Account Classifications
You might be confused about the classifications on your various statements and what they all mean. Well, you’ve come to the right place. In general terms, account classifications are the big buckets your numbers live in.
Revenue: This is what your business brings home. Whether you're selling products or services, revenue comes in the door when your business delivers what you’re selling to customers. You can slice and dice it into different categories to track your revenue better.
Expenses: Think of it as your spending. Rent, wages, supplies – it's where your money waves goodbye. Similarly, categorise it to keep tabs on where your money's going into set chart of accounts.
These two categories are in your "Profit & Loss" statement. It's a monthly report completed at month-end showing how much you earned versus how much you incurred. What's left over is your "net profit" which plays a key role in measuring your business’s success and value. Watch for any kind of trends – what's changing month by month?
Liabilities: we all know what this word means 😉 We refer to anything being a “liability” when we know it’s not gonna do us any good in future! In accounting, it’s similar. Put simply, this refers to something you owe, whether in cash or other forms where you have not yet provided value in exchange.
What do you owe right now? In fact, it might even be something you haven’t received an invoice for. But you know that soon enough you’re going to have to pay for it. It would include something like accounts payable (e.g., invoices received from suppliers but not yet paid because the due date is in 2 weeks) and/or something like a payment to the ATO (e.g. you haven’t completed your BAS return so you haven’t received an invoice but you know that you are going to have to pay this to the ATO soon).
What are you yet to provide value in exchange for? Put simply, this is an obligation you need to meet, in ways other than cash. The most common example would be unearned revenue. If you have collected monies from your customers for services or products that you are yet to deliver, that’s an obligation for you in a form other than cash. Your time, your product, your expertise, etc.,
Assets: this refers to something that you own which is of value or will bring in value in due course. You’ve all heard a saying that something is an “asset” because they bring value.
What do you own right now? For example, it could be something like stock sitting in your warehouse (because the value is that this will be converted to sales and cash), or cash in your bank accounts because it’s a tangible value that you currently have.
What will be value in due course? It would also include upcoming value like your accounts receivable (e.g. invoices you’ve billed to your customers but not yet received as they don’t need to pay for another 4 weeks) or prepayments (e.g. you already paid for something so you just need to make use of what you’ve paid. Like, paying for a whole year of insurance at once!)
These accounts are visible in your “Balance Sheet” statement which captures a specific moment in time (usually at month-end) to see how your assets matches against liabilities as at that time. What you’re left with is effectively called “net assets” which plays a key role in understanding your business’s liquidity. If you were to sell all your assets today, will it cover all your liabilities?
Accurate classifications in accounting serve as the bedrock of sound financial management for any business. These classifications are not just arbitrary labels; they are the very essence of how a company tracks, analyses, and strategises its financial health. Imagine your business as a complex puzzle, with revenues, expenses, liabilities, and assets as its essential pieces. Each piece has a specific role, and when correctly identified and placed, they form a clear picture of your company's financial landscape. Accurate classifications enable you to understand the sources of your income, where your money is going, and what you own versus what you owe. This knowledge is invaluable. It empowers you to make informed decisions, allocate resources efficiently, identify areas for improvement, and, ultimately, steer your business towards sustainable growth and success.
Without proper classifications, the financial puzzle remains incomplete, making it challenging to create a coherent financial strategy, evaluate performance, or communicate your business's financial health to stakeholders. Therefore, accuracy in these classifications is not just a matter of good practice; it's the cornerstone of effective financial management and business sustainability.
Don't let financial ambiguity hold your business back. Contact us today to discover how we can help clean up your financial classifications, providing you with the clarity and insights needed to propel your business toward greater success.
