Key Messages
Unlock the Mystery of Accounting for Everyone: A Guide to Financial Fundamentals
Accounting Made Simple provides readers with the knowledge they need to understand the fundamentals of accounting.
You don’t need to be a finance wizard or have a degree in accounting to make sense of things like cash flow statements and balance sheets – this book will help you understand all of it easily.
These sections teach you about the importance of knowing the basics of accounting.
Knowing how to read, analyze and control your business transactions is essential for success, as it allows you to get an accurate overview of your financial situation and identify any areas that can benefit from better management.
Whether you’re running a lemonade stand or trying to compare Google’s profits with your own, Accounting Made Simple helps you make sure that every cent you spend or save adds value to your business and drives it forward.
From understanding how equity works with your home to learning what a balance sheet looks like and how comparative reports function, this book covers all the fundamental aspects of accounting.
Understanding the Accounting Equation to Gain Financial Insight
Accounting Made Simple boils down to this one equation: Assets Liabilities + Owner’s Equity.
This equation is applicable for any kind of company, big or small, and it measures a company’s financial position using assets, liabilities and owner’s equity.
Assets are everything a company owns, from properties and inventory to cash, while liabilities refer to all the company’s debts such as loans.
Owner’s Equity (or also known as Shareholder’s Equity) is then the difference between these two numbers, meaning what the company actually owns after paying off liabilities.
Let’s use a lemonade stand as an example to explain how this equation works.
Suppose that you own a lemonade stand and its assets (lemons, cups, uniforms etc.) are worth $100 in total but you’ve taken out $60 worth of loans from your family and friends – your liabilities are $60.
Here’s how we would calculate the Owner’s Equity in this scenario: Assets ($100) – Liabilities ($60) Owner’s Equity ($40).
The Accounting Equation Makes Balance Sheets Simple, and It Forms the Foundation of Any Business’ Financial Position
The accounting equation serves as the foundation of your balance sheet.
Your balance sheet is a critical financial report that reveals your firm’s economic status with assets, liabilities, and owner’s equity at any given point in time.
For example, to create the balance sheet for our lemonade stand we’d list our assets such as money in checking/savings accounts, investment in lemon farm, inventory (lemonade), Mr.
Johnson’s payment for last week’s party, and pitcher & strainer.
Then include the liabilities (accounts payable and notes payable) and owner’s equity (common stock and retained earnings).
As you can see, these three items must all add up to equal the asset value.
With all this info from our lemonade stand example, we’d create a simple balance sheet like this: Assets ($100), Liabilities ($60), Owner’s Equity ($40).
So when you add together the liabilities & owner’s equity you get $100 again; thus showcasing why the accounting equation serves as an essential factor when composing a balance sheet.
A Guide to Understanding Your Company’s Income Statement and Becoming Profitable
The income statement is an incredibly useful tool that enables you to track a company’s financial performance over a set period of time.
It is effectively organized and shows how your revenues (sales) are impacted by the costs associated with producing those goods, known as Cost of Goods Sold (CoGS).
After you subtract the CoGS from your revenue, you’re left with your gross profit.
To get to your final net income result, you have to also factor in other expenses such as rent, salaries and wages, marketing and insurance.
Once these costs are added up and subtracted from the gross profit section in the income statement, it’s easy to see if there is a net profit or loss for the period.
Thus, for any company who wants to understand their earning potential over a set period of time, tracking their performance via an income statement is essential.
Understanding the Cash Flow Statement to Avoid Bankruptcy
The cash flow statement is an important document for businesses, as it records their inflows and outflows of cash.
This simple accounting record effectively tracks the movement of money in and out of a company’s accounts.
It is vital to have this statement, especially since there may be a common occurrence between the recording of income or expenditure and the actual receiving or spending of such goods.
By breaking down cash flows into three distinct categories – operating activities, investing activities and financing activities – one can easily tell when money is being withdrawn from or deposited into their firm’s accounts.
Operating activities involve transactions like salaries paid to employees and supplier payments, while investing activities cover deals done with financial securities like stocks as well as purchases and sales of property, factories or equipment.
Financing activates include paying dividends to shareholders or taking on borrowings from creditors.
In the end, all these cash flows coming in are added up in order to calculate the net amount that was gained by the company that month.
The resulting statement provides an estimation of when businesses will exhaust their bank balance if similar trends keep up – so careful monitoring of your firm’s flows should always be kept in mind for greater success.
Understand How to Calculate Ratios for Assessing a Company’s Financial Health
Keeping track of your company’s finances can be overwhelming, but with the right knowledge, you can use financial ratios to analyze your firm’s financial health.
Liquidity ratios are a great starting point as they indicate how easily a company will be able to pay its short-term financial obligations.
One type of liquidity ratio is the current ratio, which assesses whether or not your company has enough current assets to cover its current liabilities.
The formula for this is Current Ratio Current Assets divided by Current Liabilities.
For example, if your business has $200,000 of current assets and the same amount of current liabilities then the current ratio would be 1; meaning that you can pay off those liabilities on time.
Another important ratio is the quick ratio, which evaluates what would happen in a worst-case scenario if you weren’t able to sell off inventory when trying to meet liabilities; it looks like this: Quick Ratio (Current Assets – Inventory) ÷ Current Liabilities.
If your firm has $100,000 in inventory its quick ratio would look like this: (200,000 – 100 ,000) ÷ 200 ,000 0.5 – signifying potential difficulty in paying back liabilities due to decreased sales and unsold inventory items.
Alongside those two liquidity ratios there are other measures that can give insight into a company’s performance; one such measurement is profitability ratios as they reveal profitability relative to size including return on assets, which demonstrates how well assets are used to generate profit (Net Income ÷ Total Assets).
Lastly there’s Return on Equity which takes into account Shareholder Equity when calculating Net Income ÷ Shareholder Equity.
With these two powerful tools you have a better understanding of where your company stands financially and can make sure it continues along the path for success!
What Is Double-Entry Accounting & Why Is It So Important for Financial Statements?
Accountants use a special double-entry system to record every transaction, which is essential for following the Generally Accepted Accounting Principles (GAAP).
This double-entry system allows accountants to maintain balance in their accounting equations and ensures that every increase and decrease are both reflected on each side of the equation.
This differs from single-entry accounting which only records a decrease, like when you spend $1,000 on a laptop.
In double-entry accounting, this same transaction would be recorded as -$1,000 in cash and +$1,000 in assets.
The terms debit and credit replace the “increase” and “decrease” meaning an increase in assets is reported as a debit while a decrease is reported as a credit.
All of these transactions are then recorded in the General Ledger which provides an official financial statement related to all activities conducted by the company.
Wrap Up
The final takeaway from “Accounting Made Simple” is that, once you understand the basic terms of accounting, it’s not as intimidating or difficult as you may think.
You now have the skills to read financial documents and determine a company’s financial health.
This book guides readers step-by-step through the fundamentals of accounting so that even complete beginners can gain an understanding and confidence with their newfound knowledge.
With these tools, anyone can make sense of what looks like incomprehensible data and gain valuable insights into a company’s finances in order to make more informed decisions.
