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ACCOUNTING BASICS: a Guide to (Almost) Everything - YouTube
Channel: Accounting Stuff
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Accounting is like a big tree
it's been around for ages
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and it has lots of branches
There's financial accounting
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managerial, tax, audit
and bookkeeping
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But generally I think when
people say accounting they
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usually mean financial accounting
So what is financial accounting?
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It's the process of
identifying, recording,
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summarizing and analyzing
an entity's financial transactions and
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reporting them in financial statements
Hey I'm James and if this definition
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doesn't mean much to you
it's all good
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stick around me for the next
ten minutes or so and you'll see
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exactly how financial accounting works
We've got lots cover but I do recommend
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watching this right through to the end
at least once so that you can get
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an idea of the big picture
Let's do this!
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Imagine that you own Ruff Times
a tabloid newspaper covering all
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the latest gossip on our furry friends
During March you run a promotional
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offer for annual subscriptions
that begin on April 1st
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People can't get enough of your stories
and you end up with $40,000
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in new subscriptions
all paid for in cash
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The first step in financial accounting
is to identify the transaction
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Well that's easy
I just mentioned one you made
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$40,000 in new annual subscriptions
these start on April 1st and continue
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through to March 31st next year
So what next then?
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It's time to prepare a journal entry
A journal is a record of a
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financial transaction and it looks like this
You have a unique journal number,
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a date, a description, the accounts affected
in this case that's cash and
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subscription revenue
and then you have your debits and credits
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which are both $40,000
Ruff Times is a serious business so
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you're using double entry accounting
which means this transaction affects
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at least two accounts and the
total debits are equal to the total credits
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But why do we do it this way?
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What is double entry accounting?
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The first thing you need to know
is that Financial Accounting
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is built on one simple idea
The stuff that your business owns is equal
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to the stuff that your business owes
We call the stuff that your business owns
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Assets these are valuable resources that you'll
benefit from in the future
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things like cash and inventory
but on the other side of this formula
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we use two different words to describe
the stuff that your business owes
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Liabilities when you owe stuff to
third-party lenders or suppliers
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these are your obligations that you'll
need to fulfil in the future
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and equity when Ruff Times
owes stuff to you
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the owner
this represents your claim on the
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business's net assets
So assets equal liabilities plus equity
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this little formula is called
the accounting equation and it
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has big implications
It was written down a long time ago
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by this guy in this book and it
revolutionised the way we record transactions
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It鈥檚 the foundation of double-entry accounting
the theory that there are at least
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two equal and opposite sides to
every transaction because this
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accounting equation is always true
it must always balance
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Debits and credits are the words we use
to reflect these two sides
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Credits represents the sources
that economic benefit flows from
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whereas debits represent the
destinations that it flows to
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Nowadays pretty much every
large business in the world uses
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double entry accounting and so
does Ruff Times
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In this case you debit cash by $40,000
to increase your assets and you
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credit subscription revenue by $40,000
to record your income
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Are you hanging in there?
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I know there's a lot to take in
and some of these terms might not
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make sense right away
that's okay just give it some time
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and let it all seep in
After this you can always jump into
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my accounting bases playlist
and explore everything
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I mention in a lot more detail
I drop a link to that down below
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in the description
just below that big red subscribe button
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I don鈥檛 know what that voice that was but...
anyway...
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the next step is to post the journal
into your general ledger
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The general ledger is a place where you
store all of your financial data
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It contains a complete record of your
accounts and journal entries
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Back in the day it used to be this
huge book that you鈥檇 fill out by hand
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but thankfully we've moved on now
and businesses like yours
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use accounting software
which treats the general ledger
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as kind of a central database
So how do we get this journal
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into your general ledger?
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You post it to your accounts
Accounts of places where you
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record, sort and store all transactions
that affect a related group of items
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Broadly speaking there are
six types of account
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assets, liabilities and equity which we
already know from the accounting equation
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and then there's revenue,
expenses and withdrawals
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also known as dividends
These feed into the equity
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part of the equation
If you'd like to see how and why that works
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then you can check out my
video on equity I'll pop a link to
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that in the description
This journal affects two accounts
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and we can picture what they look like
by drawing out two T鈥檚
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and labelling them
cash and subscription revenue
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These are called T accounts
and they help us visualise what your
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accounts look like
Debits go on the left and
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credits go on the right
When you post this journal
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you debit the left-hand side of your
cash account by $40,000 and you
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credit the right-hand side of your
subscription revenue account
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by $40,000 as well
When we total these up you now have
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$48,000 in cash and you've made
$75,000 in subscription revenue
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But Ruff Times has other accounts too
it has a whole collection of
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assets, liabilities, equity,
revenue and expense accounts
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stored in your general ledger
You post this journal during March
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when you collect the cash
but now let's fast-forward to the
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end of your financial year
to December 31st
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We need to put together your
unadjusted trial balance
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What's a trial balance?
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It's an internal report that summarises
the closing numbers in all of your
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general ledger accounts
It can help us check for errors
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but ultimately we use it to make
financial statements as you'll soon see
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But what does it look like?
