Understanding accounting basics for small business owners

What is accounting?

Accounting is the process of calculating, documenting, and analyzing the financial transactions of a business. This can involve reporting income and expenses to tax collectors, drafting financial statements for investors, or providing stakeholders with balance sheets.

Small business owners can use accounting practices to measure their financial health, make strategic decisions, and plan for the future.

Key accounting terms and definitions

It's important to understand basic accounting definitions for financial management.

Key accounting terms include:

• Assets. Resources that a business owns, such as real estate, cash, equipment, and patents.
• Liabilities. Debts that a business owes, such as from loans and credit cards.
• Equity. A business' total assets minus its total liabilities.
• Revenue. The money a business earns from selling products or services.
• Expenses. Money you spend to run your business, such as for inventory and payroll.

Learning these terms can help you navigate financial statements like balance sheets, income statements, and cash flow statements.

Basic financial accounting equation

Business owners can use this basic accounting equation to keep their finances balanced:

Assets = liabilities + owner's equity

Basically, the equation helps ensure that each debit is offset by a credit or asset. This can help keep your business in good financial health.

The accounting cycle

The accounting cycle is an eight-step process that businesses can use to record their financial transactions for a certain accounting period, such as a month, quarter, or year.

The eight accounting cycle steps include:

• Identifying transactions. These may include sales, expenses, or debt payments.
• Recording transactions in a journal. Document each transaction in chronological order.
• Posting the transactions. Post a summary of these recorded transactions in a general ledger for each account.
• Preparing the unadjusted trial balance. Calculate the total balance of the transactions. The debits and credits should be equal.
• Analyzing the worksheet. If the debits and credits aren't equal, you or your bookkeeper can analyze the transactions for errors and track any necessary adjustments on a worksheet.
• Adjusting journal entry discrepancies. Record and post any adjustments are journal entries.
• Preparing a financial statement. Once the balances are adjusted, prepare financial statements, including balance sheets, income statements, and cash flow statements.
• Closing the books. Finalize your reports and conclude tracking transactions for this set accounting period.

Types of accounting methods

There are two main types of accounting methods:

• Accrual basis accounting. Reporting income and expenses that have been billed, even if they haven't been paid.
• Cash basis accounting. Reporting only income that has already been received and expenses that have already been paid. This doesn't include unpaid debts or invoices.

Small businesses may opt to use cash basis accounting because of its simplicity. It can also allow them to only pay taxes on income that's in their account. However, accrual basis accounting can help provide a clearer picture of a company's financial health and future performance.

Accounting principles

Small businesses may be advised to account for certain widely accepted accounting principles and standards. These standards are created to help businesses accurately and consistently report their finances; they are set by the Financial Accounting Standards Board (FASB) and Governmental Accounting Standards Board (GASB).

For example, the FASB established the Generally Accepted Accounting Principles (GAAP) as a framework for conducting business accounting in the U.S.

Accounting software and tools

You can use accounting tools and software to automate your bookkeeping and save valuable time and resources. Accounting tools may also come with additional features that you can use to better track your finances and grow your business.

Learn more about PayPal for Business.

Should you just hire a professional accountant?

Some small businesses and entrepreneurs may choose to hire an external accountant to handle their bookkeeping, manage their operating expenses, and ensure they're meeting certain standards. It's important to thoroughly research accounting solutions to find a trusted and verified associate that can help your business grow.

Discover more small business accounting resources.