Integrity is Key. This brings about honesty & good ethics & sound business principles. I am a true believer that Integrity applied to accounts that then show a true and fair value ensures that all stakeholders are receiving the correct information. Integrity in businesses leads to perpetual growth and protection from calamities. Good will lead to a mirror of nice customers and nice suppliers. With integrity, you will pay on time and you will not overcharge. Within accounting integrity will lead to the correct taxes being paid and avoid compliance breaches & fraud. Not to mention The Honest accountants and businessmen are promised Heaven. A win-win scenario all around.
I think every business should understand the concept of accrual accounting. Basically this means that you record an expense when you incur it and you record revenue when you earn it, even if bills aren't paid immediately. This concept makes it much easier to figure out how much money your business actually earned during the year regardless of when the checks were cashed.
There are various accounting principles which underline how accounts are prepared. Depending on what you read there are anywhere from five accounting principles to upwards of fourteen. Like all things I do, especially in finance, I like to keep it simple. For this reason I focus on five which I believe cover the key accounting concepts and ensure that financial information is accurate and useful. These five principles are accruals, conservatism, historic cost, substance over form and matching. Of these, I believe matching to be the most important for all business owners. Why? It’s where most business owners who know little about finance go wrong and can easily make wrong decisions. The matching principle states that income and costs relating the same thing/event/item/project should be matched and accounted for in the same period. This is vitally important as there can often be a lag between costs being incurred and income being invoiced. For example, let’s assume we are a business that repairs damaged houses for insurance purposes. Typically what will happen is that after the work is agreed for a house, the contractor will carry out the work. In doing so the contactor will incur costs – labour, materials and possibly other subcontractors, in advance of the work being invoiced on completion. The costs and income may therefore straddle more than one accounting period/month. If these costs and wages are incurred in one period e.g. June and accounted for in that period, and then the income is accounted for in July when invoiced, this will show a completely false picture. Why? Well, June will show no income and all of the costs for the project, and July will show all of the income and no costs thereby showing a loss in one month and a profit in another. If accounted for under the matching principle, a smaller profit would be shown in both months. This is why work-in-progress must be accounted for accurately at the end of every month thereby matching the costs with the income. Without this, wrong decisions can be made and indeed I have seen it many times. Recently a business contacted me stating they were going to cease trading as they were loss making. In fact, they had significant work-in-progress that had not been accounted for and that is why they were showing losses. When properly accounted for the business was profitable. Matching is essential.
One accounting principle that every business owner should understand is the accrual basis of accounting. This principle states that revenues and expenses are recorded when they are earned or incurred, regardless of when the cash is actually received or paid. Understanding this principle is crucial because it provides a more accurate picture of a company's financial health compared to the cash basis of accounting, which only records transactions when cash changes hands. From my experience working with various businesses, I have seen how misunderstanding this principle can lead to cash flow mismanagement and financial misreporting. For instance, a client once thought they were highly profitable because they had a significant amount of cash in hand. However, they had not accounted for several large expenses that had been incurred but not yet paid. By switching to accrual accounting, they were able to see their true financial position and make better-informed decisions about budgeting and spending. Understanding accrual accounting helps business owners plan more effectively, avoid unexpected shortfalls, and present a more accurate financial statement to investors and stakeholders.