There are two perspectives to defining a business. On the one hand, a business is an activity. On the other hand, it is a structure. As an activity, the business is defined as an undertaking involving two parties: the buyer and the seller. As a structure, it refers to an organization or an enterprise involved in commercial, industrial, or professional activities. A business brings together the owners and the customers. From the owners’ perspective, there are five basic forms of legal ownership: sole proprietorship, partnership, limited liability company (LLC), corporation, and a cooperative.[1] The basic unit of business ownership is the sole proprietorship. The Oxford Learners Dictionary defines a proprietor as the owner of a business.[2] In this context, any business owned by an individual on their own accord is regarded as a sole proprietorship. Essentially, a sole proprietorship is an unincorporated business conducted by the owner in his or her individual capacity.[3] Various sole proprietorship businesses encompass areas such as sales and retail, and service. Examples in sales and retail include the small and medium-sized shops in your neighbourhood run by a single individual, wines and spirits, butchery, and the mama mboga (local greengrocer). Examples of service-based sole proprietorships include individual consultants, barbershops, salons, spa, car wash, and garage.

Businesspeople across the globe customize their methods of tracking their financial records. The basic method currently in use entails recording the initial investment, sales, and expenses. The primary goal of launching a business is for profit generation. The common method of tracking profits utilized by sole proprietors entails determining the difference between the daily sales and expenses. Apparently, in the midst of all this customization lies the basic elements of the income statement – revenue and expenses. Additionally, the accounting equation elements – assets, capital, and liabilities – can be easily tracked. It is imperative for the sole proprietor that they maintain an income statement, a statement of financial position (herein referred to as “balance sheet”), and a cash flow statement. The basic tracking of profit commonly in use among the sole proprietors can be upgraded to fit the accounting provisions as followed during the drafting of the income statement. In essence, the difference between revenues and expenses yields a business’ gross profit. If the sole proprietor is liable to pay tax, then the deduction of this tax from the gross profit results in the business’ net profit. In the balance sheet, the aggregate of the assets held by the enterprise is equivalent to the sum of the initial capital invested by the proprietor and the liabilities, summarized as:

Assets = Capital + Liabilities

Understanding the income statement and the balance sheet yields 5 basic components or accounts that a sole proprietor should consider when tracking the daily transactions of their business. The 5 basic components are Revenue, Expenses, Assets, Capital, and Liabilities. For purposes of understanding these five components, this publication shall utilize a small shop for the sales and retail business and a barbershop for a service-based business. The definitions given below are in layman’s language and not necessarily the ones given in the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). With the emergence of numerous small and medium-sized enterprises (SMEs) and with the need to understand how businesses operate coupled with the continued call for scaling up, it is imperative that sole proprietors understand these components as well as the two basic financial statements.

The Five Accounts

Revenue. Revenue is the value of all sales of goods and/or services generated by a company in a particular period. Revenue is a cash inflow or income into the organization. For a small shop, revenue would include the cash generated from daily sales of items such as sugar, cooking oil, flour, etc. For the barbershop, the revenue would include cash received from customers for services rendered in the form of a clean shave, massage, and facial scrub.

Expenses. Expenses are the costs incurred in generating revenues or ensuring that a business conducts its daily operations. For both the small shop and the barbershop, common expenses would include rent, monthly water and electricity bill, and maybe a salary paid to the security guard. Nonetheless, expenses for the barbershop would include daily wages or monthly salaries paid to the employed barbers.

Assets. Assets are the resources owned or controlled by a business that are crucial in enabling it to generate a positive economic value. For a small shop, the basic assets would include the shelves (fixtures and fittings) fitted by the proprietor when launching the shop and a Point-of-Sale (POS) computer system for maintaining the daily transactions. For the barbershop, assets would include the fittings such as mirrors and wardrobes, barber chairs, and shavers/clippers.

Liabilities. Liabilities are the obligations of the business. If the shop owner bought their stock on credit, then the amount they owe their suppliers would be recognized as a liability. In the instance of the barbershop, it could be that the proprietor secured a loan to facilitate a business expansion or upgrade. Thus, the amount the barbershop owner owes the bank would be recorded in the books of account as a liability.

Capital. Capital refers to the financial resources that a business can utilize in funding its operations. The basic understanding of capital in the context of most sole proprietorships is that it refers to the initial cash investment that is made in starting the business. Essentially, if the sole proprietor accumulated savings worth Ksh. 100,000 as an initial investment towards starting their business, the amount would be recorded in the books of account as capital.

In preparing the two basic financial statements, namely, the income statement and the balance sheet, businesses seek to determine their net profit and arrive at tracking how their operations give a true picture of their current financial status and prospects in the foreseeable future. The tracking of the balance sheet elements, namely, assets, capital, and liabilities, would be crucial in determining whether most of the business’ activities are financed by its assets or obligations. Thus, for a start, it is crucial that when maintaining their business records, the sole proprietors become aware of the 5 basic components of the charts of accounts and the two basic financial statements.

References.

[1] Novak, M. (2019). 5 Types of Business Ownership (+Pros and Cons of Each). Learn.g2.com. Retrieved 26 December 2020, from https://learn.g2.com/types-of-business-ownership.

[2] Oxford Learners Dictionaries. (2020). proprietor noun – Definition, pictures, pronunciation and usage notes | Oxford Advanced Learner’s Dictionary at OxfordLearnersDictionaries.com. Oxfordlearnersdictionaries.com. Retrieved 26 December 2020, from https://www.oxfordlearnersdictionaries.com/definition/english/proprietor?q=proprietor.

[3] Prescott, G. L., Madden, E. K., & Foster, R. M. (2010). Forms of business ownership: A primer for commercial lenders. Com. Lending Rev., 25, 27.