Basic accounting
This material is for social entrepreneurs looking to focus on their customers and plan for expanding into new markets.
Competences addressed/ learning outcomes expand_more
- Research the basic information they need regarding accounting for creating their business.
- Find out how to analyze quantitative information to grow their business.
- Discover and learn how to use basic accounting skills.
- Make decisions based on the key financial data.
Objectivesexpand_more
- Understand the nature and purpose of financial statements.
- Analyze the effect of business transactions on an organization's accounting records
- Develop the ability for accounting concepts and principles.
- Communicate information.
- Convert quantitative data into qualitative information.
- Facilitate decision-making processes.
Theoretical background expand_more
What is accounting? Accounting… is an information system that:
● measures
● processes
● communicates financial information about an identifiable, economic entity.
Bookkeeping: Repetitive, mechanical process of recording financial transactions and keeping financial records.
In this frame, bookkeeping is a small part of accounting. It includes the design of an information system to meet users’ needs and its goals include the analysis, interpretation, and use of information. Moreover:
● It is a link between business activities and decision makers: decision makers use accounting information to make informed decisions about available alternatives.
● It measures business activities by recording data for future use
● It is communicated to decision makers through reports
In terms of funding, business activities include:
● Financing Activities: Activities associated with obtaining adequate funds, or capital, to begin and continue operations. Examples:
o Owner investments
o Paying a return to owners
o Obtaining loans from creditors
o Repaying amounts to creditors, plus interest
● Investing Activities: Activities associated with spending funds to begin and continue operations.
Examples:
o Buying resources such as land, buildings, and equipment needed in the operation of the business
o Selling these resources when no longer needed
● Operating Activities: Activities associated with the course of running a business.
Examples:
o spending funds to begin and continue operations
o Selling goods and services
o Employing managers and workers
o Buying goods and services
o Paying taxes
BALANCE SHEET
What is a balance sheet? A balance sheet is a financial statement that reports a company's:
● assets,
● liabilities, and
● shareholder equity.
The balance sheet is one of the three core financial statements that are used to evaluate a business. It provides a snapshot of a company's finances (what it owns and owes) as of the date of publication.
The Accounting Equation:
Assets = Liabilities + Equity
Example: An individual begins a business by investing €10,000 of his own money. The accounting equation would be:
Assets = Equity
Cash €10,000 = Owner’s investment €10,000
If then, he borrowed € 5,000 from the bank to provide the business with additional cash, the accounting equation would be:
Assets = Liabilities + Owner’s Equity
Cash €15,000 = Loan €5,000 +Owner’s investment €10,000
Elements of the Balance Sheet:
How the money is invested:
ASSETS:
● Probable future economic benefits.
● Obtained from past transactions or events.
Where did the money come from:
LIABILITIES
● Probable future sacrifices of economic benefits.
● Arising from present obligations.
● To transfer assets or provide services in the future.
● As a result of past transactions or events.
EQUITY
● The residual interest in net assets.
INCOME STATEMENT: EXPENSES – REVENUES
It explains the change in wealth of an organisation over a period of time (Revenues – Expenses). It:
● Evaluates past performance.
● Facilitates the prediction of future performance.
● Helps to assess the risk of uncertainty of achieving future cash flows.
● Is affected by the accounting methods employed.
The Four (4) Key Elements of an Income Statement are:
(1) Revenues: Money a company received during a specific period. Example: selling goods.
(2) Expenses: The economic cost of a business to earn revenue. Example: wages, rent, interest paid to banks…etc
(3) Gains: an increase in the value of an asset or property: Example: income from selling a building
(4) Losses: A net loss occurs when the sum total of expenses exceeds the total income or revenue generated by a business, project, transaction, or investment.
CASH FLOW STATEMENT (CFS)
A cash flow statement (CFS) measures the performance of a company over a period. It is a valuable measure of strength, profitability, and the long-term outlook of a company. The CFS can help determine whether a company has enough liquidity or cash to pay its expenses. A company can use a CFS to predict future cash flow, which helps with budgeting matters.
Step-by-step implementationexpand_more
1. RESEARCH THE BASIC INFORMATION YOU NEED REGARDING ACCOUNTING FOR CREATING YOUR BUSINESS USING MIND MAPPING.
Under further resources you can watch a video showing how to start mind mapping.
Here we have summarized the Steps for building a mind map:
a. Review your sources of information. Have some general ideas about the headings, titles, subtitles, etc.
b. Take out a piece of paper, write down the title and draw a picture of it in the middle. Make a circle or square.
c. Think of four to seven primary branches directly related to the main theme.
d. Give each branch different colors. Paint the secondary branches the same as the primary ones that are related.
e. Choose keywords smartly. You do not have so much space in each section. If you put too long keywords, it may leave things messy and affect your retention.
f. Organize the space to make a complete layout of the visual map.
