Every small business owner should be familiar with the five different account types that are used to record and monitor business activities. If you are currently using t-accounts to track your business finances, pay attention to these essential small business accounts. These five accounts are essential for every company and contribute to the three key financial statements: income statement, balance sheet, and cash flow statement. Having a proper understanding of these five accounts is critical for any small business owner to succeed regardless of industry.
The assets of small businesses are recorded in the asset account. Assets are often broken down into two main categories, which are current and long-term. Current assets such as cash or inventory on hand are needed for day to day operations. In contrast, long-term assets such as building leases and machinery are expected to be used for years in the future and are an essential part of sustaining long-term operations. Assets are also categorized as tangible and intangible. Tangible assets can be physically touched or seen and may include raw materials, buildings, or machinery. Intangible assets are not material objects and include goodwill, patents, and other non-physical items that provide value. This account allows small business owners an efficient way of tracking asset values.
The liability account is used to monitor all obligations a company faces. Similarly to assets, liabilities can be broken down into current and long-term. Current liabilities include items such as accounts payable, short-term loans, and other current obligations due within one year. Just like short-term assets, these are required for day to day operations. Long-term liabilities include loans exceeding one year, deferred revenue, and any other non-current obligations. This category of liabilities is used for financing larger items that will be needed for many years into the future. Both current and long-term liabilities are essential for small business financing needs.
Business owners are entitled to receive the remaining profits after expenses have been paid.
To determine the portion of earnings that each owner receives, small businesses maintain an equity account that details ownership. This is particularly important for businesses with more than one owner, such as partnerships or corporations, where profits are shared. Every business owner has a capital account that details his or her ownership stake. As owners routinely contribute and withdraw funds, their equity ownerships can change rapidly. Therefore, it is important to keep track of ownership percentages and any additional claims that business owners have on company profits.
As small businesses engage in operations to provide goods and perform services, they collect revenue or sales from customers. The revenue account records this information and distinguishes between operating and non-operating revenues. Operating revenue refers to income generated from the core activities of a business, while non-operating revenue is generated from non-business related activities. The revenue cycle is also useful for categorizing revenue by business segments, geographic regions, or a number of different ways. This helps business owners identify their strongest sources of revenue and where revenues may be declining to assist their decision making. The revenue account is also used to identify and predict cyclical trends throughout the operating year. Revenue accounts are used by all business owners for easy tracking of sales performance.
The expense account is used to monitor all expenses incurred. As small businesses engage in day to day operations, numerous expenses are deducted from sales before business owners collect profits. Types of expenses may include the cost of goods sold, salaries of employees, research and development costs, or any other items that refer to the use of assets. Having an expense account is a critical part of ensuring financial liquidity at all times. Therefore, expense accounts are necessary for every business.
Not only do each of these five accounts provide critical information to business owners individually, but they are also directly related to one another. For example, many small businesses incur loans for financing purposes, which increases the liability account. This funding is then used to acquire assets and increase the asset account. The equity account is also related to these two by the accounting equation: assets – liabilities = owners equity. Additionally, business owners compare revenue and expense accounts to ensure a healthy profit margin.
These five accounts are an essential part of success for small businesses as well as large corporations. For business owners to continue thriving in times of economic uncertainty or unpredictable business circumstances, maintaining these five accounts will be highly beneficial.