Why should an entrepreneur know basic accounting principles?

Entrepreneurs can often be the idea people, who have the courage to go after their passion and start a business. And while they will have many skills, they might not have the experience in finance or with accounting that is necessary to start and run a successful business long term.

Difficult financial decisions and complex calculations are part of everyday business and by understanding basic accounting principles, you will set yourself up to make smarter decisions about your new business venture. Keep reading to find out why should an entrepreneur know these basic accounting principles:

• Managing cash flow
• Maintaining a balance sheet
• Identifying growth opportunities
• Forecasting business performance
• Staying tax compliant

It’s important to understand how to manage your cash flow effectively, as positive cash flow is the lifeblood of a successful business. Positive cash flow means that your company’s liquid assets (such as cash in the bank, savings or investments) are increasing, due to more sales or an upturn in the market. 

If you consistently generate a positive cash flow (where your liquid assets are increasing and you are comfortably able to pay your operating expenses, leaving more profit leftover), your business has a greater chance of succeeding without relying on funding or loans. It also means you’ll be able to grow your business by investing your money into tools or resources (such as equipment or a new employee) that can help scale up your operation.

On the other hand, a continued negative cash flow means you’ll likely struggle to make ends meet in the future.

The better your liquidity and overall financial performance, the more protected you’ll be if your company takes a sudden downturn. A good example of this was during the global pandemic. Companies that had a better cash flow were much better placed to manage the uncertain times.

Knowing how to prepare a cash flow statement regularly will help you organise your finances to increase your chances of creating positive cash flow and being able to weather unexpected financial storms.

A common report for businesses that checks their financial health is a balance sheet. A balance sheet can show the business’ net worth as well as showing how well a company will be able to pay its financial obligations and operating costs.

Simply put, the balance sheet is a two-sided chart. On one side of the chart, it will show the value of what you owe, and on the other side, what you own.

As the name of the balance sheet suggests, the total of each side should come to the same amount to show if your business is financially stable or not. 

To pull together the balance sheet, you’d add your assets on one side of a table and your liabilities and equity on the other. To calculate your owners equity (basically what you would own after all assets are sold and all liabilities are paid) you can do this simple calculation:

Assets total  – Liabilities total = Owner’s equity

As the name suggests, the totals should balance and fit this formula:

Assets total = Liabilities total + Owner’s equity

It’s important to understand how to pull this report together and by monitoring your owner’s equity, you’ll notice that if it goes up, then you have fewer debts. On the other hand, if the equity total goes down then you are owing more money than you own. This snapshot of the financial status of your business can be a useful tool for managing your finances and making decisions about where to spend your money on growth opportunities. It can also highlight where you need to be saving in order to pay your debts effectively.

Bookkeeping is the process of manually recording transactions, but accounting is the practice of analysing the information. It’s important for entrepreneurs to learn how to take an objective look at their business finances to analyse them, as an accountant would, as this will highlight areas for growth, and areas that could be improved.

For example, do you have too much stock leftover, or not enough? Looking objectively at how you manage your stock levels will help you decide what to do to improve financially and operationally. Keeping more stock than usual might cost you a little more, but you may know there is a customer demand for it. Or conversely, you might be able to save money on storage by buying less stock as it takes longer to shift. 

Learning how to create a good forecast for the business will be a useful tool throughout the trading year. By forecasting sales and cash flow you’ll be able to plan stock or resources around your busier times. This can save money when your sales are a bit lower in order to have that ‘safety net’ of cash to get you through quieter times. 

Identifying seasonal trends in your business performance can make forecasts effective and will help you plan activity to boost sales at those slower times, so that your cash flow is not affected too much. Forecasting can also help you make backup plans for when sales may drop, so that your business does not get stuck in a rut, or stall business growth.

Many small business owners might have zero experience in keeping reliable books, but it’s crucial to learn how to record all transactions correctly, so that you are compliant when it comes to self-assessment season.

Entrepreneurs that are new to business may also have little knowledge of what they can expense when it comes to their tax Self Assessment. Learning how to file receipts and record expenses effectively so that there are no anomalies when it comes to self-assessment season is a skill that will save hours of financial admin.

To save time and automate accounting admin, thousands of entrepreneurs across the UK use the Countingup app. 

The two-in-one business current account has free built-in accounting software that automates the time-consuming aspects of bookkeeping, and can save you hours of financial calculations and filing time. You can also share your financial records with an accountant directly through the app, making it simple to manage your accounting. Find out more here.