Besides hand drawing, there are many free and paid mind map software that are easy to use, for example, Zen Mind Map, MindMeister, ConceptDraw, MindNode, etc.
Use the Design Thinking mind map to better understand:
● What will be your assets, liabilities, and equity?
Once you have mind mapped these 3 key ingredients go ahead and brainstorm in the group:
● Are taxes important? If so, why?
● What rules apply to your company regarding sales and income taxes?
● Do I need separate bank/credit card accounts, or can I use my personal ones?
● Do I need to implement budgeting & forecasting?
2. DISCOVER AND LEARN HOW TO USE BASIC ACCOUNTING SKILLS: ACCOUNTING ANALYSIS IN 5 STEPS
Here we are proposing and exercise with 5 simple steps to discover and learn how to use basic accounting skills:
A. Identify the accounts involved.
The first step is to determine which accounts are affected by the transaction. For example, if a business owner invests $10,000 in cash into the business in exchange for common stock, the accounts involved would be the cash account and the common stock account.
B. Establish the nature of the accounts.
Review the transaction to determine whether the accounts involved are assets, liabilities, or equity. To briefly recap:
● Asset accounts include cash, notes receivable, accounts receivable, land, equipment, buildings, inventory, and prepaid expenses.
● Liability accounts include debt incurred by the company, such as notes payable, accounts payable, and accrued liabilities.
● Stockholders’ equity includes any dividends, retained earnings, revenue (such as sales revenue), expense accounts (such as rent expense), and common stock.
C. Determine which account increases and which one decreases.
Debits increase asset accounts and credits increase liability or equity accounts. Debit simply means recording the transaction on the left side, while credit means recording the transaction on the right side:
D. Apply the rules of debit and credit on accounts.
To keep the account equation in balance, every transaction recorded must have an entry in an opposite but related account. Every debit must have a corresponding credit. This method, known as double-entry accounting, is enforced to keep the accounting equation balanced.
EXAMPLE: PURCHASE OF 50€ OF OFFICE SUPPLY WITH CASH
| ACCOUNT | DEBIT | CREDIT |
| OFFICE SUPPLIES | 50 € | |
| CASH | 50 € |
E. Record the transactions in your journal entry.
Once you’re done analyzing the transaction and have determined the accounts involved and where the transaction needs to be debited and credited, you’re ready to record your journal entry. Make sure to record your transactions in chronological order to ensure your books stay organized.
3. MAKE DECISIONS BASED ON THE KEY FINANCIAL DATA
Finally: good financial decisions are key to business success.
The 3 key elements for financial decisions are:
● Financial decisions: it involves the need for funds either to c0pnt9onue living or continue operating.
● Investing decisions: related to the need or want to purchase or invest in assets. They can be short or long term.
● Operating decision: what you will make with the profits you generate. You can either reinvest or distribute them.
While all these tips are key for taking financial decisions when you are starting your business, they should be part of a wider business strategy that will take form as you grow. Make sure you use it correctly updating your data sets. This is essential to grow your business.
FINAL REMINDER:
Make sure you look at the related contents to this material, that are:
1.5 Financial literacy
2.3 Decision making
2.5 Cost benefit analysis
3.4 Basics for investing
3.5 Forecasting for investing
Time needed and group sizeexpand_more
GROUP SIZE: 15-20 learners that can be separated into groups of 4-5 (to make sure different persona mappings are made)
Materials needed for implementationexpand_more
Besides hand drawing, there are many free and paid mind map software that are easy to use, for example, Zen Mind Map, MindMeister, ConceptDraw, MindNode, etc.
Further resources: Videos and/or useful linksexpand_more
https://www.youtube.com/watch?v=g7j_CoKD1Xs
The BALANCE SHEET for BEGINNERS (Full Example):
https://www.youtube.com/watch?v=CMv1zlZhb4Q
Referencesexpand_more
https://tinyurl.com/4hwpum68
Fitipaldi, T. (2022). Crucial Elements Of Financial Decision Making”. Link visited 04/07/2023:
https://tinyurl.com/yftnsaeu
Kelling, T. (2020),. 7 Things To Know About Accounting When Starting A Business. Link visited 04/07/2023:
https://tinyurl.com/mruythpv
Upwork Team (2022). Accounting Transaction Analysis: Learn the Basics with Examples. Link visited 04/07/2023:
https://tinyurl.com/23u2mnh6
