Fundamental Accounting Concepts


There are four basic accounting concepts in the practice of business, each of which has its own meaning. These four concepts are: capital investment, cost of goods sold, income taxes, and cash flows. The fourth one, cash flows, is probably the easiest to explain. This concept simply means the movement of money from one financial account to another (usually from a bank account to a checking account). For a business to operate successfully, it must have a good cash flow and be able to keep all its assets and liabilities at reasonable levels.

The first basic accounting concept that we will look at is capital investment. This is an investment made on equipment and real estate that produce a profit or loss. Capital investments are a type of inventory that is made by an organization so that it may pay dividends for a limited period of time, or to buy back its own stock, or both.

The next aspect of capital, expense, income, and cash flow is reflected in a financial statement. This type of statement tells how much revenue a company makes, and how much expenses it incurs. All four of these things affect each other; without the proper balance, a business cannot make any profits.

The third aspect of the financial statement is profit. Profit is simply the difference between expenses and income. Because profit is the difference between what a company pays out in earnings and what it makes of its assets, and because the balance sheet shows how much profit a business actually makes, it is also called an income statement. If the profit is negative, that means there has been a loss, and a business is being operated at a loss.

The fourth of the four fundamental accounting concepts we will discuss is cash flow. Cash flow is how a business pays its debts and makes payments to its creditors. To determine cash flow, a business takes into consideration all of its accounts receivable, accounts payable, and its gross accounts. The difference between the amount of cash that is left over for payments to its creditors and the amount of cash that are left over for paying its debts is called the cash flow of a business. Because this is the case, cash flow is important, because it is what determines the amount of money a business has to invest in the production of goods and services it can use to make future purchases.

Knowing the four basic accounting concepts and how they affect each other will help you understand the process of making your financial statements, and how to use them to benefit your business. The concepts we just discussed are important to business owners. Now that you know them, you can start using them to help you manage your business and maximize profits.