- Explain the importance of accounting
One of the key aspects of the accounting process is keeping “running totals” of “things.” Examples of things a business might keep track of include the following items:
- The amount of cash the business currently has
- What a company has paid for utilities for the month
- The amount of money the business owes
- The business’s income for the entire year
- The total cost of all the equipment the business has purchased
It’s important that businesses keep these running totals up to date, so they can be readily available when the the information is needed. It’s a similar practice to checking your cash balance in the bank before deciding if you have enough money to make a purchase with your debit card.
Some of the questions you might ask include:
- How is my business doing right now?
- Is it making money?
- How did we do last year?
- How much money is in the bank right now?
Nick Frank started NeatNiks as a sole proprietorship in October of this year. NeatNiks provides customized cleaning services to high-end homeowners in the Santa Fe area of New Mexico.
Here is a list of transactions for Nick’s business in the month of October:
- Oct 1: The owner, Nick Frank, opened a bank account in the name of NeatNiks using $20,000 of his own money from his personal account.
- Oct 4: Nick rented a truck for $12,000 cash for October through March (6 months).
- Oct 7: Purchased $2,600 of supplies on account from Cleaning Supplies, Inc.
- Oct 15: Received $1,500 cash for services performed.
- Oct 20: Billed customers for $7,250 worth of work done in October.
- Oct 25: Paid in cash: $1,500 for insurance and $1,100 for independent contractors’ work.
- Oct 26: Paid $1,000 to Cleaning Supplies, Inc. on account.
- Oct 30: Collected $1,600 from customers on account.
- Oct 31: Withdrew $4,000 cash for personal use.
- Oct 31: Nick owes independent contractors $1,200 for work done in October—he’ll pay it in November.
- Oct 31: Nick had $1,000 of supplies left over at the end of the month.
At the end of October, Nick wants answers to the following questions:
- How much money did Nick make or lose during his first month in business?
- Nick wants to buy another truck for $5,000 in order to keep up with demand—does he have enough cash in the bank to do that right now?
- How much do customers owe Nick?
- How much does Nick owe to his suppliers?
- What is Nick’s equity in his business at the end of October?
Without an accounting system, he probably won’t be able to confidently answer any of these questions.
In the next few modules, you’ll follow Nick Frank’s business through the accounting process as you discover the tools accountants use to track and analyze financial transactions, and by the end of Module 4, you’ll be able to answer all of these questions confidently.