When you first start your small business, you will probably have to take on many day-to-day administrative tasks yourself, including accounting. Understanding how to monitor and exhibit your business income and expenses is a crucial skill for success in business. Hence, it's important to familiarise the accounting principles for small business.
Even if you're willing to outsource small business accountant London and bookkeeping needs, it's still a good idea to have a basic understanding of these concepts. Hence, you are able to understand your financial professional's reports and accurately evaluate the financial health of your business.
What is Business Accounting for Small Business Owners?
Accounting for small business owners must be precise and maintain an organised record of the business's financial operations, including sales, expenses, assets, and liabilities. If you are new to accounting for small business owners, you must be aware of the accounting principles for small business and the three forms of accounting reports - balance sheets, income statements, and cash flows.
Each report includes a separate set of values and offers specific information on the financial condition of the business. The balance sheet lists the liabilities and assets of the business. This statement gives a quick overview of the financial situation of small business owners at any given time.
When providing accounting services for small businesses, accountants have the skill to quickly evaluate a company's financial figures, which include assets and liabilities. While companies generally prepare financial statements on a quarterly basis, individuals have the flexibility to generate such statements at their convenience. Within the context of a balance sheet, assets, liabilities, and capital play pivotal roles.
Essential Accounting Principles Every Small Business Owner Must Know
Although it may be an exciting endeavour, owning a small business entails a number of responsibilities, including competent money management. The knowledge of and use of accounting principles for small business is a crucial component of financial management.
1. The Accrual Basis vs. Cash Basis Accounting
Before delving into specific principles, it is essential to understand the two main accounting techniques: accrual basis and cash basis accounting.
Accrual Basis: When revenue or expenses are incurred or generated, regardless of when cash actually changes hands, they are recorded. Although more complex, it gives a more realistic picture of the long-term financial health of the business.
Cash Basis: Revenues, as well as expenses, are only recorded under the cash basis of accounting when cash is received or paid. Although it's easier to use, it might not accurately represent the financial condition of the business, particularly if you have outstanding invoices or bills.
Due to its simplicity, cash-based accounting is favoured by many small enterprises. However, it's important to note that, given tax regulations and the volume of financial transactions, accounting services for small businesses might require the adoption of accrual-based accounting.
2. The Accounting Equation
The accounting equation is the basis of double-entry bookkeeping, a method that tracks financial transactions. It states:
Assets = Liabilities + Equity
Assets: These are what the business owns, such as cash, inventory, equipment, and accounts receivable.
Liabilities: These represent what the business owes, including loans, accounts payable, and accrued expenses.
Equity: Equity represents the remaining ownership stake in the entity's assets once all liabilities have been subtracted. It indicates the owner's ownership interest in the business and may include capital investments and retained earnings.
Every financial transaction in your business should adhere to this equation. For instance, when you borrow money to buy equipment, your assets (the equipment) and liabilities (the debt) both increases.
3. Revenue Recognition
For small businesses, correctly recognising revenue is essential. Revenue must be recorded when it is earned and realisable, which means that the products or services have been delivered or will likely be delivered, and payment is expected.
For instance, if you own a web design company and complete an assignment for a client, you should recognise the revenue as soon as the assignment is completed rather than when the client makes payment.
4. Expenses Recognition
One of the important accounting principles for small business is expense recognition. Expenses should be recognised when they are incurred, not necessarily when they are paid. This is consistent with accounting on an accrual basis.
For instance, if your December utility bill includes charges for both December and January's services, you must record a portion of the expense in December and the remainder in January.
5. Double Entry Book-Keeping
Each financial transaction in a double-entry bookkeeping system impacts at least two accounts, one of which is debited, and the other is credited. This ensures that the accounting equation remains balanced. As an example, when you make a sale, both the revenue (credit) and cash (debit) accounts increase.
