Some people may just envision adding machines and balance sheets when they think about accounting, but there’s so much more to it. If you handle the books for a small business, there are several principles that go beyond crunching the numbers. Get to know the essential of bookkeeping and accounting.
Matching Principle for Revenue and Expenses
The matching principle refers to recording expenses in the same period as the revenue that the expenses help earn. For example, consider how your company accounts for its capital purchases, such as buildings, equipment, computers, and other large purchases. Rather than reporting the entire cost of an asset when you make the purchase, your company accounts for the expense gradually over time. When you purchase an expensive asset, that asset can help you earn revenue for years to come. If you account for the expense at the time of purchase, you don’t match it to the revenue it earns. Accounting for these purchases incrementally as you earn revenue creates a more accurate picture of your company’s current financial position and health.
As an accounting principle, conservatism refers to keeping financial records that create a very conservative picture of your company’s profits. To achieve a conservative picture, you don’t record revenue and sales until they actually occur. Companies that don’t employ conservatism may have misleading balance sheets. As a general rule of thumb, if you want to embrace conservatism in your bookkeeping strategies, you should record expenses and liabilities as soon as possible, even if there’s a chance of not incurring them in the future. On the other hand, you should only recognize assets and revenue when you’re certain of the item’s receipt.
For example, if you sell 10 widgets to Company X, you don’t record the sale until you receive payment for the 10 widgets. It’s possible Company X may return a couple widgets or fail to pay the invoice. So if you recorded the revenue at the time of the sale, you don’t have a complete picture of your finances.
You may want to be especially conservative about how you recognize revenue. When you want your books to reflect an accurate picture of your company’s financial health, don’t record revenue until you actually receive the payment.
For example, if your credit card payment processor takes three days to process payments, don’t include that revenue in your bookkeeping until it’s in your bank account. To illustrate another scenario, imagine you extend credit to a number of clients. On paper, you make a lot of sales and reduce your inventory accordingly. If you like, you can record the revenue from these sales, but that isn’t a very conservative approach to bookkeeping. In fact, in this situation, your company is revenue-poor and cash-rich. For more accurate books, wait and record the revenue as your customers pay down their credit lines.
Going concern is when a company can continue operations indefinitely. If your company is a going concern, you can feel comfortable recording expenses incrementally as explained above. If there are signs that a company may need to sell its assets and close shop, it’s no longer considered a going concern and you should adjust your bookkeeping strategies in response.
These accounting and bookkeeping principles become extremely important when working with investors, lenders, or shareholders. Although your business may not be legally required to adopt these approaches to accounting, these ideas work together to create the most accurate books possible for your small business.
While knowing general bookkeeping and accounting terms and principles is a great start, you need to keep your accounts in pristine condition. This means recording all items in a central location. Keep your books accurate and up to date automatically. Change the way you manage your finances now.