Accounting is a lot more than just tracking revenue and expenses. If you handle the books for a small business, there are several principles that go beyond crunching the numbers.
Matching Revenue and Expenses
The matching principle refers to recording expenses in the same period as the revenue that the expenses help earn. To illustrate a common use of this principle, consider how most companies account for capital purchases. Rather than reporting the entire cost of an asset when it’s purchased, most companies account for the expense gradually over time. When you purchase an expensive asset, that asset can help you to earn revenue for years to come. If you account for the expense at the time of purchase, it isn’t matched to the revenue that it earns. However, if you account for it incrementally as you earn revenue, that creates a more accurate picture of what’s really happening with your business finances.
As an accounting principle, conservatism refers to creating financial records that create a very conservative picture of your company’s profits. 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 that the expenses won’t be incurred. On the other hand, you should only recognize assets and revenue when you’re very sure those items will be received.
You may want to be especially conservative about how you recognize revenue. In particular, if you truly want your books to depict the financial health of your company accurately, you may not want to record revenue until you have the cash in hand. For example, if your credit card provider takes three days to process payments, you may not want to 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’ve made a lot of sales, and you’ve reduced 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. To make your books more accurate, you may want to wait and record the revenue as your customers pay down their credit lines.
Going concern is when a company can continue operations indefinitely. If a company is a going concern, you should 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 can be 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 allow you to create the most accurate books possible.