If you are to invest in a new business, knowledge of accounts can make life much easier. Even if you are simply looking to manage your personal finances better, knowledge of some basic accountancy is advisable.
Broadly, accounting is split into two categories-
Cash Accounting (Financial Accounting)
Cash accounting is simply the management of an individual’s cash transactions. (Remember that for taxation purposes, a limited company is treated as an individual.) Track is kept of the money withdrawn, deposited into accounts, given to or received from another individual &c. To be effective, there must be a discipline to ensure that all cash (whether in coin or cheques) is properly recorded. It is always advisable to record transactions in an analysis cash book supported by a journal for those small amounts that can be amalgamated.
Management accounting requires all transactions to be recorded even if no money has been exchanged. Management accounting gives a very accurate view of the running costs of a business by calling all expenditure to account. It can also provide an excellent basis for creating ‘standard costs’ to be used in the calculation of estimates for work that is being bid upon. Since all expenditure is recorded, management accounting will produce fairly accurate indications of whether or not a profit is being made and could also indicate areas of expenditure in which savings can be made.
Some accountancy terminology should be understood.
An asset is, as the name implies, anything that will enable the business to continue to exist either by way of facilitating production or providing resources when times are less propitious.
These are the infrastructure of the manufacturing/distribution process. Fixed assets include such things as buildings, plant, machinery and motor vehicles. Fixed assets are usually held at a ‘book value’ which is the cost of the asset less any depreciation that has been charged against it.
Current assets are generally liquid (a form of cash) or easily and quickly liquidated (sold for cash). They will include bank balances, cash balances and stock in hand as well as the money that is owed to the company by customers who have received goods but not yet paid for them.
A liability is anything that the company is responsible for providing. Liabilities are usually in the form of cash debts but can also include any promises regarding disposal of assets. Although all liabilities may be deemed to be ‘current’, some are very long term (mortgages, for example).
The capital of a business is the balance between the assets and the liabilities. When a business is first started, capital is often provided by the people starting it. Because of the way accounts are maintained, capital introduced into a business is both an asset and a liability so, on paper, there is no value accruing to the business from capital. (See, double entry book keeping).
Double entry book keeping
To ensure that all transactions are correctly recorded (as far as is possible), Most businesses use a system of double entry book keeping. This system ensures that, because every transaction needs to be recorded twice, once as a debit and once as a credit, a simple check can be made on the books of account by simply summing each account, listing them on a two column (debit and credit) page and ensuring that the total of debit entries is the same as the total of credit entries. This is not a fool-proof test because it cannot expose unrecorded transactions nor errors that compensate for each other. This list will be known as a trial balance.
‘Incomplete records’ is a very simple form of book keeping that records each transaction only once. To create meaningful accounts from incomplete records requires the conversion to double entry by posting the obverse of each transaction.
This is not intended to be a complete disclosure of accountancy practice but if you require clarification or more detailed information, please contact me on askoldcoot AT gmail DOT com