Assets refer to the value of a possession. Possessions may be physical in nature such as a vehicle or intangible such as money owed to the business by a customer. The most commonly used asset on the books of a business is the cash account. So cash is an asset and in reality it is the most important asset. Every business operates using cash and when the business operation is sold, the goal is to have more cash transferred to the owner than he initially invested. When cash is tight or low, operations become more difficult to maintain and therefore, more stressful for all involved.
Assets include amounts owed to a business from customers, prepaid expenses, inventory, fixed in nature (vehicles, equipment and real estate) and other forms such as legal rights or long term receivables. This type of an account is customarily reported on the balance sheet in the upper half.
On the opposite side of assets are liabilities. The most common liability in business is accounts payable. These are the amounts owed to suppliers or subcontractors for goods and services provided to the business. These vendors allow the business to pay later for these goods and services. Other liabilities include amounts owed for payroll and the associated benefits provided to employees.
In business owing money is not a good situation as debt creates drag in business operations. As debt builds most businesses experience insolvency issues and ultimately fail. The liabilities are found in the bottom half of the balance sheet.
The equity section of the balance sheet identifies the value of the investment made by the owners of the company. In most presentation formats it reveals the initial investment, lifetime earnings to the beginning of the fiscal period and the current earnings for this year. In addition, this section also states how much money has been withdrawn by the owners of the company.
Most individuals confuse revenue and sales. Revenue is more comprehensive and includes the subset of sales. Revenue can include interest earned on the cash deposits, fees charged to customers for late payments and more. Sales are confined to the primary purpose of the business.
Revenue is customarily reported in the upper section of the income statement or the more common title: profit and loss statement (P&L).
Cost of Sales
Cost of Sales is the more generic term referring to the costs associated with the corresponding sale. There are a multitude of different names associated with cost of sales and include:
• Cost of Goods Sold (used in retail)
• Cost of Services Rendered (used in professional services)
• Costs of Construction
• Cost of Meals Served (used in food service)
• Costs of Transportation (hauling and mass transit)
Each industry uses their own title corresponding to their respective function. The most common term is cost of goods sold.
The final type of an account is expenses. These are your customary operational costs such as rent, insurance, office operations, management costs, marketing and so on. They are typically reported in the lower part of the P&L.
In general, the P&L subtracts both cost of sales and expenses from the revenue to determine profit for the business over a period of time (accounting cycle often one month in small business). Other names for expenses include overhead, general, operating and administration.
Summary – Account Types
The purpose of understanding the six account types before moving on with other lessons is that you’ll soon learn that all data entered in the books of record have to get logged to one or more of these account types. In future lessons you will begin to understand that there is a relationship that exists between these account types and how they interact with each other. For this lesson, the goal is to understand that there are only six account types and no more. Only six!
5. Cost of Sales
Act on Knowledge.
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