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Accounting Part 1: Financial Statements
Accounting in the business world is one of those things that requires much study for the light-bulb to go off in your head. Accounting for business transactions requires mastery of the dreaded debits and credits also known as double-sided entry. It seems that most people only follow one side or the other to any entry that defines a transaction. I hope to shed some light on this and other accounting basics. My hubs will be short and to the point so that concepts can be easily reviewed and absorbed without me droning on for hours. And the good news is there won't be any tests!
In support of my comments I would like to say that I am a CPA having passed all four parts of the CPA exam at the same time back in 1994 in my first attempt and I've been in the business world for quite a long time having worked as a Controller, a Budget Manager and as a Financial Planning Manager for several public companies.
To begin with I believe an overview of the financial statements is in order. Please note I won't be discussing notes to the financial statements, statement of cash flows or changes in retained earnings until a later date. The following are the two main sets of financial statements that should be utilized and understood by anyone in the business world regardless of their job title:
The balance sheet is a statement of your financial position at any given point in time. In other words, it states your assets (cash, receivables, inventory), your liabilities (amounts you owe to your creditors) and your net worth (assets minus liabilities).
Also please note the following:
Assets = Liabilities plus Owner's Equity
This will be discussed later.
The balance sheet is stated as of the last day of any given month. The heading typically reads as follows:
As of December 31, 2010
The balance sheet format lists assets first, then liabilities and then your net worth (owner's equity section). In the asset section your assets are stated in order of liquidity (how quickly it can be converted to cash) with cash being the most liquid.
Liabilities are typically stated in order of due date (those owed in less than a year then those owed in a period longer than one year from the balance sheet date).
Both sections are further sub-divided between current and long-term assets and liabilities. The term current typically is defined as any asset that can be converted to cash within a year or is to be used to pay a liability in a year or less and a current liability being any liability that is due to be paid in one year or less.
The owner's equity (net worth section) should be the difference between your assets and your liabilities. And if you owe more than you have then you will have what is called negative net worth.
The income statement measures your revenues (sales) and your expenses (payroll, office supplies, postage etc.) for a given period of time. This could be for one month, a quarter (in the business world it is typically Jan - Mar, Apr - June, July - Sept, Oct - Dec) or for an entire year. The typical heading for an income statement is as follows:
For The Year Ending December 31, 2010
As you can see from the heading the user of the financial statement is being told that the revenues and expenses stated in the income statement are for the entire year of 2010. If you wanted it to be for shorter time frame then the heading would read: For The Month Ending Dec 31, 2010 or For The Quarter Ending Dec 31, 2010 (measures Oct - Dec).
The income statement typically is stated in the following order:
Whether you are starting your own business or are a non-financial employee (marketing, engineer, HR etc) it is important to understand the terms of the business world. You should be able to explain to anyone the basic definitions and common usage for the financial statements that I offered above without difficulty. This may seem elementary but it is a way to build towards more complicated topics in accounting. And it will help make you a well-rounded employee who will project a versatile and sophisticated image in the work place.
And now on to part 2 - Cash Basis versus Accrual Basis accounting...