Basic accounting concepts

In this section of our accounting guide we refer to the basic accounting concepts that every entrepreneur should know.

Assets

These are all the goods and rights that belong to the company. It forms part of the balance sheet together with liabilities and equity. Assets are classified into current and non-current assets.

Non-current or fixed assets are those assets that cannot be converted into cash in the short term and are therefore the investments made by the company in the medium and long term. Non-current assets include, for example, installations, premises or machinery.

Current assets are assets that can be converted into cash in less than one year. Current assets include, for example, inventories or customers receivable.

Liabilities

Liabilities represent the debts and obligations with which a company finances its activity and therefore serves to finance its assets.

Liabilities are debts that we have in the present but which we have incurred in the past. An example of a liability would be for example a loan with a financial institution.

Liabilities are one of the three asset and liability items on the balance sheet, together with assets and equity.

Liabilities are made up of two asset and liability items, non-current liabilities and current liabilities.

Non-current liabilities consist of all long-term debts and obligations of a company. In other words, debts with a maturity of more than one year.

Current liabilities are the part of the liabilities that contain a company’s short-term obligations. That is, debts and obligations that have a duration of less than one year.

Equity

The equity of a company consists of all the company’s own financial assets and liabilities. In the balance sheet it is the difference between assets and liabilities.

Equity is mainly made up of shareholders’ equity (the money contributed by the shareholders and the reserves kept by the company and the profits it has generated).

Equity is one of the three assets and liabilities on the balance sheet.

To obtain the net assets of a company, we subtract the liabilities from the assets.

Annual Accounts

The annual accounts are documents that contain financial information and are intended to meet the needs of users in an economic decision-making process.

The information contained in the annual accounts is intended for all those persons who, for whatever reason, have a relationship with the company that deposits them and are therefore interested in knowing the situation and progress of the company.

The annual accounts of small and medium-sized companies comprise the balance sheet, the profit and loss account, the statement of changes in equity and the notes to the financial statements. These documents form a single unit and must be drawn up in accordance with the provisions of the Commercial Code, the Consolidated Text of the Public Limited Companies Act, the Limited Liability Companies Act and this General Accounting Plan for Small and Medium-sized Enterprises.

Without prejudice to the foregoing, these companies may include in their annual accounts a cash flow statement, which shall be prepared and presented in accordance with the provisions of the General Accounting Plan.

The annual accounts shall be prepared on a twelve-monthly basis, except in cases of incorporation, modification of the closing date of the financial year or dissolution.

The annual accounts shall be drawn up by the entrepreneur or the administrators, who shall be responsible for their veracity, within a maximum period of three months from the end of the financial year. For these purposes, the annual accounts shall state the date on which they were drawn up and must be signed by the entrepreneur, by all the partners unlimitedly liable for the company’s debts, or by all the directors of the company; if the signature of any of them is missing, the reason for this shall be expressly stated in each of the documents in which it is missing.

The balance sheet, the profit and loss account, the statement of changes in net assets and the notes to the annual accounts must be identified; the name of the company to which they relate and the financial year to which they refer must be clearly indicated on each of these documents.

Balance sheet

The balance sheet, also known as accounting balance sheet or statement of net worth, is a financial statement that reflects the economic and financial information of a company at a given moment, separated into three assets, liabilities and net worth.

The balance sheet is a very important tool as it provides us with a quick and agile overview of the state of the company at any given time.

Profit and loss account

The profit and loss account is an accounting document whose usefulness is to know the economic result of the financial year, which will be obtained by the difference between two large masses formed respectively by the income and profits on the one hand and by the expenses and losses on the other.

Revenues or profits are those operations or results of operations that lead to an increase in the value of the company’s assets and liabilities.

Conversely, transactions or results of transactions that result in a decrease in the enterprise’s net asset value are expenses or losses.

The difference between revenues and profits on the one hand, and expenses and losses on the other hand, is referred to as the “profit or loss for the year”. If this result is positive, it is called profit, if negative, it is called loss.

Annual accounts report

The notes to the financial statements are an accounting statement that completes, amplifies and comments on the information contained in the other documents making up the annual accounts. The notes to the financial statements should be prepared together with the other financial statements, as they form a unit.

