Accounting Transactions and Accounting Balances

Accounting consists of balances and transactions. Accountants record events that happen such as customers buying products, staff performing work or a company purchasing new machinery. Accounting balances on the other hand are not events, instead they are things that the business either owns or owes.

This can all get quite abstract, and the best way to visualise and really understand accounting is as a simple system of water pipes and tanks. Water is stored in various tanks that are connected together by pipes. In the analogy, the water in the tanks are accounting balances. Accounting transactions cause water to flow from one tank to another. Let's look at a simple example.

Revenue vs Cash

When most people hear the word revenue they automatically think "money in". This isn't a terrible way to think about how accounting works, but it is not quite right. Let's look at how revenue is actually linked to money in.

To keep things simple, let's consider a business that supplies goods to supermarkets and explore how its revenue is linked to its cashflow. Watch the video to see how the timing difference between revenue and cash receipts gives rise to a receivables balance.

 

The video shows an interactive model that lets you alter the amount of revenue generated and the amount of credit offered to customers. These simulation models form the foundation for our online Basic Accounting course which allows you to visualise how accounting works as a simple, connected system. To launch this model yourself, click here. You will need to enable Adobe Flash in your web browser.

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What is Revenue?

So if revenue isn't the amount of money that comes in, then what actually is it? The simple answer is that revenue is the best estimate of the amount of money that a business believes it has generated through the sale of its products or the provision of its services. Often some of the actual cash receipts from this revenue are not received by the business until much later.

At this point you may be wondering why revenue is the "top line" of every profit and loss statement. Wouldn't it be better to use cash receipts because these are what the business actually receives? The reason for this is to do with the accrual principle, which is the fundamental principle that governs how accounting works. The accrual principle is the starting point for our simple online Basic Accounting course.

Basic Accounting Course

This online course assumes no prior knowledge and gradually introduces all the building blocks of accounting such as revenue, costs, assets, equity, liabilities and double-entry bookkeeping through a series of ground-breaking business simulation models. It explores financial statements and working capital and it reveals how profit & loss, cashflow and the balance sheet are all connected. Develop an intuitive understanding of accounting principles in just a few hours of online study!

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