A company needs a basis in capital, either equity or borrowings. Issuing stock or long-term liabilities provides funds to purchase assets. When a business itself is purchased, often something intangible called goodwill is involved. This is like “buying” a company’s reputation. Investments in other things are valued at cost but some assets can be influenced by the market and accounted for accordingly. Assets produce income, but these depreciate and can become impaired. A company must be consistent in its depreciation method. Likewise, natural resources deplete, and financial assets amortize.
Long term liabilities arise from the long term benefits or troubles the company acquires. Pensions, defined in a couple of ways, guarantee benefits for workers. Leases, arrangements to use property and equipment, take on a long term character in some cases. Accounting for taxes involves temporary and/or permanent differences with how the IRS treats taxable income. Contingencies may also arise, such as a pending lawsuit or warranty arrangements.
A company is paid for the goods it sells and services it provides in cash or as a receivable, which is an agreement to be paid. If they want more security, a note can be written. Current assets also include inventory, which is costed when sold. Along with current liabilities, like payroll, this constitutes working capital for day-to-day operations.
When activity in the journal is posted to a ledger, or chart of accounts, the accounts themselves are used to form statements. An income statement shows a company’s operations, its revenues and expenses. Income flows into retained earnings, which appears as an equity account on the balance sheet. A balance sheet shows assets and the external claims on them (liabilities) and the owner’s claim on them (equity). A cash flow statement shows how cash flows through a business: a company raises capital (financing); capital is used to purchase assets (investing); assets produce income (operations).
Theory is a good basis. Here are some practical things to help navigate financial life.