Understanding Financial Accounting

Introduction

Accounting is the language of business. To understand accounting for your small business/freelance work/startup/agency, you need to understand six key words: assets, liabilities, shareholders' equity, revenues, expenses, and dividends.

Assets
Assets are things of value that a company (or you as a freelancer/small business owner) owns or controls. The key idea is that assets are things of value. Some examples for a small business:

• Cash
• Accounts receivable (money owed to you by customers)
• Inventory (products you've purchased to sell)
• Property like land, buildings, equipment, vehicles
• Investments

Liabilities
Liabilities are anything that has to be repaid in the future. For a freelancer or small business, examples include:

• Accounts payable (bills you owe within 30 days like utilities, rent, supplier invoices)
• Notes payable (loans from banks, informal loans)
• Wages/bonuses payable to employees
• Mortgages or loans on property/equipment

Shareholders' Equity
Shareholders' equity represents the owner's share of the company. It is calculated as Assets - Liabilities. For a freelancer or sole proprietor, this is simply your equity in the business.

The accounting equation is: Assets = Liabilities + Shareholders' Equity

This shows that what a company (or you) owns (assets) is equal to what they owe (liabilities) plus the owners' stake (shareholders' equity).

Example 1:
You are a freelance web developer. You have:

• Assets:
  - Cash in bank: $5,000
  - Computer/Equipment: $3,000
• Liabilities:
  - Credit card balance: $1,500

Using the accounting equation:
Assets = Liabilities + Shareholders' Equity
$8,000 = $1,500 + Shareholders' Equity
Shareholders' Equity = $8,000 - $1,500 = $6,500

So your shareholders' equity, which represents your ownership stake in the freelance business, is $6,500.

Example 2:
Your small marketing agency has:

• Assets:
  - Cash: $25,000
  - Accounts Receivable: $10,000
  - Equipment: $15,000
• Liabilities:
  - Accounts Payable: $7,000
  - Loan Payable: $20,000

Assets = Liabilities + Shareholders' Equity
$50,000 = $27,000 + Shareholders' Equity
Shareholders' Equity = $50,000 - $27,000 = $23,000

Example 3:
Your startup company has:

• Assets:
  - Cash: $150,000
  - Inventory: $75,000
  - Property: $500,000
• Liabilities:
  - Accounts Payable: $25,000
  - Notes Payable: $200,000

Assets = Liabilities + Shareholders' Equity
$725,000 = $225,000 + Shareholders' Equity
Shareholders' Equity = $725,000 - $225,000 = $500,000

The accounting equation shows that the company's assets are funded by either liabilities (debts) or shareholders'/owners' equity. Tracking this equation is critical for any business.

Revenues
Revenues are what a company earns from doing its business. For a freelancer, this is your income from client projects. For a small business, it is the sales revenue from products/services.

Expenses
Expenses are the costs of operating the business and earning revenues. For freelancers, this includes home office expenses, software subscriptions, professional development costs. For any business it includes expenses like salaries, rent, utilities, marketing costs.

Dividends
Dividends are profits paid out to shareholders from a company's retained earnings (profits kept in the business). For freelancers and small businesses, dividends could represent the owner paying themselves profits from the business rather than keeping all profits reinvested.

With these six terms - assets, liabilities, equity, revenues, expenses, and dividends - you have the core accounting concepts for operating and tracking the finances for your freelance work or small business. Understanding them thoroughly is critical as you move forward in accounting.