It may not be the buzziest or the sexiest thing about running a business, but when you’re starting out, it all boils down to euros and cents. Accounting requires an attention to detail that either bores people to tears or sends them running for the hills screaming the word ‘outsource’. But having some fundamental accounting knowledge and knowing what the numbers are telling you is a must for entrepreneurs–it will allow you to gauge the financial health of your company and understand how numbers affect how people see your business.
Most companies operating in the European Union are required to prepare financial statements. Many of these companies need to prepare financial statements according to the International Financial Reporting Standards (IFRS). These standards are developed by an independent body based in London called the International Accounting Standards Board (IASB). You will need to check with your respective national business register to find out exactly what to file and how to file it. These standards are what certified or chartered accountants use to create reports. Understanding these concepts can only help your business going forward.
You might be tempted to fudge the line between these two but it is important to keep them separate. Unless you’re extremely adept at taking a deep dive and spending weeks sorting through both business and personal expense records at a critical time when you have everything else to do, start off on the right foot and keep it separate. You may not be able to see it now but it will pay off in the long run, especially if you need to go through an audit.
Time period principle
Set defined time periods for your reports and be specific. Usually, reports are monthly, quarterly, or annually. Once you have established your reporting time period, make sure to include a header indicating the time period covered by the financial statement. For example, a cash-flow statement could have the heading: “For the month ended June 30.” Since balance sheets indicate a snapshot in time, the header would state: “as of June 30.”
Many people think that revenue is only earned when the money is in your bank account. In accounting, revenue is different from cash. Revenue can be recognized when you earn it. As an example, if you sold a product or a service in January and issued a net-90 day invoice term, the revenue from the sale would be recognized in January even though you may not get paid until April. Alternatively, if you got paid in advance, you wouldn’t recognize the revenue until you delivered on the contract. This concept forms the basis of accrual accounting which is mandated by the IFRS.
Expense recognition and the matching principle
Expenses are recognized similarly to revenue–they should be recognized when they are used regardless of when you actually spent the money. In addition, with regards to the matching principle, expenses should be recognized in the same period as the revenues they are related to. Say you spent €5,000 on a project now that will only deliver revenue next year. You would recognize the expense next year, even though you already spent the cash. Or let’s say you had to invest a lot of money in new equipment. That large expense can be recognized over the projected life-span of the equipment. This can help smooth out your financial statements to reflect how your business actually runs.
Regardless of how you feel about numbers, these are some of the essential things you should know about accounting. In the beginning, when you have fewer transactions and they are for the most part straightforward, it’s generally clear what’s what. But as your business grows and your financial transactions become increasingly complex, look into taking on a CFO who has a proven track record of financial expertise or consult a professional accountant for advice.