The study of accounting is split broadly between financial accounting and managerial accounting. Financial accounting deals with preparing and presenting information to stakeholders. Managerial accounting encompasses analyzing relevant information to aid managers in making decisions. Since small businesses are not required to disclose information outlined by GAAP (generally accepted accounting principles — we’ll get to that later), every small business owner needs to know the basics of managerial accounting.
Understanding costs is arguably the most important concept for any beginner to accounting to understand. Costs that can be traced directly to a product are deemed direct, while costs that can’t easily be traced are indirect. When manufacturing a product or providing a service, eliminating unnecessary costs is essential to remaining competitive. Understanding whether a cost is direct or indirect aids managers in partaking in or refraining from an economic expenditure.
Assets, liabilities, and owner’s equity is important to understand, which collectively form the accounting equation: Assets = Liabilities + Owner’s Equity. Assets are economic benefits such as cash, inventory, and equipment. Liabilities are probable future economic sacrifices, or, in layman’s terms, amounts owed to creditors for bank notes, bonds, and other obligations.
Owner’s equity (also referred to as “stockholder’s equity,” or more simply, “equity”) is the overall claims against assets — so, an asset’s net worth. So, if we consider a home with a fair market value of $250,000 backed by a 30-year mortgage with $100,000 still owed, the home is an asset, the mortgage is a liability, and the worth of the home less the amount of the mortgage is resulting equity. So, our accounting equation looks like $250,000 = $100,000 + $150,000.
Information systems tie in closely with modern accounting. Keeping track of a small business’ petty cash balance with a physical journal is difficult, let alone inventory and other assets. Digitizing a business is essential to accurately tracking a business’ accounts and minimizing inefficient use of scarce working capital. This has everything and more to deal with how managers can allocate retained earnings (money earned through a business’ operations) and other capital. Small businesses often fail because they lack proper funding or become overwhelmed by unfullfilable bank notes, so dealing with what money a business has on hand efficiently is important.
The practice of accounting also attempts to instill transparency and good faith in business. Internal control systems are important in reducing employee fraud and overall waste. Requiring multiple employees to verify accurate balances is an example of an often-used, important internal control. Knowing how to deal with internal controls is an integral part of being a successful manager and in holding individual employees accountable.
It should go without saying that details are ever important in the accounting practice. Discrepancies should be easily explained by reviewing invoices and a business’ general ledger. The whole point of accounting is to track the flow of resources in a business, so checking figures and providing sufficient documentation is part of every manager’s job. All managers should strive to encourage accurate documentation by employees and attention to detail. If a business’ general journal is not accurate with what transactions actually occurred, a business will not be able to reasonably determine the accuracy of its performance.
Steve Breitman trained as a CPA and has over 30 years of accounting, financial and operational management experience. He graduated Magna Cum Laude from the University of Texas at Austin, with his BBA degree in Accounting. He is the founder of Mindful Business Solutions, Inc. and helps a multitude of businesses with their finances.
