STUDY

Accounting Fundamentals · Lesson 1 · about 10 minutes

Why accounting exists

Accounting gives a business a reliable way to understand what is happening with its money and other resources.

The basic idea

Imagine running a small business without keeping records. Money arrives when customers pay you. Money leaves when you buy supplies, pay rent, or pay workers. You might look at the bank balance and think you know how the business is doing.

But the bank balance does not tell the whole story.

Some of that money may already be owed to someone else. Customers may owe the business money that has not arrived yet. Equipment has value even though it is not cash. Bills can exist before they are paid.

Accounting creates an organized record of those things.

At the simplest level, it helps answer questions such as:

Accounting is more than watching cash

Suppose a business has $10,000 in its bank account. That sounds healthy.

Now suppose $8,000 of that money came from a bank loan.

The business has $10,000 in cash, but it also has an obligation to repay the bank. Treating the entire $10,000 as money the business earned would give a false picture.

Accounting records both sides of the situation.

Knowledge check

Think before opening the answer

A business borrows $2,000 from a bank. Did the business earn $2,000 of revenue?

Check your answer

No. The business received $2,000 in cash, but it also took on a $2,000 obligation to the bank. Borrowing money is not the same as earning revenue.

Three ideas to retain

  1. Accounting records the financial activity of a business.
  2. Cash by itself does not tell you whether a business is doing well.
  3. Money received is not automatically revenue; sometimes it creates an obligation.

Review schedule

Revisit these three ideas tomorrow. If they still make sense, review them again in about a week. The next lesson gives names to the major pieces of this financial picture.