The Four Essential Accounting Principles For Business Executives
Many business executives have a hole in their basic accounting education
. Either they forgot what they learned in business school or never got formal accounting training. A business leader that doesn't know what they don't know is in a dangerous position.
Do you trust your accountant and finance manager? A vast majority of them are trustworthy and reliable. However, business history is full of cases where people in charge of the company purse abused their position of trust through accounting manipulation, book-cooking and outright fraud. The essential foundation for financial oversight is an elementary study of financial record keeping and reporting.
Where can you get educated? The purpose of an effective executive education or coaching program on accounting is to give a broad overview of financial record keeping. The topics should include an elementary yet essential overview of the balance sheet, income statement and cash flow statement and how they are interrelated. The accounting material should be engaging with hands-on participation through the creation of fictitious company accounting records. You should be asked to construct and dissect general journal entries to see how it all comes together in the financial statements. You will soon discover the big picture of accounting without getting bogged down in too much accounting theory or complex details.
At a minimum you should learn and retain the following four essential principles of accounting:
Debits means left and credits means right. Double entry record keeping is the foundation of modern accounting. Luca Paciolo is generally considered to be the Father of Accounting. Paciolo was born in Tuscany around 1445. His most important work was a book about mathematics titled Summa de arithmetica, geometria, proportioni et proportionalita (which is translated: The Collected Knowledge of Arithmetic, Geometry, Proportion and Proportionality). The book was published in 1494 and was the first work to describe double entry accounting in detail. Double entry simply means for each entry on one side of the accounting ledger there must be a corresponding entry on the opposite side of the ledger. This process keeps the accounting records in balance. T charts are a basic but effective tool to graphically represent double entry accounting. Ask your executive education instructor or coach to demonstrate accounting entries using T charts.
The accounting cycle is circular. The process of recording financial transactions and producing financial statements generally follows a series of activities. Each transaction is recorded in some form of accounting journal whether manually or electronically. The journal entries become the source to produce the accounting ledger which shows the cumulative debits, credits and balance for each account. The ledger drives the trial balance to root out any entry errors. The balance sheet, income statement and cash flow statement are prepared using the entries in the ledger. The accounting cycle then starts over with the next set of transactions.
Financial statements are either snapshots or time lapsed accounting images. The balance sheet captures a moment in time during the accounting cycle, usually the end of the month, quarter or fiscal year. Assets (i.e. current, liquid, illiquid, fixed, intangibles, etc.), Liabilities (i.e. current, short term, long term, etc.), and owner equity (i.e. retained earnings, initial investment, additional capital, etc.) accounts show the balance at the end of the accounting period. The income statement and cash flow statement show all activity during a period of time whether a month, quarter, year or some other time period.
Accrual accounting is different than cash basis accounting. External parties like investors and bankers usually want to see financial statements produced on the accrual method of accounting. Accounting rules determine when revenue is recognized and when expenses are taken. The accrual method of accounting smooths out the lumpiness of cash basis accounting. As a business leader you want to know how much cash is coming in and going out of your business. The cash flow statement is adjusted for accrual accounting and gives a clear picture of changes in cash during the period. Your business is unique and your accountant can determine whether accrual or cash basis accounting is the right choice.
Community colleges, universities, trade associations and coaching services offer basic accounting education. You will have the essential tools after training to understand your company financial record keeping procedures and make informed business decisions from the financial statements. You will be able to have confident conversations with your accounting staff, CPA and tax adviser and be a more financially capable executive.
by: Michael Shelton
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