Overview of Small Business Accounting
Business accounting consists of operational accounting (book accounting) and tax accounting. Operational accounting accounts for the actual revenue and expenses to the business. Tax accounting also accounts for revenue and expenses, but incorporates considerations for tax deferrals and write-offs. Restated, book accounting maintains the actual book or market value of assets; while tax accounting would focus on the tax value of the asset given the relevant stage of depreciation.
The primary differences in book and tax accounting arises through the use of 1) cash-based and accrual-based accounting methods; 2) depreciation valuation (straight-line or accelerated) and actual valuation; and 3) the treatment of inventory (LIFO vs FIFO) for valuation of assets and income recognition.
These issues are covered in greater depth in our Accounting Resources Library.
The financial status of the business is documented or recorded in the form of financial statements. Below is an overview of the main financial statements: Balance Sheet, Income, Statement, and Statement of Owner’s Equity.
The balance sheet is a statement of the assets, liabilities, and owner’s equity (capital contribution) of a business. Unlike that a large corporation that may employ a complex scheme of recording asset value to include intangibles and depreciation rates, the small business balance sheet is more straightforward. The small business balance sheet lists The current assets such as free cash, real property, fixed assets such as land, buildings, and equipment, accounts receivable, etc. Importantly for most startups, the balance sheet will include certain intangible assets, such as patents – however the valuation of these assets are often ill represented. Liabilities take the form of any outstanding debt, accounts, payable, etc. The owner’s equity is the simple difference between the assets and liabilities. Most of the owner’s equity is a result of a combination of capital contribution and retained earnings.
The income statement has generally 2 parts. The first part focuses on revenue – how much revenue is coming into the business during a specific period of time. The revenue is simply the money coming in from the sale of goods or services, without taking into account costs or expenses. The second part focuses on expenses that were paid during the period. The costs and expenses include all write-offs, such as depreciation, amortization of various assets, and taxes. After deducing the expenses from revenue you arrive at the net income. The purpose of the income statement is to indicate whether the business made or lost money during the period.
Cash Flow Statement
The cash flow statement, as the name indicates, tracks the flow of capital in and out of the business. It doesn’t depict transactions that do not affect cash flow, such as exchanges in kind, bad-debt right-offs, depreciation, etc. The cash flow statement is broken down into 3 components: Operating Activities, Investing Activities, and Financial Activities.
As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. The cash flow statement is likely the most important document for small businesses. It depicts the viability of the business and its ability to meet its operating obligations as they come due. This is where potential investors will look first to determine how funds are being spent. Further, it is generally used in the decision making process that ultimately affects the balance sheet.
Conclusion: Business accounting is a difficult subject-matter that requires in-depth analysis. We explore accounting concepts in our Accounting Resources Library.