An understanding of accounting is essential for entrepreneurs to make their business ventures successful for many reasons. The first reason is to enable the entrepreneur to make predictions about the company's future. This will increase the chance of success and also attract people to work towards a shared vision of where the business is headed.
The second reason is to make more efficient commitments of time, energy, and money. By maximizing the effectiveness of commitments companies can attract more customers, increase their capacity to serve present and future demand while investing in assets that increase productivity and lowering operating costs. The third reason accounting is essential for business is because it measures and assesses progress. Having an accurate measure of progress enables an entrepreneur to increase productivity, reward profitable behaviors, identify trends in revenues and expenses, and change directions when necessary. An entrepreneur's accounting knowledge should include an understanding of generally accepted accounting principles (GAAP), journals and ledgers, the accounting cycle steps, bank reconciliations, and financial statements.
GAAP maintain definitive rules that provide guidelines and procedures for preparing financial statements, as well as providing objective standards for judging and comparing financial data. It is necessary to have a working knowledge of GAAP to be able to prepare and interpret a company's financial statements. In accounting, a journal is a business diary that records the daily business transactions using the double-entry system of bookkeeping. The double-entry method records the debit and credit changes in individual ledge accounts caused by each transaction. Journal entries will also be entered into the company's ledger, which stores all the accounting information and summarizes the financial transactions.
The accounting cycle is used to process financial transactions and consists of six steps. Identifying and analyzing the transaction as they occur is the first step. The second step is to record the transaction in the appropriate journal. Step three occurs when information from the journal is transferred to the general ledger where debits and credits are posted. The fourth step consists of calculating and adjusting, as necessary, the trial balance to ensure that the sum of the debits is equal to the sum of the credits. Preparing the financial statements is the fifth step. The final step is to close the temporary accounts to owner's equity.
Bank reconciliations analyze and bring into agreement the account balance reported by the bank on the bank statement with the account balance shown in a company's ledger. The balances may differ due to timing differences or errors. Timing differences may include deposits in transit that have not posted to the bank's balance, outstanding checks that have not been presented to the bank, bank service charges that have not been entered into the general ledger, and not sufficient funds (NSF) checks that would require an adjustment be made to the ledger. Bank reconciliations can identify bank or business errors when the bank and book balances do not reconcile. To identify errors and ensure books are being kept in order reconciliations should be done on a regular basis when the bank statement becomes available.
Financial statements will provide entrepreneurs with the most comprehensive information to understand a company's past, current, and projected future profits and productivity. Four basic types of financial statements include the balance sheet, income statement, statement of retained earnings, and statement of cash flows. The balance sheet, also known as the statement of financial position, reports the company's assets, liabilities, and owner's equity at a given point in time. From the information on the balance sheet the quick ratio, the current ratio, the debt-to-equity ratio, and working capital can be determined. The quick ratio, also known as the acid test, measures the company's ability to pay off current liabilities with their current assets, and does not include inventory. The current ratio is the same as the quick ratio, but includes inventory. The debt-to-equity ratio, also known as leverage, is a measurement of how the company finances its assets. Working capital shows the available cash for day-to-day operations. Balance sheets are used to determine the company's financial risk and to aid entrepreneurs with decision-making.
The income statement, also known as the profit and loss statement, reports the company's income, expenses, and profits over a period of time. There is a large amount of information that can be derived from the income statement, including the gross profit margin, operating income, operating profit margin, net profit margin, return on assets (ROA), and return on equity (ROE). Income statements show how profitable the company is and demonstrates productivity. The statement of retained earnings, also referred to as the statement of owner's equity, reports and explains changes in retained earnings over a period of time. The statement of cash flows reports the inflow, outflow, and movement of cash in the company over a period of time and consists of three parts, which are the cash from operations, cash from investing, and cash from financing. This statement of cash flows combines information from the balance sheet and the income statement to demonstrate how money is being generated and used throughout the company.
Having a good understanding of accounting enables entrepreneurs to increase the probability their business will be successful. The information that accounting provides allows entrepreneurs to make predictions about the future of the company, to make more efficient commitments, and to accurately measure the company's progress and productivity. Given the higher likelihood of success for entrepreneurs knowledgeable in accounting, and the wealth of information accounting can provide, everyone who is interested in opening their own business should make an effort to acquire accounting skills.
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