Accounting 101: Basics for Small Business Owners and New Entrepreneurs (Part 2)

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Congratulations on the launch of your small business if you just started one, and yes to the start of your entrepreneurship journey, this is a huge milestone and we celebrate you. Now, let’s talk about setting up an accounting system, without which your business is less likely to succeed.

An accounting system is a system used to manage the income, expenses, and other financial activities of a business. With an accounting system, you can keep track of what your business owns, who it owes money, and track outstanding debts from its customers. You can also manage your cash flow, track spending, meet deadlines, evaluate the performance of your business, and generally prevent your business from the risk of making errors in your finances.

If you missed part 1 of this article, you can catch up here. Now let’s look at some top accounting terms every business owner should know:

Accrual accounting

Accrual accounting is a method of accounting where revenue and expenses are recorded when a product or service is delivered to a customer with the expectation that money will be paid in the future. Unlike cash accounting, where payment is recorded only when it’s received, accrual accounting records the expenses of goods and services even when the customer is yet to pay.

This method provides the company with a clear picture of its financial position.

Cost of goods sold (COGS)

Cost of goods sold also referred to as Cost of sales is the direct cost of producing the goods sold by a company. This includes the cost of the materials and labour and the cost of some products you bought for resale purposes. This excludes indirect expenses incurred during distribution and sales.

Expenses

Expenses are costs incurred in the course of doing business. Business expenses you should track include salaries, rent, utilities, software, equipment or equipment rental, adverts, membership dues, subscriptions, commissions, and other items involved in business operations.

Expenses reflect the cost of doing business and they are an integral part of the income statement.

Inventory

In business, inventory is the goods owned by a business that is available for sale or being made ready for sale and raw materials used to produce goods available for sale. The three stages of inventory are:

•  Raw materials used to produce the goods
• Work-in-progress such as kits and assemblies
• Finished and ready for sale goods

Doing an inventory in your business helps you track what’s in stock and what’s on backorder, so you don’t oversell products.

Net profit/loss

Net profit or loss is the total company’s earnings after all expenses have been subtracted from the revenues. This is calculated by subtracting all expenses from the total revenue.

Revenue

Revenue is the total income generated by the sale of goods and services. It is the money you receive when your customers pay for goods and services provided by your company.

Journal entry

A journal entry is a record of the business transactions in the accounting books of a business. A journal entry should have the correct date, amounts to be debited and credited, a description of the transaction, and a unique reference number as well.

Overhead

Overhead refers to all ongoing business expenses that are not directly related to creating a product or service. It is any expense incurred to support the business while not being directly related to a specific product or service. Expenses such as insurance, rent, utilities, travel expenditures, repairs, legal fees, and advertising fees are overhead expenses. It is used to find out how much a company should charge for its products to make a profit and also for budgeting purposes.

Equity

Equity also referred to as shareholder’s equity or owner’s equity is the owner’s stake in a business. It is the amount of capital invested or owned by the owner of a company. It is measured by calculating the difference between assets and liabilities found on your company’s balance sheet.

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