Lesson 98 - Beginner accounting course

98. Case Study: A Simple Business and Its Financial Transactions

In this case study, we will follow a simple business and track its financial transactions through the accounting cycle. The business is called "Green Thumb Nursery," a small garden center selling plants, soil, and gardening tools. The goal is to demonstrate the basic principles of accounting, including journal entries, general ledger posting, and the preparation of financial statements.

The Business:

• Name: Green Thumb Nursery

• Type: Retail business selling plants and gardening supplies

• Location: Local neighborhood in a mid-sized city

Opening Balance:

Green Thumb Nursery has the following opening balances at the beginning of its operation:

• Cash: $5,000

• Inventory: $2,000

• Accounts Payable: $1,000 (amount owed to suppliers)

• Owner’s Equity: $6,000

Step 1: Financial Transactions

Transaction 1: Owner Investment The owner invests an additional $3,000 in cash into the business.

• Journal Entry:
  Debit: Cash $3,000
  Credit: Owner’s Equity $3,000

Transaction 2: Purchase of Inventory on Credit The business buys gardening tools and soil worth $1,500 on credit from a supplier.

• Journal Entry:
  Debit: Inventory $1,500
  Credit: Accounts Payable $1,500

Transaction 3: Sales Revenue Green Thumb Nursery makes a sale of $2,000 (cash) worth of plants.

• Journal Entry:
  Debit: Cash $2,000
  Credit: Sales Revenue $2,000

Transaction 4: Payment of Accounts Payable The business pays off part of its accounts payable, $1,000, to the supplier.

• Journal Entry:
  Debit: Accounts Payable $1,000
  Credit: Cash $1,000

Transaction 5: Payroll Expense The business pays $800 in wages to its employees.

• Journal Entry:
  Debit: Salaries Expense $800
  Credit: Cash $800

Step 2: Posting to the General Ledger

Each journal entry is posted to the general ledger, where all accounts are tracked. The general ledger provides a summary of each account's activity.

Step 3: Preparing Financial Statements

1. Income Statement: The income statement shows the business’s performance over a period, including revenues, expenses, and profits.

2. Balance Sheet: The balance sheet shows the financial position of the business at a specific point in time, with assets, liabilities, and equity. 

Step 4: Analyzing the Financial Results

• Profitability: Green Thumb Nursery generated a net income of $1,200. This indicates that the business is profitable in its first month of operation.

• Liquidity: With $8,200 in cash and only $2,500 in accounts payable, the business has enough liquidity to meet its short-term obligations.

• Solvency: The owner's equity is $9,000, suggesting a solid foundation for the business, with assets greater than liabilities.

Conclusion

This case study illustrates the basic accounting processes for a simple retail business. Through recording financial transactions, posting them to the general ledger, and preparing financial statements, we can assess the business’s performance and financial position. These steps form the core of accounting and are essential for managing a business effectively.