The Art of Accounting

Cash in the Bank does not Equal Profit
Many people run their businesses on the basis of how much money is sitting in the bank account. If there is a lot of cash in the bank, they feel that the business is doing well and if there is a small amount of cash in the bank, then the business is failing to operate to its potential. The problem is, this is the basis that many business owners use to assess how their business is going.

Business owners need to realise that cash in the bank does not equal profit. You cannot manage your business properly on this basis. Your business will eventually fail if you do not know the difference between cash and profit. Never ignore the difference between the two.

There are 4 things that business owners need to learn:

  1. Money in Bank - The amount of money you have in the bank is not an indication of how well your business is going.

  2. Bills  have an effect - Even though your bank balance may appear healthy, there may be many bills sitting in the desk drawer that have not been paid. Once those bills are paid, your cash balance will reduce and the business may not appear to be as healthy as you first thought. On the other hand, you may also find that there are invoices for money due to the business that have not been collected, and once these are collected the bank balance will improve.

  3. Cash and Profit - You need to realise the difference between cash in the bank and profit. While cash simply signifies dollars in the bank, available for use by the business, profit is to do with not only the dollars in the bank, but also with the true financial position once those dollars are used to pay outstanding bills, and once invoices due to the business for sakes made are received.

  4. Adequate Info - You need an adequate system in place so the accurate results of the financial affairs of the business can be extracted at any time. These results enable decisions to be made or directions changed to ensure profitability, or to avoid a financial loss or potential disaster.

The summary of the lesson is this - You must have an adequate bookkeeping system in the business, you must have kept adequate records and you must run your business along proper financial and accounting lines so that at any time you can properly extract the right data to calculate whether the business is making a profit or not and if not decide on what to do about it.

2 Basic Methods of Accounting
There are 2 basic methods of accounting - a cash basis and accrual basis.

The method you finally choose will depend on your type of business. The cash basis is a simpler method. It is mainly used by businesses that run everything on a cash type basis, that is, they pay for services and for goods in cash and most of the sales they make are in cash and not by offering credit.

The accrual method is used by businesses that do not pay immediately for goods and services, but pay at a later date and also for businesses that allow sales to customers on a credit basis, so that they do not receive the sales income until a later date.

  1. Cash Basis Method
    In cash basis accounting you record the sales when the cash is actually received and when the expenses have actually been paid. Under this method, all accounts receivable (all debtors) are not recorded as a sale until they have actually been received and banked. The accounts payable (or creditors) are not recorded as an expense or a purchase until the account has been paid from the bank account by check or other means. The cash basis method is not really appropriate for those businesses that extend sales on credit or that purchase goods or services on credit. It is not the most accurate way of determining the true financial position of a business.

  2. Accrual Basis Method
    In accrual basis accounting you report your income and expenses as they are earned or incurred, rather than when they have been received (sales revenue) or paid (expenses). This means that income or sales revenue includes those sales that have been charged out, but have not actually been received in dollar terms by your business. Similarly, expenditure includes those expenses which the business has been charged for, but which the business has not yet actually paid out from its bank account. The accrual method satisfies one of the main accounting principles - the one called the "concept of matching". This concept means, the income is matched up with the related expenditure in the period in which they are both incurred.