What should you understand about accounting when you start your business?

Business owners who understand and adhere to the basic principles of accounting can greatly increase their businesses' chances for success. A basic definition of accounting is a process of recording business transactions and using that information to analyze the prospects for the business.

A business that maintains accounting will track both the accounts payable (debts that the business owes to its creditors) and accounts receivable (the money that is owed to the business). By tracking these amounts, a business owner can readily draw conclusions about how the business is performing. When concerns arise, a business owner may change tactics or make greater attempts to generate sales or create efficiencies.

Businesses will record the assets that the business holds, such as the accounts receivable, cash, inventory, securities or other items that can be converted into cash. Similarly, liabilities such as the accounts payable, the debts owed by the business, expenses like wages and salaries, taxes and payments on business loans or notes will be recorded on a balance sheet. The balance sheet will subtract the liabilities from the assets to show the net worth of the business, or the business owner's equity in the business.

How do businesses account for profits and business valuation?

Other guidance may be gained through accounting. By tracking the income and expenses for a certain period of time, accountants can produce a profit/loss statement. Also known as an income statement, this is a financial statement that shows the results of business activities.

Other intangible assets, such as goodwill, or the value of the business's reputation and relationships that generate continuing business, patents or mailing lists may also be considered when valuing a business. In fact, while the book value of a business, or its total assets less its liabilities, does not consider the value of goodwill, the fair market value of the business will take into account the goodwill that the business has in the community. Fair market value is the price that is agreed upon by a willing buyer and a willing seller when all relevant facts about the business are known.

What is considered an asset or liability?

Business assets may include tangibles, such as the inventory of the business, and intangibles, such as goodwill. Businesses may also own assets that are intended to accommodate the business such as furniture, vehicles, real property and factory equipment. These assets are not intended for sale and are referred to as fixed assets or long-term assets.

Business liabilities can include debts to creditors as well as accrued payroll and accrued payroll taxes, debts that the business owes to employees for past work and money owed to the government for taxes on the employees' wages. Businesses may also have long-term liabilities, such as the debt repayment for a mortgage on real property used for the business.

What accounting concepts can be used for analysis?

Accounting for business profits and losses can yield meaningful information for business owners, potential buyers, banks and others. Some concepts that may be considered during a sale or loan application are the business's debt/worth ratio, the result of the business's total liabilities divided by its total net worth, the business's liquidity, or how quickly and easily its assets can be converted to cash, and its working capital, or the capital available to the business in the short-term calculated by subtracting current liabilities from current assets.

DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent counsel for advice on any legal matter.

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