"I don't understand accounting, do I need to?"

Accounting is not my problem, why should I need to know that?

How many times have I heard that said to me by small business owners?

Let me say that if I had one dollar for every time I heard that I'd be a wealthy man. So I'm going to share with you the basic concepts and hopefully it's going to put everything into a little more perspective.

Every sale or purchase you make will create transactions within your general ledger system. These are called Debits (DR) and Credits (CR).

That's why it's called "Double entry", because each transaction in the general ledger will record a debit and a credit.

Your software will record the transactions automatically so don't be too concerned on how it does that, but focus your understanding on why.

The next step is where it can get a little tricky at first but I'll try to simplify it for you. Once you understand these concepts then you will begin to really understand how to run your business more effectively. I promise I'll make my examples simple for you to follow along with.

Below are two of the 3 essential financial reports The essential financial reports you need to know are right here

Profit and Loss Statement

• Income
• Cost of Sales
• Expense
• Net Profit

• Assets
• Liabilities
• Equity

Depending on the type of transaction you're dealing with, there will always be a corresponding entry recorded to another account. This is how debits and credits affect each category:

Account	Debit	Credit
Income	decrease	increase
Expense	increase	decrease
Asset	increase	decrease
Liability	decrease	increase

Sales You have just sold something to a customer for $100 on credit (i.e. on their trade account with you). How is that transaction shown in the system? I'll show you.

• Debit - Trade Receivable (asset) - $100
• Credit - Sales (income) - $100

Purchases You have just purchased some raw materials on credit for $80 from your supplier. What's the entry?

• Debit - Cost of Sales (expense) - $80
• Credit - Trade Payable (liability) - $80

Now comes the WHY..!

In the first example you sold goods for $100 to a customer of yours, the sales have increased the sales line item on your Profit & Loss statement by $100. It has also increased your trade receivables (amount owed to you) on the Balance Sheet by $100. The customer may not be required to pay you for another 30 days so this represents an asset to you but a liability to your customer.

In the second example you purchased $80 of raw materials on credit from your supplier. This means you owe them $80 and are most likely not required to pay them for 30 days. Can you see how managing your cash flow plays an important part in running a successful business?

Tips to manage your cashflow better

Now let's see what your financial reports look like:

Profit and Loss Statement
Sales	100
Cost of Sales	80
Gross Profit	20
Expenses	10
Net Profit	10

Balance Sheet
Assets	100
Liability	80
Equity	20

That was easy, wasn't it? Effectively that's what accounting is. Everything else will follow the same theme. Go through the examples again and review the table above and you will soon see the logic behind how your business activities becomes what you see when you review your financial reports.

Another misconception I would like to clarify for you is Depreciation Return from Accounting to Home Page