6. Chart of Accounts
A chart of accounts is a list of all the accounts you use to monitor the financial activities of the business. It categorises accounts into assets, liabilities, equity, revenue, and expenses. Organising your chart of accounts meticulously makes it easier to track and report financial information accurately.
7. Cash Flow Management
Managing cash flow is vital for a small business's survival. Even if revenue recognition takes longer than expected, you still need to make sure you have adequate cash on hand to meet expenses. Monitoring your cash flow regularly helps you make informed decisions about spending, borrowing, or investing in your business.
8. Financial Statements
Small business owners should be familiar with three essential financial statements:
- Income Statement (Profit and Loss Statement): This provides a summary of the expenses, revenues, and net income or loss over a specific period. It helps in assessing the profitability of the business.
- Balance Sheet: This shows the business's financial position at a specific point in time, showing the equity, liabilities, and assets. It helps in understanding the business's overall financial health.
- Cash Flow Statement: This tracks the cash movement into and out of the business over a specific period. It helps in identifying trends in cash flow and potential cash flow problems.
Managing all these statements can be a tedious task especially for small business. If it becomes difficult to manage the same, taking help of accounting services for small business can be the go-to solution.
9. Financial Ratios
Financial ratios provide insight into the efficiency and stability of your company's finances. For small business owners, some crucial ratios include:
- Liquidity Ratios: These measure the business's ability to meet short-term obligations. The current ratio (current assets divided by current liabilities) and the quick ratio (current assets minus inventory divided by current liabilities) are common liquidity ratios.
- Profitability Ratios: These measure the business's ability to generate profits. Common profitability measures include gross profit margin (gross profit divided by revenue) and net profit margin (net profit divided by revenue).
- Debt Ratios: These measure the amount of debt owed by the business. Examples of debt ratios include the interest coverage ratio (earnings before interest and taxes divided by interest expenditures) and the debt-to-equity ratio (total debt divided by total equity).
10. Forecasting and Budgeting
Creating a budget and financial forecast is essential for planning and achieving your business goals. A budget outlines the expected income and expenses, whereas forecasts convey financial performance into the future. Comparing your actual financial results to your budget and forecasts enables you to make necessary adjustments.
11. Tax Compliance
Small businesses in London must adhere to tax rules and regulations. To fulfil tax obligations effectively, businesses need to engage a credible accountant, London and maintain meticulous records, including accurate tracking of income and expenses. Developing a comprehensive understanding of tax deductions, credits, and deadlines can also help optimise your tax position.
12. Accounting Software
Investing in accounting software can streamline the accounting processes and improve accuracy. You can manage invoices, keep track of expenses, create financial reports, and streamline tax preparation with the use of software.
13. Internal Controls
Internal control implementation protects the business against fraud and errors. Ensure that different individuals handle financial tasks like recording transactions, reconciling accounts, and authorising expenditures. Review financial records often to look for anomalies.
14. Professional Advice
While understanding the principles of accounting is important, do not be hesitant to ask for professional advice when needed. There are many reputed accounting services London, to help in preparing small business accounts.
Accountants and financial consultants are qualified to help you with tax planning, provide insightful advice, and ensure the accuracy and compliance of your financial records.
How Can Unicorn Accountants Help You?
In conclusion, understanding accounting principles is not only essential, but it is also a powerful tool for small business owners to propel their ventures towards success. Whether you are handling accounting tasks yourself or outsourcing them, understanding the basics is crucial for making informed financial decisions and evaluating the health of the business accurately.
By understanding concepts such as accrual and cash basis accounting, the accounting equation, revenue and expense recognition, and financial statements, small business owners can navigate the financial aspects of the business with confidence.
Unicorn Accountants specialises in delivering specialised accounting services designed to meet the distinct requirements of small businesses in London. Our team comprises experienced accountants and financial advisors, ready to aid you in a wide range of areas, including tax planning, compliance, financial reporting, and analysis. Don't hesitate to reach out to us today to explore how our services can bolster your business's financial prosperity.