Description: Accounting tutor, Emma, shares her expert knowledge and views on why Accounting is the language of Business.
Financial records and accounting reports tell the story of a business— using numbers instead of words.
ACCOUNTING is the universal language of business.
It is the process of recording all income and expenditure that happens in a business on a daily basis.
We are also recording the economic meaning of the transaction, categorising it in a way that will give us useful information later for decision-making and planning.
Using the categories on the chart of accounts, the accounting data is summarised into a standard format, which is broken down into three different financial statements:
- Balance Sheet
- Income Statement
- Cash flow Statement
Let’s look at these three basic financial statements and analyse the story they’re telling us.
The Balance Sheet
The balance sheet is a financial report that tells the story of what a business owns (Assets) and what it owes (Liabilities) at a point in time, for example, the year ending 31st March.
The balance sheet is also referred to as the “Statement of Financial Position”.
It is used primarily to help us understand the financial strength of a business.
Over time, changes in the balance sheet help us understand important trends in the business.
As transactions are recorded, the impact of each transaction on the assets and liabilities of the business is also recorded.
For example, when you make a sale, you not only record income, but you also record an increase in the value of an asset — your bank balance.
When you make a purchase, you record the amount of the expense, but you also record the reduction in the value of your bank balance.
(This is called “double entry” accounting!)
The difference between the assets and the liabilities of the business represents the book value of the owner’s equity in the business.
In a company, this is referred to as shareholder’s equity.
The Income Statement
The income statement is a financial report that tells the story of what a business has spent and earned over a specific time.
The statement can cover any period of time, although it’s most commonly prepared at the end of a month, a quarter, or a year.
It does this by summarising the economic results of all of the transactions that occurred during that time, showing you whether you have made a profit or a loss over that time.
The income statement can also be referred to as the “Profit and Loss statement or P&L.”
You can learn a lot about a business from analysing the income statement. It’s not enough to simply know if you made or lost money.
You will also want to use this statement to understand precisely where the money is going each month.
The total profit or loss is what has been earned minus what has been spent. If this amount is positive, it’s called net income. If it’s negative it’s called a net loss.
An income statement can also help you calculate profit margins, which show how good the business is at converting revenue into profits.
The Cash Flow Statement
The cash flow statement is a financial report that shows which parts of the business generated cash and which parts spent money during a given period of time.
Whether cash is going out faster than it comes in and whether the business can pay its expenses.
This statement explains the change in the cash balance from the beginning to the end of the time period, by breaking down the business activity into three sections:
Bottom of Form
1. Cash flow (in or out) from operations – cash from sales and cash spent on expenses running the business
2. Cash flow (in or out) from investments – cash spent and received from buying and selling large items like plant and machinery
3. Cash flow (in or out) from financing – cash received from or paid back to lenders and investors, and cash put in or taken out by the owner
Since good cash flow is critical to any business, it’s extremely important to clearly understand where your cash is coming from and where it’s going. This statement is a little trickier to learn to read, but it is worth the effort.
Final Note
Understanding the story of a business as told through the financial statements is a powerful tool for your career in accounting. You’ll be glad that you took the time to learn the language!
By tutor, Emma. Contact Us