A Founder’s Roadmap to Essential Financial Understanding

Accounting comprises all tasks involved to document and record the various financial transactions within an organization. The output of accounting is crisp financial reports that give an actional insight into the financial health of a company, the cash flow status and the overall performance of the company. To produce these financial reports, each transaction is documented and assessed and finally, the key insights are put into the report. These reports are submitted to governing organizations, higher management, tax collectors and regulators.

Accounting and bookkeeping can be used interchangeably, but the key difference is that bookkeeping simply tracks and documents all financial transactions without trying to derive insights and analyzing these transaction records to understand the financial performance of a company. It is more of a mechanical than an analytical process. Accounting is way more complex and time-consuming with a high possibility of errors. Thus, accounting is not something you take up unless you own a company. And even in these cases, most business owners prefer to make their life easier by using automation by accounting to carry out most accounting processes.

A business or corporate entity is an organization set up by one or more persons to engage in commercial activities that drive profits. The types of corporate entities differ based on their ownership and structure. These can be sole proprietorships, LLCs, partnerships, corporations etc.

A sole proprietorship is a business owned by a single person who is responsible for all management, liabilities, and profits. While it is the easiest way to start a business venture, it also provides the least amount of legal and financial protection to the owner.

A partnership is when two or more persons own and co-run a business. Each partner takes equal responsibility and right over all aspects of a business like the assets, the work, expertise etc. Similarly, they also share the gains and losses of the company.

Limited liability corporations (LLCs) are the most flexible company structures that combine aspects of both sole proprietorship and corporations. This allows them to enjoy both tax benefits that sole proprietorships enjoy and the limited liabilities of corporations.

A cash-based accounting only accounts for and records transactions that have been completed. For example, income will be considered only if payment has been received. This system is generally followed by organizations such as NPOs, government entities, community organizations and small firms.

Accrual-based accounting on the other hand records transactions even before money is obtained or paid. This system uses accounts payable and receivable to keep track of the transactions like credit owed by clients and amounts owed to suppliers etc.

Profit and Loss Statement-

This financial statement records your total revenue and expenses over a defined financial period such as a quarter or a fiscal year. This gives an insight into if or not a company is in a financial position to further increase profits by either increasing incomes or by cutting expenses. It summarises if you have been spending more than you have been earning or vice versa. This information can help you assess the financial status of your company which is highly useful. This statement is produced usually produced in both cash and accrual format.

Balance sheet-

The balance sheet is a tool to evaluate an organization’s actual value also referred to as “book value”. This helps understand the financial health of the organization at a particular point in time called as reporting date by taking into account a firm’s assets, liabilities and shares. Balance sheets serve two distinct functions depending on who is analyzing them. They are used by external parties to assess a company's financial health. Also, they are used internally to help managers make strategic decisions about how to allocate available capital for best results.

Cash flow statement-

A cash flow statement (also known as the statement of cash flows) is a financial statement that shows the money flowing in and out of business over a specified time period. It is important to regularly monitor your cash flow to ensure you have sufficient liquidity to pay bills, invest in assets, and satisfy your operating needs.

The core purpose of a cash flow statement is to give investors an idea of how well a company manages its cash position. A positive cash flow means that more money moves into the company than that flows out. This is great because that means the extra income can be used to pay off debt, invest more into the growth of the business, invest in R&D etc. Negative cash flow indicates that money flows out more than it flows in. This is considered an alarming situation and needs to be looked into. However, in certain situations, this can be explained by investing greater amounts to develop a business which in a long run would be more beneficial.

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