Are you someone who is excellent with numbers? Then you should consider a career in accounting. Accountants prepare and maintain financial records for businesses and institutions. They are also responsible for examining the data to be used in various reports and analyses.
As with any industry, there are basic principles that every accountant must grasp in order to work in the field. This beginner’s guide to accounting summarizes three important concepts to give you a brief peek into this exciting industry.
Debits and Credits
This is the most basic concept in accounting and you will use it many times when preparing journal entries or T-accounts (visual aids used to depict an account in a general ledger). In general, an increase in assets or a decrease in liabilities results in a debit whereas a decrease in assets or an increase in liabilities results in a credit. When you record them in T-accounts, remember that debits = the left side and credits = the right side.
Balance Sheet, Income Statement, and Cash Flow Statement
These are your three financial statements that reflect a company’s performance. Each statement is used to measure different things, and because they show up very often in accounting, it’s important you know when to use each one.
The balance sheet is a snapshot of the company at a particular time, and compares their assets, liabilities, and owner’s equity. One of the main functions of a balance sheet is to give the company insight on the revenues they can expect to gain from receivables and expenses they can expect to pay from payables. It also shows the company what they own, for example, the land, buildings, and other assets they possess.
The income statement compares revenues and expenses to measure a company’s financial position over a period of time. This helps the company track their profits and losses, and determine when decreases in production costs are needed.
The cash flow statement reflects a company’s cash position on hand at the end of a fiscal period. This is important for companies because they need to know how much of their revenue is coming from cash compared to other receivables or short term assets.
Return on Assets, Return on Investment, and Return on Sales
Many companies want to calculate profitability based on their current performance so they can determine if they need to make any changes in cost production or total efficiency. There are many ways to calculate profitability, but three popular profitability ratios are ROA, ROI, and ROS.
ROA, or return on assets, determines how well management uses their assets to generate income for the company. ROI (return on investments) can help a company determine if they’re getting enough profit for the amount of capital invested in a project. There are many ways to calculate ROI, but the simplest formula is listed below. Finally, ROS (return on sales), shows the company how much profit they make from one dollar in sales.
ROA = Net Income / Average Total Assets
ROI = (Gain from Investment – Cost of Investment) / Cost of Investment
ROS = Net Income / Total Sales