Understanding the nuts and bolts of accounting: an engineering perspective
I was a latecomer to accounting. I first completed a degree in engineering and only moved to accounting after that. Almost everyone who heard what I was doing told me how difficult I would find it and that I would struggle to get to grips with it, never having done it before.
However, I actually found it find quite straightforward and not nearly as daunting as I was led to believe. While there’s a lot of jargon that can be off-putting to someone new to accounting, it becomes a bit easier if you try to think of it in terms of processes with inputs and outputs, as an engineering training would encourage.
Let’s start with the inputs.
Understanding your inputs
It’s useful to start by thinking of your accounts as a database of all the various transactions that happen within your business. So the first thing to do is ask what sort of transactions go on in your business – and, funnily enough, the types of transactions are relatively common across most businesses, regardless of industry and sector.
- Sales – every business sells something to customers. This means that we need to record our sales and we need to have customer records to track what we’re doing for each customer.
- Purchases – The business will also buy things from suppliers. This means we need to record purchases and we need to have supplier records to track our activity with each supplier.
- Payment and receipts – Finally, we need to receive and spend money, so we need a way to record these as money in and money out to/from the business.
That gives us three main types of transactions – sales transactions, purchase transactions, and payment/receipt transactions.
Next, we need to think about how to capture and record those transactions – creating the financial records that, ultimately, will become your accounts.
There are a number of ways of setting up and maintaining those records. You can have paper records (traditional but on the decline in the digital age), you can use Excel spreadsheets or you can buy accounting software. Unless your business is very small, it’s better to use accounting software. Most accounting packages will do what we need fairly easily. However, if the software is well designed, it can also give you a lot of other useful information that would be impossible to collate with paper files or Excel files.
Understanding your outputs
Next, we should move to focus on the outputs for the business. What sort of information do we need our accounting records to provide?
- Business health – we need a measure of how well the business is doing and whether were actually getting a return on our investment (both time and money).
- Financial reporting – we need reports that will prompt us when actions are necessary; i.e. when to pay a supplier, or when to chase a slow-paying customer.
- Business performance – finally, we need information that will help us to understand what’s going on in the business and why we’re getting the results we’re seeing.
To understand how well a business is doing we need to know the ‘net worth’ of the business. The net worth is the difference between what a business has and what that business owes. Accountants call “what a business has” the assets of the business and they call “what the business owes” the liabilities of the business. So the key report in accounting language is the ‘balance sheet’ as this lists the assets and the liabilities of the business.
The other thing you will want to understand is where the business is getting money from and where it is spending money. You probably already know that this report is the ‘profit and loss account’ (we’ll talk about this more in a future blog post). It’s the report that shows how money moves into, and out of, the business – a vital way of measuring performance.
The need for insightful information
So, we’ve explained the basic nuts and bolts of accounting for you. You now understand the importance of breaking your transactions down into the ‘inputs’ and ‘outputs’ that explain the flow of money through your business.
The next step is to start turning these financial transactions into insightful, useful business information – a topic we’ll cover in the next in this series of blogs.
If you’d like some help to understand your accounting basics, please do get in touch with us and we’ll be happy to help.