Financial statements

Financial statements, also known as annual accounts, financial statements or financial reports, are the accounting records of a company and show the economic structure of the company. The financial statements reflect the economic activities of the company over a certain period of time.

The financial statements are classified into balance sheet, income statement, cash flow statement, statement of changes in equity and notes to the financial statements.

Journal

The journal is a document in which all the operations relating to the company’s activity are recorded on a day-to-day basis.

The journal is made up of all the accounting entries of a company. It is therefore considered the main accounting record. This is because it contains the first record of a transaction.

This is one of the accounting books held by the company that is obligatory according to the Commercial Code. Therefore, it is necessary to file it with the Commercial Register. In addition, although it is advisable to keep records on a daily basis, the Commercial Code permits the recording of joint transactions within a maximum period of one quarter, provided, however, that the details are recorded in other books.

General ledger

The general ledger is a document that records in chronological order all the company’s accounting transactions recorded in each of the accounts. There is a general ledger for each account used in accounting.

The general ledger contains the concept of the transaction recorded, the debit, the credit and the balance of the account. This document allows a detailed view of the movements that have taken place in each account. It details the entries and withdrawals. The accounting procedure consists of recording the transaction in the journal and then transferring the movement to the general ledger.

It should be noted that the general ledger is not compulsory, although it can be very useful in the management of the company, as it allows account-by-account consultation of each of the movements that have been recorded in the company.

Income

The Spanish General Chart of Accounts (PGC) defines income as “increases in the net worth of the company during the year, either in the form of inflows or increases in the value of assets, or decreases in liabilities, provided that they do not arise from contributions, monetary or otherwise, to shareholders or owners, in their capacity as such”.

The Spanish GAAP distinguishes between two types of income: income from the sale of goods and income from rendering services.

Expenses

Expenditure is the use or consumption of a good or service in exchange for a consideration, usually in the form of an outgoing amount of money. It is also called expenditure.

What fundamentally distinguishes an expense from a loss is precisely the consideration, since in the case of a loss we do not obtain anything in exchange for the outflow of money, but we do lose money or stop receiving it, whereas with an expense we receive something in exchange.

Treasury

Treasury is all those procedures and actions aimed at the administration and management of money in an organisation.

It is a very broad term, as it encompasses many functions related to financial and monetary activities: sales collections, payments to creditors, payroll payments, loan negotiations, cash management, sales and purchase operations, etc.

Provision

A term that refers to the current recognition in a company’s accounts of an expense that is expected in the future. Thus, the decrease in the income statement occurs at the time the provision is made, and when the expense is finally incurred, only a cash outflow (cash movement) will be recorded in the accounts, with no effect on the income statement.

Working capital

Working capital is the part of a company’s current assets that is financed by long-term debt (non-current liabilities). It is calculated as the difference between current assets and short-term debt (current liabilities).

Working capital will vary depending on the time of the year due to the activity of the company. Therefore, its control is very important to ensure the liquidity and solvency of a company in the short term.

Amortization

Depreciation is the reduction in the value of an asset or liability, and in business terms, its definition is also linked to the initial value of an asset and its useful life.

It is a term that refers to the loss in value of any item over time and is a way of quantifying the loss.

Break-even point

The break-even point is the minimum number of units a business needs to sell of one or more products to cover costs and start making a profit. In other words, it is reached when the total sales revenue equals the operating costs of the business.

Once the break-even point is reached, the business is considered to be at the minimum volume of production and sales needed to be profitable.

Solvency ratio

The solvency ratio measures a company’s ability to pay its debts. That is, if a company were to pay all its debts at any given time, it determines whether it would have assets to meet those payments.

Liquidity ratio

Liquidity ratios are a set of indicators and measures whose objective is to diagnose whether a company is able to generate cash, i.e. whether it has the capacity to convert its assets into short-term liquidity.

Bank reconciliation

Bank reconciliation is the action of justifying each of the bank movements with our transactions. It involves matching the different movements in the bank with our invoices and determining that each of the transactions is part of an invoice.

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