Going self-employed in 2022? Basic accounting terms you need to know

Accounting is the language of business, which communicates the accurate picture of business operations, whether you are a sole trader, operating as a partnership or a company. Financial performance and financial position are the two most essential factors assessed at the end of each specific period, known as reporting period. The financial performance depicts what the business earned or lost, which is calculated through profit and loss, also known as an income statement. In this statement, the revenue (income) is compared with expenses (business spending) to ascertain the profit/loss figures.

Let’s assume that during last month your business earned an income of $20,000 and incurred $15,000 as an expense, which means that you have earned net income/profit of $5,000. In case of higher expenses than income, the business would be operating at a loss.

The reported amount of profit or loss will determine the direction of the business’ future decisions. If you generate a lower profit or suffer loss, these can be amended by increasing sales volume, increasing per unit sale price, or reducing expenses. It’s best to talk to your accountant and make sure that the amendments are in line with your business, marketing and growth strategies.

The business’s financial position shows how much the business owns in terms of cash, receivables, machinery, plant and vehicles. In accounting, all these items are collectively known as assets. On the other hand, the financial position also tells us how these assets are financed and whether they are purchased from a third-party supplier or invested by the owner in the business. In case if the assets are purchased from a vendor with a future payment commitment, then this will create a liability. All future obligations of the business are known as liabilities, i.e. accounts payable, bank loans, salaries payable, tax payable etc. Sometimes, the owner brings these assets into the business, which are termed as owner’s equity. So we can express this financial position with the following equation, known as the accounting equation.

Let’s assume the business has three assets, a building costing $40,000, a vehicle $15,000, and cash $20,000, which is borrowed from a local bank. The building and vehicle are brought in by the owner into the business. Keeping in view the above-mentioned figures, the accounting equation of the business will be shown as in the following.

Assets                                                                         =			Liabilities       +	Owner’s equity
Building	Vehicle	Cash                =	Bank Loan      +	Owner Investment
$40,000	$20,000	$20,000           =	$20,000           +	$60,000

So the total of assets is $80,000, and the total of liabilities and owner’s equity is also the same. In business books, all accounts basically fall under these three categories. If the business is selling goods, then the goods are the assets of the business until they are sold to a customer.

The statement of financial position is also prepared with these three components, assets, liabilities, and owner’s equity. You can observe the position of its business by checking the amount of assets, but he also has to focus on how these assets are financed. If the business is purchasing all its assets on credit, these will increase the amount of liabilities, which will not be a positive indication for any successful business.

In a general sense, it is perceived that accounting and bookkeeping are the same. However, accounting is a vast subject in which also includes financial accounting and management accounting. Bookkeeping is the process of recording financial transactions in the books of accounts, which are further classified into respective accounts. These individual accounts are used to check the financial performance and financial position of the business through the statement of profit & loss and balance sheet.

Accounting might seem like a complex subject for someone going self-employed for the very first time. However, no matter what industry you operate in, at Spectrum Accounting, we act as a partner helping you grow your business. If you ever have any questions, we are here to help. Let’s talk about your new business and make sure you are set for success from the very beginning. Get in touch with us today.