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Here's your general ledger again
and now let's jump ahead to the
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end of December
Building a trial balance is
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actually quite simple
you list out all of your accounts
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and their closing balances and
that's all there is to it
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A closing balance is the
cumulative total of all transactions
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affecting an account
As usual debits are on the left
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and credits are on the right
At the bottom of your trial balance
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you have your total debits and total credits
these should match each other exactly
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because the accounting equation
is always true
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Trial is another way of saying test
which is what the trial balance was
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originally used for
as a test to check your debits
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and credits are in balance
and this is an unadjusted trial balance
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because we haven't adjusted it yet
but we will
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now actually because you've ended
a financial year so we need to
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post some adjusting entries
Adjusting entries are journal entries
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that bring your books in line with
something called the
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accrual method of accounting
What's that?
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To understand you really need to know
about the accounting rule books
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Yes accountants have to be good
and follow the rules
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but the rules change a bit depending
on where you're based
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you might follow the
international financial reporting standards
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or some variation of the
generally accepted accounting principles
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IFRS or GAAP
These two rule books make sure that
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your financial statements reflect
a true and fair view of your business
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which is important because a lot of people
rely on financial statements
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particularly those who鈥檝e lent you money
or invested in your business
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Anyway IFRS and GAAP have one
major thing in common
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they both want you to follow
the accrual method of accounting
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which means you need to recognise
your revenue as you earn it
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and record your expenses
as you incur them
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This is the most accurate way to
calculate your profit
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but here's the thing
Ruff Times hasn't been
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playing by the rules
In March you ran a promotion on annual
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subscriptions starting on April 1st
You collected $40,000 in cash and
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posted a journal to recognise that
whole amount as revenue on March 31st
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This is called cash accounting
and it's not the same as accrual accounting
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in cash accounting you
recognise your revenue as you receive cash
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and record your expenses as you pay it out
But receiving cash is not the same as
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earning revenue
let me show you
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You received $40,000 of cash during March
but you actually earn that revenue
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over the next twelve months
this is when you do the work
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this is when you release each issue of Ruff Times
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So today as things stand on December 31st
you've recognised 12 months of income
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this financial year but you haven't
earned three months of it yet
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and you won't until the end of March next year
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But it's all good
that's what adjusting entries are for
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These are the journal entries that you post
to bring your books in line
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with the accrual method
We can fix this situation by reversing
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3 out of the 12 months of your
subscription revenue which is $10,000
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and temporarily holding it as a liability
in an account called deferred revenue
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or unearned revenue
This is a liability account because you
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still have an obligation at the end
of the year to provide your customers
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with Ruff Times from January to March
Let's post this one to your general ledger
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and run ourselves a
new adjusted trial balance
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This time is adjusted because
you鈥檝e posted your adjusting entries
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We can see that your subscription revenue
has gone down by $10,000 and your
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liabilities have gone up by $10,000
Your debit and credit totals still
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match each other because there are
two equal and opposite sides to the journal
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and now you're playing by the rules
because you're following the
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accrual method of accounting
Nice one!
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Now we can create your financial statements
Financial statements are
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accounting reports that summarise your
business's activities over a period of time
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These are external reports
designed to give your
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investors, lenders and creditors
and an understanding of your
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business's financial health
The three main financial statements
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are called the balance sheet,
the income statement and the
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cash flow statement
We can build all of these
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using your adjusted trial balance
Your balance sheet looks like this
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it gives us a snapshot of your
business's assets, liabilities and equity
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at a single point in time
which can teach the readers about
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your financial position
they can see what you own and what
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you owe at the end of your financial year
Now let's check out your income statement
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this summarises your business's revenues
and expenses over a period of time
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Here that's the previous year
and it gives the readers a glimpse of your
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financial performance and profitability
If you were cash accounting
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then this income statement would also
mirror your cash flows
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but you're using the accrual method so
profit and cash flow aren't the same thing
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You keep track of your cash flow
separately in a cash flow statement
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This report summarises your cash inflows
and outflows over the same period of time
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Once you've created these three
financial statements you can send
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them out to your
investors, lenders and creditors
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if Ruff Times was listed on a
stock exchange then investors
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all around the world would compare
your performance against their
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expectations and decide whether to
buy or sell shares in your business
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They'd analyse your statements
using financial ratios which is
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something that we haven't covered
on this channel yet
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so if you'd like see some videos on that
then by all means
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please let me know down in the comments
But we're not finished yet
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Once you're done with your
financial statements you need to
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post some closing entries
to prepare your books for next year
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A closing entry is a journal entry
that you post to clear out all of your
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temporary accounts like
revenues, expenses and dividends
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For Ruff Times your journal would look
something like this
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You鈥檇 debit your revenue accounts and
you鈥檇 credits your expense accounts
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to clear them down to zero
The balance of $26,440 goes to
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retained earnings in the equity section
of your balance sheet
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These are your profits that you're
holding on to for the future
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So if we look at your trial balance again
then we can see your
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revenue and expense accounts have been
reset to nil and now you're ready to
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tackle the new year
Together these steps make up the
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accounting cycle and this is
what Financial Accounting is all about
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It鈥檚 the process of identifying, recording
summarising and analysing your
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business's financial transactions and
reporting them in financial statements
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Shout out to Munesh at home food maniacs
for requesting this one
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a long time ago
so thanks for being so patient with me
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and thank you for subscribing
We've now hit a hundred thousand
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subscribers on this channel
which is mental
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If you'd like to support this channel
then you're welcome to buy my cheat sheets
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I've added a new one covering the
accounting cycle which we just went through
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or you can hit that join button below
and if you'd like to learn more about
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accounting then I recommend
starting right here
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Thanks for watching and
I'll see you in the next one!
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