Accounting Made Simple

Accounting Made Simple is your guide to learning the fundamental charts, equations, and concepts of managing a business’s financial statements.

There are many benefits to taking good care of your books. In my companies, it lets me estimate taxes and know how healthy they are. We’ll start with the basics of accounting with the equations that are fundamental for the balance sheet.

The accounting equation, as it’s known, lets you get a picture of the financial position of your business using three terms:

Assets: these include everything the company owns. Some of my company’s assets include my laptop, car, and phone.  Liabilities: anything the company owes is in this category. If you have a car loan, for example, this would go here. Owner’s (or Shareholder’s) Equity: This value is what’s left of the assets after subtracting liabilities.

The basic principle here is that two equations are always true of these terms:

Assets = Liabilities + Owner’s Equity Owner’s Equity = Assets – Liabilities

Let’s see a more concrete example. Imagine you own a lemonade stand. You’ve got assets including the stand itself, cups, and lemonade worth, say, $100. But to start you had to borrow $60 from your parents, so that’s your liabilities. Calculating your Owner’s Equity, then, is simple:

Owner’s Equity = Assets – Liabilities = $100 – $60 = $40

You also have other accounts to work with these figures to understand your business’s money situation, including:

Balance Sheet: this helps you sort out assets and liabilities more specifically and represents a specific moment in time, like a month. Income Statement: creating this lets you see what your net income is after all costs. Cash Flow Statement: a record of inflows and outflows of cash, this account is vital to your company’s financial health.

Alright, so all those accounts are done but now what? How do they tell you about the health of your business? This is where the liquidity ratio and profitability ratio come in handy. There are a few different types of liquidity ratios, all of which help you see how well your company can meet its short-term financial commitments. The current ratio, for example, gives you an idea of how well you can pay liabilities with assets at the moment. To calculate this, use the following equation: Current Ratio = Current Assets/Current Liabilities The higher the ratio, the better the health of your business. A more revealing way to look at the liquidity ratio, however, is through the lens of the quick ratio. This is the same as the current ratio, but without inventory balances: Quick Ratio = (Current Assets – Inventory)/Current Liabilities You might have $200,000 in assets and $200,000 of liabilities, so your…