Strictly speaking, business owners don’t need to be especially good at keeping the books to be successful. After all, they can always hire an accountant to do the job better than they ever could. In fact, hiring a dedicated accountant is probably one of the first things business owners in New Zealand should do since they’re going to have their hands full doing other things needed to grow the organisation.
However, regardless of whether your accountant is outsourced or in-house, it does help if you and other key business stakeholders understand important accounting principles. Having a little more knowledge about key accounting principles means that fewer things are “lost in translation” when accountants and other finance officers provide reports. This wider knowledge can help prevent misunderstandings about the true state of the business and enable better decisions to be made, with fewer delays.
Fortunately, hiring accountants Dunedin businesses trust can give you access to professionals who can simplify these concepts for you. But even then, mastering the following critical accounting principles will do much to smoothen out communication between you and your accounting and finance teams:
1) Consistency
This principle refers to the need for businesses to maintain uniformity in their accounting methods and reporting practices, throughout the entire organisation and over time. Consistency isn’t usually an issue for small businesses operating out of a single location, but it will become necessary if it expands.
Consistently applying the same accounting procedures across business units and through time will ensure comparability between financial statements and increase the accuracy of any financial projections.
2) Accounting Periods
These are time frames used for financial reporting purposes. Businesses typically report their financial results monthly, quarterly, or annually, though other fixed periods could also be used. Knowing about differences in accounting periods provides important context related to your business’s financial position and makes it possible to execute timelier spending decisions.
3) Accrual vs. Cash Basis
Businesses follow either an accrual or cash basis for their accounting. The basis used can have a major impact on how cash flows are interpreted.
If a business follows an accrual basis, its revenue and expenses are recognised when they are earned or incurred, regardless of when the transactions occur. A business that operates on a cash basis recognises revenue and expenses only when cash is received or paid out.
There are benefits and drawbacks to either approach, with most smaller businesses using cash basis and larger organisations leaning toward accrual. In any case, knowing the differences lets you better understand what accounting report figures might mean for your business’s cash flow.
4) Matching
This is the principle of matching expenses with revenues in the period they are incurred, rather than when cash is exchanged. This makes it so that the costs associated with creating revenue are recognised in the same accounting period as the revenue itself. In turn, this makes it possible to have a more nuanced view of profitability and performance over time.
5) Materiality
This refers to the relative significance of financial information. If a piece of information can impact decisions, it’s material. If it doesn’t, then it’s immaterial.
Fortunately, with modern cloud-based accounting software, it’s relatively easy for accountants to include every transaction made by a business and to later filter these for reports, reducing the odds of material data being overlooked or omitted.
6) Going Concern
The “going concern principle” assumes that business will operate indefinitely unless there is evidence to the contrary. This concept is central to financial report preparation and helps decision-makers defer some expenses until a later date. Ultimately, however, whether or not a business can operate into the foreseeable future is somewhat subjective and depends on the assessment of your accountant or external auditors.
7) Conservatism
Conservatism is the default approach to accounting. It recognises losses and liabilities as soon as they are probable and delays the recognition of gains and assets until they are certain. This approach prevents businesses from overextending resources (i.e. spending money they don’t have), and it can also help them avoid regulatory risks. Accounting conservatism is sometimes open to interpretation, and a good accountant should be able to clue you in if opportunities present themselves.
8) Economic Entity Assumption
This principle treats businesses as separate economic entities from their owners. In practical terms, this means that your personal and business transactions should be recorded and reported separately. This assumption makes it possible for accountants to create more accurate financial reports and prevents the misuse of funds. More importantly, it can also help shield you and your business from legal risks.
9) Accounting Equation
You and anyone else who looks at financial reports need to know this concept. The accounting equation, sometimes called the “balance sheet equation,” states that an entity’s assets always equal its liabilities plus equity.
This principle is the foundation of double-entry bookkeeping and provides a framework for understanding the relationship between a company’s assets, debts, and ownership interests. Without knowledge of this one key principle, it will be impossible to contextualise your accounting reports effectively.
Mastering Accounting Principles: A Requisite for Stability and Adaptability
Developing a solid grasp of these accounting principles will smoothen out your relationship with your finance and accounting teams significantly, putting you all on the same page and ensuring your business’s stability in the long term.
Luckily, all you need to gain a mastery of these concepts is a willingness to learn and to ask questions. With better knowledge of these ideas, you’ll soon be achieving financial objectives with minimal difficulty, and you’ll gain the capability to pivot your business in whatever direction it needs to go.
