assets and liabilities are mentioned before long-term assets and liabilities in financial statements. A business or company always has to make a balance between the both sides of this equation.

Components of the Basic Accounting Equation:

Assets:

The resource controlled or owned by the business for future use or benefit is called an asset. Assets can be tangible such as cash and intangible such as copyrights or goodwill.

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Receivables are another type of common asset which implies a promise that a payment will be paid from a party to which a service has been provided or a product has been sold on credit.

Some common types of assets are mentioned below:

Current Assets

  • Cash
  • Accounts Receivables
  • Prepaid Expenses

Fixed Assets

  • Machine and vehicles
  • Land and buildings

Theoretical or Intangible Assets

  • Goodwill
  • Patents
  • Copyrights

Liabilities:

Liabilities refer to the amount of money owed to another institution or company or person. Payable is the most common form of liability which is the exact opposite of receivable. It is a promise to pay the other party from which a service is received or an asset is obtained on credit.

Some common types of liabilities are mentioned below:

  • Accounts payables
  • Lines of Credit
  • Bank Loans
  • Officer Loans
  • Personal Loans
  • Unearned Income

Owner’s Equity:

The part of the company’s assets owned by the owners or partners or stockholders refers to owner’s equity. Owners can expand their share by investing money in the company or reduce their equity by quitting funds of the business. Similarly, revenues expand equity and expenses reduce equity.

Equity accounts consist the following common items:

  • Owner’s Capital
  • Owner’s Withdrawing
  • Unearned Income
  • Officer’s Loan
  • Paid-in Capital
  • Common stock
  • Preferred stock

3 Golden rules of accounting:

It’s no secret that the world of accounting is run by credits and debits. Debits and credits make a book’s world go ‘round.

Before we dive into the golden principles of accounting, you need to brush up on all things debit and credit.

Debits and credits are equal but opposite entries in your accounting books. Credits and debits affect the five core types of accounts:

  • Assets: Resources owned by a business which have economic value you can convert into cash (e.g., land, equipment, cash, vehicles)
  • Expenses: Costs that occur during business operations (e.g., wages, supplies)
  • Liabilities: Amounts owed to another person or business (e.g., accounts payable)
  • Equity: Your assets minus your liabilities
  • Income and revenue: Cash earned from sales
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A debit is an entry made on the left side of an account. Debits increase an asset or expense account or decrease equity, liability, or revenue accounts.

A credit is an entry made on the right side of an account. Credits increase equity, liability, and revenue accounts and decrease asset and expense accounts.

You must record credits and debits for each transaction.

The golden rules of accounting also revolve around debits and credits. Take a look at the three main rules of accounting:

  1. Debit the receiver and credit the giver
  2. Debit what comes in and credit what goes out
  3. Debit expenses and losses, credit income and gains
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