Accounting Basics
Learn what accounting does, the five account types, cash vs accrual, and the three core financial statements.
TL;DR
- Accounting records money in and out to show a business's
financialHealth. - Every transaction lands in one of five
accountTypes. - The books roll up into three core
financialStatements.
What Accounting Does
Records TransactionsEvery sale, purchase, and payment becomes an entry.
Each dollar in or out is loggedSorts Into AccountsEntries are filed by type so totals make sense.
Grouped by accountReports the ResultsTotals roll up into readable statements.
Books -> statementsGuides DecisionsThe numbers show what is working and what is not.
Data behind every choiceThe Five Account Types
AssetsWhat the business owns and controls.
Cash, equipment, inventory, receivablesLiabilitiesWhat the business owes to others.
Loans, payables, unpaid wagesEquityThe owner's leftover stake in the business.
Assets - liabilitiesRevenueMoney earned from selling goods or services.
Sales and service incomeExpensesThe costs of running the business.
Rent, wages, supplies, utilitiesCash vs Accrual
Cash BasisRecord income and costs when money moves.
Paid or received = recordedAccrual BasisRecord them when earned or incurred.
Earned now, paid laterSimple vs TrueCash is easier; accrual shows a truer picture.
Small = cash, growing = accrualBe ConsistentPick one method and apply it every period.
Switch only with good reasonThe Three Statements
Balance SheetWhat you own and owe at a moment in time.
Assets = liabilities + equityIncome StatementProfit or loss over a period of time.
Revenue - expenses = net incomeCash Flow StatementThe actual cash moving in and out.
Operating + investing + financingThey ConnectNet income and cash both feed the balance sheet.
One story, three viewsTips
- Separate business and personal money from day one with a dedicated
businessAccount, so your books stay clean and provable. - Record each transaction as it happens, not at year-end, so your
financialStatementsalways reflect reality.
Warnings
- Do not confuse
profitwithcash; a business can look profitable on paper and still run out of money to pay bills. - Skipping
sourceDocumentslike receipts and invoices leaves your entries and deductions unprovable if anyone checks.
In Practice
See how a month of activity turns into profit and flows into the statements.
You run a small service business. In one month you earn $10,000 and spend $6,500 on rent, supplies, and wages.
- Total revenue for the month: $10,000.
- Total expenses for the month: $6,500.
- Net income: $10,000 - $6,500 = $3,500.
- That $3,500 profit raises your equity on the balance sheet.
The month produces $3,500 of net income that builds your equity.
Revenue minus expenses is profit, and profit flows into what you own.
FAQ
Accounting is the system for recording, sorting, and reporting a business's money. Every sale, purchase, and payment becomes an entry, and those entries roll up into statements that show whether the business is making money and what it owns and owes. Bookkeeping is the day-to-day recording; accounting is the wider job of organizing and interpreting it.
Cash accounting records income and expenses when money actually moves. Accrual accounting records them when they are earned or incurred, even before cash changes hands. Cash basis is simpler and common for small businesses; accrual gives a truer picture and is required once a business grows past certain size limits.
Profit is revenue minus expenses over a period. Cash flow is the actual money moving in and out. They differ because of timing: you can record a $5,000 sale as profit today but not collect the cash for 60 days. A profitable business can still fail if it runs short on cash, which is why both matter.
Not to start. Simple software or even a spreadsheet can handle basic bookkeeping if you record transactions consistently and keep receipts. A professional becomes valuable as you take on employees, inventory, or complex taxes, and for reviewing your statements and filing returns accurately.