Accounting 101/1 - The Accounting Framework

Sorry, I realized that in this blog so far, I was jumping sometimes at detailed accounting/financial concepts without at least giving my readers some good foundations.

Therefore, I shall attempt here to correct this mistake. Look from now on at blog titles where "101/xx" appears and we will together build stronger foundations to help you improve Your bottom-line.

First, you need "to study" some definitions (don't worry they are not so many and since they are key to control your business, they should be of prime interest for you to memorize them). Visit the following link. In a nutshell, the author gives you the basic accounting/financial jargon to better understand your books.

This first Foundation blog will talk about two of the ironclad "equations" of accounting:

• Sales = Expenses + Profit
  
• Assets = Liabilities + Owner's Equity

These two equations can be represented graphically as seen in above blog

(You will remark that your books are made up of two key items: First, the Balance Sheet giving you a snapshot at any point in time of your assets and liabilities and then the Profit & Loss - also called "Income Statement" - representing the year-to-date results from Your business activities.)

The first equation is pretty obvious as Sales are supposed to be bigger than expenses incurred. What remains represents your profit (hopefully, you are in that situation, but many companies incur downturns at some point or another where Expenses are greater than Revenues/Sales hence making a loss - it is clear that such situations cannot be repeated too often in a company's life without raising the question of its survival).

The second equation tells you that in your balance sheet if all your assets (bank accounts, fixed assets such as office furniture, computers, ..., Receivables from your customers, Stock of items, ...) are higher than your liabilities (loans, accounts payables to suppliers, bank overdrafts, ...), Your Net Value also called "Owner's Equity" is positive. You also see in the graphics above that the owner's equity is made up of two main items, i.e. your Capital + your yearly profit (another item call "Retained Earnings" belongs here to the Capital line and will be revisited in another blog).

Now, you get the base to understand your books. The whole purpose of your business can be seen as two-fold:

1. to grant yourself a decent salary to pay for your efforts in growing a profitable business
2. at year-end, you can revisit your books and , oh nice, eventually grant to yourself a bonus based on the gross annual profit calculated. Only one word of caution here: Leave not only part of this profit to pay your company taxes, and with what's left why don't you leave some more cash for the following year to take actions such as retiring loans faster, launching a new product, buying a new asset, etc ...