What Is Accounting?

Adapted from Paul Hynek's course at Pepperdine University in Malibu, California.

Right off the bat, let's clear up three myths:

1. You need a CPA to understand accounting.
2. You can hire someone to do the accounting for your projections and your business, so you don't need to know this stuff.
3. It takes way too long to learn enough to make it worth your time.

With these short lessons and EZ Numbers, you'll quickly learn the basics that matter. You'll be able to sit in front of investors and walk them through your financial projections without that deer in the headlights look.

That's the Good News. The Bad News? That's the Better News, because there ain't any Bad News. Now let's jump in.

Accounting Is the Language of Business

It's not boring or complex. It's just numbers put into agreed-upon categories. From the Lebombo Bone, about 44,000 years ago, until today, accounting has kept one focus: communicating financial information accurately and openly, inside a company and out.

Accounting is about creating transparency and trust in the numbers you're given.

Bookkeeping, Accounting and Auditing

• Bookkeeping is Recording: entering the data.
• Accounting is Communicating: analyzing and correcting the numbers.
• Auditing is Verifying: independently confirming the numbers.

The Rules Everyone Follows

The guiding principles of accounting are called Generally Accepted Accounting Principles, or GAAP. They're a shared set of conventions, so statements from different companies and nonprofits can be compared side by side.

Perhaps the most important is Conservatism. For your startup projections, that means staying on the low side when projecting Revenue and on the high side when projecting Expenses.

Another one to know is Matching: we record revenue and the expenses that produced it in the same period.

The main examples of Matching are Depreciation (for Tangible Assets) and Amortization (for Intangible Assets). Say you buy equipment for $70,000 and it will be useful for 7 years. If you put the whole $70,000 on the P&L in the year you buy it, that year's profit looks distorted: you're absorbing the cost of something that will help earn money for 6 more years. So instead we Depreciate it over the 7 years, recording $10,000 each year. The expense now matches the revenue it helps create. Amortization works the same way for Intangible Assets.

Cash Method vs. Accrual Method

• Cash Method: the simplest, used by many new and small businesses. You record revenue and expenses when cash changes hands. Sign a big contract, and nothing goes in the books until the first cash arrives.
• Accrual Method: you record revenue when you earn it, and expenses when you take on the obligation.

EZ Numbers uses the Accrual Method, because that's what investors and banks want to see.

Accrual leads to Accounts Receivable (AR) and Accounts Payable (AP). Accounts Receivable is money your customers owe you for products or services they may already have received. Accounts Payable is money you owe your vendors for products or services you may already have received.

Receivables and Payables are two reasons why CASH IS NOT PROFIT. We'll go over this thoroughly. Now let's see accounting in action, with a lemonade stand.