What Is Accounting? Why It Matters Even If You're Not an Accountant

Accounting is the language of business. If you run a small business, manage a team, work in sales or simply want to understand a company's numbers before you invest, negotiate or sign a lease, you need to read that language, even if someone else keeps the books. This free bookkeeping course starts from zero, skips the jargon you don't need and uses one real-world small business from its first day to its valuation.

What accounting is, in one sentence

Accounting is the system that records, classifies and summarizes a business's transactions in dollars so that anyone can answer three questions:

1. What does the business own and owe on a given date? That's its financial position.
2. Did it make or lose money over a period? That's its results.
3. Where did the cash come from and where did it go? That's its liquidity.

Every sale, purchase, paycheck or loan is a transaction. Accounting captures each one with a consistent method, double-entry bookkeeping, which you'll master in lesson 4, and at the end of each period rolls them up into financial statements: the income statement, the balance sheet and the cash flow statement.

Bookkeeping vs. accounting

In the U.S. the two words are often used interchangeably, but they describe different jobs. Bookkeeping is the day-to-day recording: entering invoices and receipts, categorizing bank transactions, running payroll and reconciling accounts. Accounting takes that data and turns it into financial statements, analysis, budgets and tax returns. A bookkeeper keeps the records clean; an accountant or CPA (Certified Public Accountant, a state-licensed professional) interprets them and signs off on tax and audit work. Clean bookkeeping comes first: without it, even the best accountant is guessing. For a practical setup guide, see our article on bookkeeping for small business.

Why it matters if you're not an accountant

• Small business owners: know whether you're actually profitable, how much you can pay yourself without starving the business, how much cash you'll need next month and how to work with your CPA as a partner rather than a black box.
• Managers and salespeople: understand margins, costs and budgets, and defend a proposal with numbers instead of opinions.
• Investors: read a company's 10-K before buying its stock, or a small company's statements before becoming a partner.
• Everyone: the same ideas organize your household finances. Our free personal finance course applies them to your own money.

The four main branches of accounting

The method is the same everywhere, but accounting specializes depending on who uses the information:

This course focuses on financial accounting, the foundation for the others, and adds the managerial and tax topics small businesses ask about most. Public companies must follow GAAP and file audited statements with the SEC. Private small businesses usually aren't legally required to follow GAAP, but banks, investors and buyers expect statements that do, and its logic is simply the best way to see what's really happening.

The principles behind the numbers

GAAP rests on a few basic ideas. You don't need to memorize them, but you should understand them, because they explain most of the "strange" things you'll see in financial statements:

• Business entity: the business's money is not the owner's money. If you pay for your groceries with the company debit card, that's not a business expense; it's an owner's draw. Mixing the two is the number one small business mistake, and for an LLC or corporation it can even weaken the liability protection you set it up for.
• Accrual basis: revenue is recorded when it's earned and expenses when they're incurred, not when cash changes hands. Sell in December, collect in January, and the sale belongs to December. That's why a business can show a profit and still have no cash.
• Going concern: the business is assumed to keep operating, so assets are valued for their use, not at fire-sale prices.
• Conservatism: when in doubt, don't anticipate gains, but do recognize probable losses.
• Consistency: use the same methods year after year so the numbers can be compared.
• Historical cost: most assets are recorded at what you paid for them, not what they might be worth today.

Cash basis or accrual basis?

Many small businesses may file their taxes on the cash basis, while larger ones, and some with inventory, must use accrual. Ask a tax professional before choosing, because switching later generally requires IRS approval. Whatever you file, managing on accrual gives you the truer picture, and that's what this course teaches.

The accounting cycle in 6 steps

All the accounting work for a period, usually a month, follows the same cycle. The lessons of this course walk through it in order:

1. Step 1Capture the source documentAn invoice, receipt, bank statement, payroll report or contract. No document, no entry. The IRS expects you to keep records that back up your tax return.
2. Step 2 · lesson 2Analyze the transactionUse the accounting equation: what goes up and what goes down?
3. Step 3 · lessons 3–4Record it in the journalPick the accounts from your chart of accounts and write a balanced entry with debits and credits.
4. Step 4 · lesson 5Post it to the general ledgerThe ledger groups every entry by account so you can see each balance.
5. Step 5 · lessons 5–7Adjust and checkRecord adjusting entries and prepare a trial balance to prove debits equal credits.
6. Step 6 · lessons 8–10Prepare the financial statementsIncome statement, balance sheet and cash flow statement. Then close the books and start again.

Today almost nobody does this by hand. Software such as QuickBooks, Xero or Wave, or even a well-built spreadsheet, handles steps 4 through 6 automatically. But if you don't understand steps 2 and 3, the software just hands you numbers you can't interpret, and miscategorized transactions flow straight into your tax return.

Meet Brightside Coffee

Throughout the course you'll follow Brightside Coffee, a small coffee shop that Maya Torres is opening in Austin, Texas. She set it up as a single-member LLC, one of the most common structures for U.S. small businesses (you'll see what that means for taxes in lesson 13). Here are its first transactions:

1. Maya invests $40,000 of her savings in the business.
2. The shop buys an espresso machine and grinders for $12,000, paying cash.
3. It buys coffee beans, milk and cups for $6,000 on account (to pay the supplier in 30 days).
4. It takes out a $10,000 bank loan.
5. It sells $18,000 of coffee and pastries during the month, paid by card and cash.
6. It pays $3,500 of rent for the space.
7. It pays $7,000 of wages to its baristas.
8. At month-end, a count shows $1,000 of supplies left, so $5,000 worth were used.

Before selling a single latte, Maya had to fund the business. This is where her $50,000 of startup money came from:

In the coming lessons you'll record these transactions, build Brightside's books and, by lesson 10, produce its three financial statements. Later you'll budget its next quarter, figure out what a new barista really costs, price a new line of cakes and estimate what the business is worth.

Summary

• Accounting records, classifies and summarizes transactions to show what a business owns and owes, whether it earns a profit and how its cash moves.
• Bookkeeping is the daily recording; accounting turns those records into statements, analysis and tax returns.
• U.S. financial statements follow GAAP; tax returns follow the tax code, and the two often differ.
• The business is separate from its owner, and the accrual basis records revenue and expenses when they happen, not when cash moves.
• The accounting cycle runs from the source document to the financial statements, every period.

Next lesson: The Accounting Equation: Assets, Liabilities and Equity, with Examples. You'll learn the one formula behind every balance sheet and use it to analyze Brightside's first month.