The Basics of Accounting
Companies need to keep track of their Assets, Liabilities, and Shareholder's Equity.
Additionally, they must keep track of Revenues and Expenses.
Concurrently, companies keep track of the Sources and Uses of Cash Flow.
Without these procedures and systems to control the business,
a company will fly out of control in short order
and end up disappointing customers, employees, lenders and shareholders alike.
How does a company set up its accounting systems?
First, it creates a Journal of Accounts,
which is a detailed listing of the items a business must track in detail.
This will consist of Assets and Liabilities, as well as revenue items and expenses.
The Journal of Accounts will include assets such as Cash in Banks, Receivables,
Raw Material Inventory, Finished Inventory, Property, Plant and Equipment,
as well as costs for development.
Liabilities include Accounts Payable, Loans Payable,
as well as certain Deferred Items like Deferred Taxes
where the Taxes have been expensed for accounting purposes,
but not payable because of timing differences in booking income and expense
for tax versus book accounting purposes.
For instance, the company can depreciate (expense) fixed assets
faster for tax purposes than required for accounting purposes.
In other words, companies are motivated to minimize expenses for taxes,
and maximize accounting profits.
The difference is reconciled through the deferred tax accounts.
Any business must keep track of its Shareholder's Equity.
Shareholder's Equity must be equal to Assets less Liabilities,
and represents how much of the business the Shareholder's actually own
after giving account to amounts owing to others.
These Accounts consist of Paid In Capital
(the amount shareholders paid for issued shares of equity ownership),
Retained Earnings and etc.
The Income Statement specifically tracks revenues and expenses,
and helps track profitability of the business.
Generally, the Journal of Accounts is set up with a degree of specificity
that allows very detailed accounting by product, by division, etc.
Companies employ double entry bookkeeping which balances entries
by having a debit and credit for each action and movement in the business.
For instance, a sale with an invoice or bill rendered to the customer
would credit sales, and debit accounts receivable in the same amount.
Analysis should key on liquidity, asset turnover, financial leverage,
profitability, operational leverage, and growth in earnings.
Accounting policies can affect how the results of business operations are presented.
It is critical to understand these policies because there is sufficient latitude,
that you may be comparing apples to oranges between companies
if accounting policies are different.
Policies relating to acquisitions, capitalization of expenses, tax accounting,
amortization and useful life definitions, etc.
can lead to different results of operations of companies in the same industry.
All those statements reveal what a company owns, what a company owes to others, and the investments its owners made.
They detail how a company finances its operations and what assets the company has acquired with this financing.
The key to understanding the principles of accounting is in the most basic and fundamental of all accounting equations:
Assets must equal liabilities plus shareholders' equity.
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