Are you a business owner or manager and need to know some simple concepts of accounting? We know that you did not start a business because you loved accounting. That is why we have made it easier for you to understand the basics of accounting.
This guide is made to cover the very essentials of accounting. We don’t go into details with all concepts, to avoid confusion and unnecessary noise.
In accounting we deal with 3 overall sheets: an income statement, a balance sheet and a cash flow statement. Let us cover the essentials and explain why they are important. Specifically, we will focus on the income statement and cash flow as these two are the most crucial sheets to understand as a small and medium size business owner.
The income statement lets you know whether you are making money or not. Simply by subtracting the costs from the revenue, you know whether you have a profit or a loss. This sheet covers 3 things: revenue, costs, and profit/loss.
The costs are typically split up into 2 different categories: the variable costs (or cost of revenue) and fixed costs.
The variable costs are the costs directly associated with the revenue. It could be the products you sell in your store or the sodas you sell in your café. Something you have to pay for in order to sell your product or service.
The fixed costs are costs that are independent of your revenue. It could be your rent, salaries to full time employees, etc. Things that you will have to pay for whether your revenue is 1.000€ or 10.000€.
By subtracting the variable costs from the revenue we get the gross profit. This should always be positive, otherwise, you will be selling your product for a lower price than the price you purchased the product for.
To stay in business the gross profit should also be high enough to cover the fixed costs. Though there are some exceptions. Here are two examples:
- If you are starting your business, it is quite common not to have a profit in the beginning. You just need to have enough cash to reach a break even. The budget will give you an idea of how much cash you need.
- If your business is sensitive to seasonal fluctuations then it would be okay to have monthly losses, if you generate enough profit in other months.
Note that all the figures in this statement are without VAT. The reason for this is that the VAT frequently is paid back to the local government, and thereby does not affect the revenue or costs.
The cash flow statement tells you how much cash you have in the bank each month. This knowledge is especially important if you are in the startup phase of your business if your business is sensitive to seasonal fluctuations or are expecting an uncertain future.
The statement simply states the cash amount at the beginning of a month, adds income, and subtracts the expenses and the amount of cash at the end of the month.
Here we include both output VAT and input VAT. The reason for this is that you pay and receive VAT when you buy and sell something. This thereby affects your bank account.
The amount of VAT that is paid back to the government is defined as the amount of output VAT minus the amount of input VAT.
- Input VAT: The VAT you pay when you buy something
- Output VAT: The VAT you receive when you sell something
The balance sheet consists of two major parts: assets and liabilities. Note that the number of assets and liabilities should always be equal to each other.
- Assets consist of your amount of cash, receivables, and tangible- and intangible assets e.g. buildings you own, goodwill, etc.
- Liabilities consist of your equity, provisions, long-and short-term debt.
Now you're familiair with the basics of accounting, it is perhaps time to start making a budget for your business. And in order to make that process easy for you, we created a budget template that is fairly easy to use!