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Key Accounting Principles

Provided by SME Solutions Center - Kenya


Important Accounting Concepts

Financial statements are integral constituents of your business. They facilitate accurate financial reporting.

Principles of Accounting

Accounting codes guide your everyday business operations. These principles of accounting comprise several key concepts. For effective management of your business, you need to be conversant with certain basic accounting concepts. You also need to have accurate accounting information. Major accounting elements include:

  • Liabilities
  • Assets
  • Balance sheet
  • Debt
  • Equity
  • Accounts payable
  • Accounts receivable
  • Income statement
  • Cash flow statement
  • Operating expenses
  • Cash flow management
  • Sales
  • Cost of Goods Sold (COGS)
  • Gross profit
  • Income before taxes
  • Net income from continuing operations
  • Net income

Liabilities

These are your outstanding debts, such as, unpaid tax or shareholder dividends, as well as your equity.   

Assets

These denote your business’ property’, both fixed (long-term) and current (temporary).

Fixed Assets

 Fixed assets include items like; real estate, equipment, or buildings.

Current Assets

Current assets include: trademarks; patents; inventory; accounts receivable; or prepaid expenses.

Balance Sheet

This is a momentary overview of the fiscal situation of your business. Liability and asset items are listed in the two opposite columns of the balance sheet. Normally, the two sides have to balance each other.

Uses

  • A balance sheet presents a picture of your business’ financial status
  • As such, it is a crucial tool used by potential financiers to assess your business’ monetary situation

Equity

This refers to the property or money you have invested and maintained within the business. Owners’ equity is a common revenue source. To properly manage investor expectations and comply with tax requirements, you need to suitably manage equity.

Debt

Debts arising from loan or lines of credit constitute a common income source. Usually, you have to repay these debts with some interest. You need to properly manage debts so as to avoid bankruptcy situations.   

Accounts Payable

Outstanding debts that do not attract interest fall under accounts payable. These include items such as monies owing to suppliers and vendors as well as your outstanding supplies and inventory bills.

Accounts Receivable

These denote monetary sums owed from sales of your services or products.  

Cash Flow Management

This is the tracking of your accounts payable and accounts receivable. More accounts receivable means that the cash on hand is less. Alternatively, more accounts payable means that your cash reserves are stretched.

Income Statement

This financial report enumerates your various expense and revenue items, thereby determining your Gross Profit figure. Key income statement items include:

  • Sales
  • Cost of goods sold
  • Gross profit
  • Operating expenses
  • Operating income
  • Income before taxes
  • Net income from continuing operations
  • Net income

Sales

This item denotes the cash amount you obtain from selling your products or services

Cost of Goods Sold (COGS)

COGS denotes the expenses that directly go into the production of sold products or services.    

Gross Profit   

Gross profit is the figure you arrive at after subtracting COGS from your Sales figure.  

Gross Profit = Sales - (less) COGS

Operating Expenses

These are the indirect costs that are involved in product or service generation. They include items like product development, marketing, and sales costs.

Operating Income

This is the figure you arrive at after subtracting operating expenses from your gross profit figure.

Operating Income = Gross Profit - Operating Expenses   

Income before Taxes

This is the figure you get after deducting the interest you paid on debts from the operating income figure.

Income before Taxes = Operating Income - Interest paid on Debts

Net Income from Continuing Operations

You arrive at this figure after deducting taxes from your income before taxes figure.

Net Income from Continuing Operations = Income before Taxes - Taxes

Net income

This is the figure you get after subtracting one-time costs, such as lawsuit damages, from the net income from your continuing operations figure.

Net Income = Net Income from Continuing Operations - One-Time Losses

Cash Flow Statement  

This financial report shows all your outgoing and incoming cash within particular time duration. It organises cash items into three key categories, that is:

  • Investments - comprising non-operating assets, securities, and real estate ownership
  • Financing - comprising equity and loans
  • Operations - comprising operating expenses and sales   

 

As a business person, you need to have some knowledge about certain key accounting concepts. This knowledge will enable you to do accurate financial reporting. Liabilities and assets are the central concepts. Other concepts include: Balance sheet; Debt; Equity; Accounts payable; Accounts receivable; Income statement; Cash flow statement; Operating expenses; Cash flow management; Sales; Cost of Goods Sold (COGS); Gross profit; Income before taxes; Net income from continuing operations; as well as Net income. You develop accounting ratios from key business numbers. Being conversant with major accounting concepts is crucial as it helps you to comprehend major business events. You will prepare proper financial statements.

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