Lesson 2: Key Terms
Intro to Bookkeeping
Golden Rule of Accounting
Below is a list of key terms and concepts to get you started on the right foot:
Accounting vs Bookkeeping: Accounting is the science and concepts that define Net Worth and drive the mechanics behind accounting systems. While bookkeeping is the practice of those concepts and continuous updating & maintenance of the systems. Bookkeepers do not necessarily have to be accountants, as long as they can understand certain business cycles and perform data entry. However, all bookkeepers are absolutely aided by having an accounting degree/education and most companies require it. When you think bookkeeping, think low level accountant & data entry extraordinaire. When you think Accountant, think CFO and high level analysis.
This crash course will be focused on the bookkeeping of transactions but it essentially doubles as an accounting lesson as well. I want you to know the necessary accounting basics so you can be the best personal finance bookkeeper you can be.
Assets = Anything of value that you can exchange for something else (usually for money). Cash is the simplest form of an asset. A $20 bill has $20 worth of value and you can always exchange it for $20 worth of goods or services (or another asset). A checking account is another example of an Asset account. If you have $500 in your checking or savings account, then you have an asset worth $500. These are the easy ones but it can get more complicated; houses, stocks, 401k/IRAs, some vehicles, equity stakes in small businesses, Bitcoin/cryptocurrency, gambling accounts, etc. are all Assets for your Net Worth calculation. If you can sell it, cash it out or exchange it, then it's likely an asset.
Liabilities = Debt. If you owe money, you own a Liability. That may be $10 IOU to your mother for the Cash App she graciously sent you or it may be the $100,000 balance on your home mortgage or student loans. Other common examples include credit cards, auto loans, and payment plans. Liabilities are technically "bad;" the more money you owe, the less money you own. However, debt is useful when it's time to purchase a valuable or expensive asset like a home or vehicle. Debt is one of those things that can be beneficial if you learn how it works and use it effectively.
Equity: For personal finance, equity and Net Worth are interchangeable terms that mean the same thing:
Net Worth = the difference between assets and liabilities = Equity = the value of your Assets that you actually own.
If you own a home worth $200,000 and have a mortgage (debt) balance of $100,000 on it, then you have $100,000 worth of equity in the home. In other words, you own $100,000 of the asset because you could sell for $200k and walk away with $100k. Or let's say you owe somebody $1,000 but have $0 to your name. Your Net Worth would be -$1,000, meaning you don't technically own the next $1,000 you earn. Increasing Net Worth, by any ethical means possible, is the name of the game!
The whole point of this website is to help you better understand the nuances of each of these terms, concepts and financial categories. I will teach you the confusing, technical aspects of accounting by using personal finance and layman's terms to help you truly understand how to think like an accountant. A financial mindset that will help increase your equity.. or maximize your Net Worth!
Click here to continue to Lesson 3 on the Balance Sheet and the golden rule of accounting.