MONEY BASICS for architects
“If you can actually count your money, then you are not really a rich man.” - J. Paul Getty, American industrialist
One of the key factors to measure the success of your architectural practice is the ‘Financial temperature’ of your firm. To maintain normal financial temperature of the firm, it is important to have basic insights of finances so that firm can manage to achieve its goals.
The financial strength of your company is based on 5 basic accounting concepts. These concepts are the core of any business finance. They are:
Income / Expense
Arthur Sullivan describes in his book ‘Economics: Principles in action’ that “assets represent the value of ownership that can be converted into cash”.
It is an economic resource. It can also be understood as the “possessions which are tangible or intangible in nature which can be increased.”
We can understand assets better when we look at its different forms. Assets are mostly categorized as:
Cash: Money that a firm can count in the form of currency. It is the most liquid or handy money available to the firm.
Bank deposits: Banks are authorized institutions to manage money. The firm keeps its money in the current account (a/c). Individual’s money is kept in saving a/c. Surplus money can also be invested in fixed deposit a/c to earn more interest.This is a second most liquid form of assets.
Stock/Share: Often, surplus money is invested in the shares. By trading these shares, you can generate some immediate cash. But it is important to understand and accept that the trading of stocks/shares is a risky proposition and a business in itself. Thus, sufficient knowledge and understanding of the stock industry is required before you step into this venture.
Mutual fund: Mutual fund is also an investment in shares. The difference here is that your shares are managed by recognized financial institutions. You can read about nine basic concepts associate with mutual funds here.
Foreign exchange: The practice of currency trading is also commonly referred to as foreign exchange, Forex or FX. Every country has its own set of rules for trading in Forex. This is similar to stock market where return on investment is not guaranteed due to its speculative nature.
Movable and immovable assets: Most likely, this is where your major block of assets will be lying. Immovable asset is an asset that cannot be moved without destroying or altering it. For example, an estate or a house is immovable assets. Movable assets are those which can be transferred from one place to the other without any damage or alterations. For example, stocks, cash, furniture, vehicles, office equipment, jewellery, etc.
Intangible assets: This is not reflected in the account statement, but you build it significantly if you understand the importance of it. By and large, intangible assets cover goodwill, patent, franchise, copyright, etc. No goodwill can be mentioned in the account statement and can turn into salable assets at the time of settlement.
Additionally, assets can also be categorized as:
Fixed assets: It is a term applied in accounting for assets that cannot easily be converted into cash. For example, furniture and equipment, property and buildings, vehicles, etc.
Current assets: These are assets available to the owner as a prompt source of money. For example, cash on hand, fees receivable, pre-paid expenses, insurance, bank deposits etc.
Financial obligation is an obligation or an entity that you owe to others, For example, car loan, bank loans or borrowings from your relatives, etc. This is the amount which you are legally required to pay back in installments or as per agreed terms and conditions.
Liabilities come in different varieties. For example: Notes payable (a written promise to pay a specific sum of money), Interest payable, Sales Payable, Salaries payable, Unclaimed dividend, Long/short term loans, etc.
On a balance sheet, liabilities may be described in two categories:
Current liabilities: these liabilities are short-term (which may be needed to be paid back within a year). They usually include payable such as salaries, bills, taxes, account payables, portions of long-term bonds to be paid this year, short-term obligations (e.g. From purchase of equipment).
Long-term liabilities: these liabilities may be expected to be liquidated after one or more years. They usually include long-term bonds, notes payable, long-term leases, pension obligations, long-term product warranties, and so on.
On a balance sheet, there are two sides - one of the assets (what you have) and the other for Liabilities (who owns it). Assets are on the left and Liabilities are on right. You can learn more about creating the balance sheet here.
Equity is the value of the firm’s assets, generally called ‘Net Worth’. The meaning depends on the context.
For an architectural business, it is the amount that owners have contributed + the retained earnings/losses.
Equity (net worth) = Assets - Liabilities
In general, it can be understood as the sum of all assets after the debts associated with those assets are paid off. You can see more about equity and its relations to the balance sheet here.
4. INCOME & EXPENSE
Income is also called Revenue. Gross income is generated from project fees, any other joint venture, dividend, royalties, etc. Here it is important to understand the distinction between receipt and income.
“Receipt” means total cash (money) received after the sale of a particular service or asset and is usually a one time in nature.
“Income” means total money received against one’s job performance/investment and is recurring in nature.
Net income = Gross income - Expenses
Expenses are usually categorized largely into two types:
Direct expense: for an architectural firm, these are the costs you incur for the production of your projects. For example, travel, printing, salary of project staff members, equipment maintenance, etc.
Indirect expenses: These are the costs that a firm incurs but are not directly associated with your projects. For example, insurance, staff training, overheads, accounting and legal services, office rent, etc.
Income and expense statement also widely known as profit/loss statement is important because it shows the profitability of a company. The format may vary depending on the size and Profit and loss may also be computed under certain standard rules laid down by the direct tax act. The income/expense statement along with the balance sheet can also be used to monitor several financial ratios. These ratios indicate the financial status of the company in relation to other factors. You can learn more about these financial ratios here.
5. Accounting methods
There are two methods of maintaining accounts transaction:
Cash basis: a mode of accounting where income and expenditure is recorded when they are actually realized or paid. Most individual and professionals start as cash basis as this method is a lot simpler and easy to use for a start-up firm. However, for management purpose and project wise accounting many firms maintain accounts on accrual basis also. Cash basis is simple method and you pay taxes on actual transactions. But it doesn't give a clear financial picture.
Accrual basis: A method of keeping accounting records in which revenue is recognized as having been earned when services are performed and expenses are recognized when incurred, without regard to when cash payments are received or made. It’s also called mercantile basis of system. The accrual method is required if your business’s annual sale is very high and your company is structured as a corporation.
More information about different aspects of accounting can be found at www.accountingcoach.com
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