Basic Financials and General Ledger

Let’s setup a new company named ABC Corporation that would do financial consulting.

1. What happens when you setup a new company?

2. What do you need once a company is setup? 

Money to buy furniture, get the most talented people onboard, enable them with right infrastructure to help them carry out their work and so on…

3. Does it all require funds to get it all done? Of course unless someone is willing to give it for free!

4. So how do we pay for it? You as an owner of the business can contribute some amount to the business OR you can approach bank for loan OR you can go public, list your company on a stock market and get money from public in exchange of shares.

So isn’t the business owing the money from owner or bank or public? Yes indeed! The amount that owner contributes to the company is called Capital. The amount that we get from bank in the form of loan is a liability. The amount that we get from public in exchange of shares is called Shareholders’ Equity.

For simplicity let’s call it as “Capital” for now.

5. And what do you do with that money? Buy Furniture, buy laptops, for your employees. So what’s furniture and laptop – Assets – because you own them and you have right to use it.

6. Now you got your resources on boarded, provided them with necessary infrastructure. So they are all set to go to the customers and provide them with consulting services.

7. The consultants have to travel from one place to another to go to the customer’s location, you as the owner of the company need to advertise your services/products, you need to pay salary to your consultants. What does this mean to your company – Expenses

8. Your consultant did a great job providing financial solutions to the customers and they paid your company for the services provided. What does this mean to your company - Revenue

Why Financials?

•There are several financial transactions that are carried out within an organization

•Such financial transactions need to be captured and recorded in a systematic manner so that we can draw meaningful conclusions

•What do we mean by meaningful conclusions?

•Is my business incurring profits or losses?

•How much expenditure did I incur in this month? Was it greater than last year same month? How much greater?

•How much revenue did I get by selling products/services to the customers?

•How much taxes did I pay this month and year?

•And many others….

•How can I capture and record the transactions so that I can answer these questions?

The only way to derive meaningful conclusions is by following certain guidelines or rules for recording these financial transactions.

•What are these guidelines / rules?

This gives rise to Financial Accounting. Financial accounting is a branch of accounting that uses standardized accounting principles & guidelines to record financial transactions. Example: India GAAP, US GAAP, IFRS etc.

Objectives of Financial Accounting

•To report the financial condition of a business at a point in time.

•To report changes in the financial condition of a business over a period of time.

Inshort•First, record the economic events affecting a business.
•Second, summarize the impact of these events in a report called financial statements.

Financial Statements

To be able to answer the financial questions and arrive at the right picture of an organization, the financial transactions should be recorded in a way that can produce the following 3 financials statements

•Income Statement
•Balance Sheet
•Cash Flow Statement

Who’s interested in these statements?

•Every company/organization has to be registered under laws (Companies Act 1956, 2013 in case of India) that gives it a separate identity.

•Companies need to publish the audited financial statements on an annual basis

•Who’s interested in it?

•Company’s internal board of directors, management

•Investors who have invested in company

•Auditors who attest the statements

•Banks who have provided loans to the company

•Securities and Exchange Board of India if a company is listed on stock exchange

Elements of Financial Statements

The information in the financial statement is organized in 5 major elements

•Owners’ Equity / Capital

•Asset

•Liability

•Revenue

•Expense

These elements are divided into classifications called accounts. For example a business might incur several expenses like stationary, office equipment, postage, rent, advertising & marketing expenses etc. To capture various types of expenses an organization would keep maintain expense accounts. Similarly for assets an organize would want to maintain various assets like Office Building, IT Hardware, IT Software, Telecommunication Equipment, Bank accounts, Cash etc.

How to manage these various accounts systematically?

Answer: Chart of Accounts

Chart of Accounts

•Every company has a chart of accounts, sort of like a table of contents in a book

•Each account is assigned a number. Usually assets start with 1, liabilities with 2, owner’s equity 3, income 4, expenses 5

etc.

•Examples include

Asset

An asset is a resource controlled by the enterprise from which future economic benefits are expected to flow to the enterprise. Assets can be tangible as well as intangible. Includes: Property, Plant & Equipment, Furniture, Accounts Receivable, Copyrights, Patents etc.

Asset	Account Description
10001	Cash In Hand
10002	Bank Balance
10003	Building
10004	Plant & Machinery
10005	Investment
10006	Debtors

Liability

A liability is a company’s financial debt or obligations that arise during the course of its business operations. Includes loans, deferred revenue, accounts payable etc.

Liability	Account Description
20001	Creditors
20002	Outstanding Expenses
20003	Bank Loan

Equity

Amount of capital contributed by the owners of the company. Includes owner’s equity and a portion of profit retained with the organization for further business operations

Equity	Account Description
30001	Owner’s Equity
30002	Retained Earning

Revenue

The amount of money that the company actually receives during a specific period

Income	Account Description
40001	Sale of Goods/Services
40002	Interest / Dividend Received

Expense

The economic cost that the business incurs during a specific period through its operations to earn revenue.

Expense	Account Description
50001	Salaries & Wages
50002	Rent
50003	Freight
50004	Telecom Expenses
50005	Electricity Expenses
50006	Taxes
50007	Depreciation
50008	Interest paid
50009	Advertising Expenses
50010	Travel Expenses