A simple explanation of accounting for small businesses.
Basic accounting for a small business can be simple, although you will probably want to use the services of a professional CPA to audit your books and figure out your taxes at the end of a fiscal year. Unless, of course, you are an accountant, in which case you will probably not be reading this!
The double entry system and the nature of the Accounting Equation calculates the figures in a way that gives a correct total at the end of a fiscal period.
The Accounting Equation:
Assets=Liabilities + Net Worth
Adding to an Asset Account means debiting it.
Adding to a Liability Account means crediting it.
Adding to a Revenue Account means crediting it.
Adding to an Expense Account means debiting it.
The figures are kept under control by posting entries to the following accounts.
The Sales Account is credited for the revenue amount of each sale that you make in your business.
The account debited is Cash, since cash is what you presumably got for this sale.
DR CASH CR SALES
DR CASH CR SALES TAX PAYABLE
When you pay the Sales Tax to your State Government, the entry is:
DR SALES TAX PAYABLE CR CASH
There can be different categories of Sales, for example if you want to keep track separately of certain items of merchandise. But basically at the end of the year you will want to know how much revenue you made in sales and how much money went into your bank account.
If you do business on an accrual basis, which means the customer receives the merchandise before paying the bill that you send to him each month. In this case your accounting entry will be:
DR ACCOUNTS RECEIVABLE CR SALES
When the customer pays the bill, the entry is:
DR CASH CR ACCOUNTS RECEIVABLE
Your expenses work in the same way but in reverse. Inventory that you buy to be sold to a customer is entered in the following accounts:
DR INVENTORY CR CASH
Simply explained, the difference between the price you pay for the inventory item and the price you charge your customer for it, is profit, but, of course, there are other expenses which cut into that profit.
Other expenses you may have, such as rent, supplies, payroll, etc, are entered into the accounts in the same way:
DR RENT CR CASH
DR SUPPLIES CR CASH
DR GROSS PAYROLL CR CASH
Like the Accounts Receivable system, items bought can also be on an accrual basis using an Accounts Payable account:
DR SUPPLIES CR ACCOUNTS PAYABLE
When the bill is paid:
DR ACCOUNTS PAYABLE CR CASH
At the end of the month, you will calculate all of these accounts and at the end of the year you will calculate these monthly totals.
Revenues and Expenses are summed for the year. The balance is credited to Owner’s Equity, although you will probably want to invest it, or some of it, back into the business.
This is a very simplified accounting explanation. Other accounts to be debited and credited involve property that you buy or rent in which to run the business, equipment that you buy or rent, and Depreciation Expense for both of these. Also, Inventory and a Cost of Goods Sold Account play a part on the books. Loans that you take out, posting of Interest Expense, and any Investments you make, with Interest Income involved, are also posted to the books (in much the same way.) But, basically, the above is how an accounting system works.