Understanding Accounting Concepts
Accounting is basically information, and this information is published periodically in business as a profit and loss statement, or an income statement.
A necessary part of any business is knowing where all your money is being spent. Accounting principles are designed to accommodate this need in an organized fashion. To the untrained eye, it may look like pandemonium, but it really is simple.
The principles of accounting are as follows: Accounts are divided into three types, namely assets, liabilities and equity. Each account type has it’s own properties.
The accounts can be represented as simple “T” accounts with a left and right side separated by a vertical centerline. All you need to do is make a large T. Each side of the “T” will record increases or decreases in that account balance in the form of debits or credits. Debits are always on the left side while credits are on the right.
TIP: Since the words “right” and “credit” have R’s in them, that’s how you can remember this.
Asset accounts use debits as increases and credits as decreases. Liability and equity accounts are the exact opposite.
For every debit, there must be a corresponding credit. This is so that there is a balance that can be tracked. All this sounds a bit confusing, but it really is simple and it is an absolute necessity for any person doing business anywhere. Take the following example:
Suppose you get a loan of $5000 to open your business. That cash is an asset of your company. So you would enter a $5000 debit to the asset account and a corresponding credit to an equity account. If you apply the accounting equation (assets=liability+equity), you will see how that works. Namely, your assets (now $5000) equal your liabilities ($0) plus your equity ($5000). See how the two sides balance out? This is the basis of accounting.
As you can probably see, the use of accounting will tell you exactly how much money you have, how much you owe and how much your business is worth at any given time. It is important to know these things for many reasons. Primarily for tax purposes and taking care of monetary responsibilities in a timely fashion.
Accounting used to be done by hand using “T” accounts, debits and credits or ledger books. While these methods worked and were functional, the advances of the Internet and computers have greatly streamlined the accounting process. Complex software is available that allows you to make your entries and track your accounts in minutes. Accounting software is simple to use and while no previous experience is necessary, it does help to have some background knowledge in accounting.
These pieces of software will allow you to print documents detailing specific transactions, financial reports, print checks and some even feature the ability to send payments to creditors via E-check online. The real advantage of using this software is the minimum amount of paper files you need to have. Everything is located on storage devices like CDs, floppy discs (old) or a separate hard drive designed to hold this information.
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