Whether you are managing a business or a home, accounting is an integral part of everyday life.
You look at your salary, pay the bills, and
decide where else to spend your money. You also look at your pantry and take
inventory of canned goods and other products before grocery shopping.
Two accounting statements, the balance sheet and the income statement, are valuable to understand and practice for business and personal use. These
statements can help you know where your money is going and how to best use what you have.
The Balance Sheet is a statement of your assets and liabilities. Your home is an asset because it is worth something, and the
amount you owe on it is a liability. After subtracting the cost of mortgage payments, the equity portion is what you have
left in the home's value.
The equity portion is also called your net worth.
In the simplest terms, income statements represent the
incoming and the outgoing. The incoming are your paychecks, customer
payments, or dividend and interest income. The outgoing is what it costs
you to maintain your home or business: the gas, the electricity, the groceries, and the supplies used to make the product you sell or use in the service you sell.
When the incoming is less than the outgoing, you are "in the red."
This means you are not making a profit and have a negative net worth.
The balance sheet and the income statement are dependent on
each other. On the balance sheet, there is a liability called Accounts Payable.
These are bills you have to pay. When you record accounts payable, you also
record an expense. The Accounts Receivable is the money others owe you. When
you record accounts receivable, you record Income.
Credits and debits can be best understood by understanding
the Balance Sheet and the Income Statement. On the balance sheet, the assets
are debits, and the liabilities are credits. Equity and net worth are also credits.
On the Income Statement, Income is credited (and the asset increases to Cash or Accounts Receivable), and expenses are debited (Cash is reduced and Accounts Payable are reduced). When you record your paycheck, you debit your checking
account and an asset, and credit your Income. When you pay your bills, you
credit your checking account and accounts payable and debit your expenses. When you balance your checkbook and have cash left over at the end of the month, this is
your net worth.
Because you have cash left, the credit of the money coming in
and the debit of the cash going out is a credit balance. This credit balance
passes to the Balance Sheet Equity portion and reduces the liability portion.
Hopefully, your assets equal liabilities, and you are "in
balance."
Clear as mud?
Think of it as an X. At the top of the X, on the right and left sides, are
the Assets (on the right) and the Liabilities/Net Worth (on the left). At the bottom of the X, horizontally to the left of the Asset line, is the income-credit to Asset. At the bottom of the X, horizontally to the right of the Liability/Net Worth are expenses (decrease to Accounts payable) and Equity (cash).
Assets increase cash and Accounts Receivable. Liabilities increase Accounts Payable and Equity (the net Income left over after all bills are paid). Income minus Expenses is Net Income. A positive net income is a credit balance that
moves to the balance sheet. The Assets minus the Liabilities equal Net
Equity or Net Worth.
Can't you hire
someone to do this? Of course, but you need to know how
much cash you have at the end of the day. When you apply for a loan, the bank looks at your
net worth in this way. That is why they ask about how much you owe on your
home, what investments you have, and what you owe. It helps, especially in
today's economy, to understand what you have and do not have and how to
manage the cash coming in to pay your expenses and have some left over.
