Accounting Basics

SAABI keeps your books using double-entry bookkeeping. You do not need to understand it to raise an invoice or record a payment — SAABI writes the entries for you. You do need it to read the reports, to judge whether a figure looks right, and to post a journal entry by hand. This chapter is a short primer on the ideas the rest of the manual assumes.

A small business in four transactions

Imagine you are starting a home interior business. Four things happen in the first month.

Owner investment. You put $500,000 of your own money into the business.

First expense. You rent a co-working space where you can work and meet clients, at $40,000 per month. This is your first expense.

First income. You make your first sale, worth $30,000, and the customer pays at once. This is your first income.

Amount payable. You hire a web agency to build a website. They charge $50,000, payable in two months. No money has moved, but you are liable to pay it, so it is recorded under Accounts Payable.

Events and accounts

Listing the four events and their effect:

That $440,000 total is what the business is worth to you after the four events.

The same four events, sorted into the five types of account, with the balance each one carries:

The website charge is an expense in the month the work was done, even though the cash has not left the bank yet: the expense and the liability are recorded together.

The accounting equation

Everything a business owns was funded either by someone it owes money to, or by its owners. That gives the accounting equation:

Assets = Liabilities + Equity

Income and expenses are the two things that change equity during a period, so the fuller form is:

Assets = Liabilities + Equity + Income − Expenses

Check it against the figures above: assets of $490,000 equal liabilities of $50,000 plus opening capital of $500,000, plus income of $30,000, less expenses of $90,000. The closing equity of $440,000 matches the total in the first table.

Every transaction is recorded in two accounts, one debit and one credit of the same amount, so the two sides can never drift apart. When they do, the Trial Balance report shows it.

How each transaction affects two accounts

1. Owner investment. The money in the bank, an asset, increases by $500,000. The owner's claim on the business, an equity account, increases by the same amount.

2. Rent. Rent is an immediate expense, recorded in the Rent account. The money is spent from the bank account, so that asset decreases by $40,000.

3. First sale. The sale is recorded in the Sales account, an income account, which increases by $30,000. The payment arrives in the bank account, which increases by as much.

4. Hiring the web agency. You are liable to pay in future, so Accounts Payable increases by $50,000. The work is an expense, so the expense account increases by $50,000 as well.

Every transaction touches two accounts. To see this in your own books, submit a sales invoice, then open General Ledger and look at the rows carrying that invoice number: one debit and one credit for every amount on the invoice.

Credit and debit

Credit and debit mean opposite things depending on the account they are applied to.

• For asset and expense accounts, a debit increases the balance and a credit decreases it.
• For liability, equity and income accounts, a credit increases the balance and a debit decreases it.

The five account types in SAABI

Every account in your chart of accounts belongs to one of five types, and each type sits under one of SAABI's five root groups. Open Setup > Chart of Accounts to see them.

Accounts come in two kinds. Ledger accounts are the ones transactions are posted to. Group accounts hold other accounts and carry no entries of their own — their balance is the sum of what sits beneath them. The five root groups are group accounts.

Assets, liabilities and equity are balances at a point in time, and are what the Balance Sheet reports. Income and expenses accumulate over a period and reset at the year end, and are what the Profit and Loss report covers.