7 Important Accounting Lessons Everyone Must Learn
The true measure of a great class is not the grade you earned in it, but how much you remember years after you have taken it. Accounting is such a class. I have taken the lessons I learned in that and other finance classes, and have applied them to my daily life. It seems like I use them even more as I get older.
To prove that these are lessons I have actually learned, I shall attempt to recount from memory the important lessons I have learned from my accounting and finance studies. I believe everyone must learn them and use them to keep their finances in control.
I was taught the double entry method of accounting. For every debit I entered, I had to enter a credit. In my first accounting homework, I found that I had a very minor difference, less than a dollar. I was frustrated at having to correct it. It turned out that in correcting that minor error, I found several big errors that had been hidden.
You probably aren't going to be using a double entry method in your personal life. I don't. The biggest lesson from that was that your debits must equal your credits. Your expenses must equal your income. There may be times you can get away with the numbers not balancing, but eventually it will catch up to you. You have to find a way to reduce your expenses so you are not spending more than you are earning.
In business class, we learned that you cannot spend everything you are earning. If you take all the income from your business, it will eventually die.
You must reinvest in the business. Otherwise your business can't grow. On a personal level, this means you should be willing to pay for things that will help you earn additional income, like obtaining additional education, buying some securities, or upgrading your property. By making sure that you spend your money on things that are investments instead of simply things you want, you can ensure that your decisions are best for your financial security.
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One fundamental part of accounting is simply to keep a record your financial activities. When you record your entries, you can keep track of your income and your expenses. You know where your money is coming from, and more importantly, where it is going. It is easier to see which items have significant impact on your finances, and which ones are minor blips.
Keeping track of your finances can help you see how things have changed over time. You can see if things are going as you expected. Sometimes a small change might seem insignificant, but may really be impacting your bottom line.
In addition, these records can help when it is time to fill out your tax forms, and financial aid forms for college.
You can record these manually in a notebook or a ledger, but you may want to use some personal finance software. This software helps you balance your checkbook, keep track of your income, investments and expenses, provides reports at tax time, and creates charts to help you see where your money is going. Most of the newer programs will let you download directly from your bank or credit card statement, so you will not need to manually enter the information yourself.
Cost Benefit Analysis
Oftentimes when we come up with a situation that requires a decision, we do not take the time to do a cost-benefit analysis to determine whether it is feasible or worthwhile. Should we lease or buy a car? Can I afford to stay home to take care of the kids? Should we buy or rent a home?
Many times we take the advice of the sales person or someone else who has been through the situation. Unfortunately, these people have not done the cost-benefit analysis for your particular situation. It is even possible that they may not have done a cost-benefit analysis for their own situation. By taking their advice, you wind up following their path when another option might have been better for you.
By taking the time to do your own cost-benefit analysis, you can compare the expected benefits with the expected costs that are customized to your own particular situation. By taking the time to do this, you may think of costs or benefits that you had not considered, or may find out that the total numbers are different than what you expected. Most importantly, you will be able to make a reasoned decision that is based on facts that apply to your family situation, and based on your own priorities.
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Another important financial lesson we can learn from Accounting is to prepare forecasts and budgets. By budgeting, you can plan for our future changing needs, and make sure that you are on the right track towards our goals. Budgeting can also help you keep financial emergencies to a minimum. When you plan ahead for the car or appliance that will eventually break down, or the tax bill that only comes once or twice a year, you can be prepared and make sure you have money available for that contingency.
Preparing a budget may seem like a lot of work, especially since you don't know what the future will hold. Keep in mind that there are a lot of things you do know about the future, if you take the time to think them through. It is time well spent however, for the benefits and peace of mind it provides.
How to Amortize a Loan
I don't know if I learned how to amortize a loan in Accounting Class, but it is an important lesson for everyone to learn. In the United States, they have laws now that banks are required to tell you your annual percentage rate (APR), and the amount of interest you are paying, but if you prepare your own amortization schedule, you can learn all that and more for yourself. An amortization spreadsheet will tell you how much interest you are paying each month and for the life of the loan.
More importantly, you will be able to make sure that there isn't a bank error in your schedule. How many times do you simply pay what the bank tells you to pay without doing the math to check that it is the right amount? I know I did that often. How do you know if you are being overcharged if you don't check? The person entering the data may make an error, or the computer may be programmed incorrectly. You may also be surprised to learn that some calculations are done by individuals, maybe with the help of spreadsheets that they create themselves specifically for your loan instead of big computer programs.
Another benefit to creating your own amortization schedules is to see how much impact an extra principal payment makes on the whole loan. When you see that a small payment now makes such a big impact on the loan, you may be more willing to use your money to pay down the loan instead of spending it on something frivolous.
How to Read Financial Statements
Learning to read financial statements may seem like a waste of time, especially if you don't encounter them very often. However, I think that you should take the time to learn and read them often. Read the statements of the company you work for, so you can keep informed of how the company is doing. They may be saying one thing, but the numbers may tell you a different story.
When you buy investments, you will want to read the financial statements of the companies before you invest in them, and keep reading future ones to make sure they are headed in the right direction.
Which of these is the most important accounting lesson to learn?
Important Accounting Lessons
Everyone must learn these important accounting lessons and use them in their daily lives.
- Cost-Benefit Analysis
- How to Amortize a Loan
- Reading Financial Statements
These accounting lessons will help you understand and optimize your financial transactions, and make sure you are using your money wisely. They also help you achieve more success in your life and fund your dreams, as you optimize the way you use your money.