What Is the Key Difference Between Cost and Price?

If you’re new to running a business, it’s important to understand the key difference between cost and price. While these terms are frequently used interchangeably, they have very different meanings in financial statements. Misunderstanding or using these terms can lead to making accounting errors or wrong business decisions. 

In this article, we will bring you an overview of the key difference between cost and price and the factors that affect each, with a bonus of the most typical examples of cost and price. 

The key difference between cost and prices

In its most basic form, cost refers to the total expenses incurred to create a product or service, while price refers to the total amount a customer is willing to pay for a service or product.

Profit is the first difference between the costs incurred and the price paid. The price of any service or product is usually more than its cost because it includes the profitability and the cost of producing the item. 

The second difference between cost and price is that the cost of a product can influence its price. For example, if there is an increase in labor costs, businesses need to increase the price to earn profit. 

Market factors can affect both the cost and the price of every product. The difference here is that: While price fluctuations usually occur outside the business context, and you can do nothing about it, a business can lower the product price, which stays under its control, to minimize this effect. 

What are the factors that affect the price?

Two fundamental factors that significantly impact price are supply and demand.

Supply

Supply refers to the number of goods or services that the industry can deliver. It includes both visible and invisible products and services, such as cars, data entry, marketing, etc. Several times, the quantity is limited. This implies that only a limited amount of items and services are available at any given moment.

Demand

Demand refers to the market’s need for an item, whether tangible or intangible. Like supply, the number of consumers is limited. Demand may fluctuate depending on several factors, including affordability, the worth of an item, and the need for such products.

What are the factors that affect the cost?

The cost of a product is determined by two main factors: risk and inflation.

Risk

The cost of a product is directly impacted by risk. If the capital required to create an item is high-risk, the price will almost certainly be higher.

Inflation

Product prices are also affected by inflation. In most circumstances, financial institutions engage to maximize employees’ wages.

Furthermore, the supply of raw materials and other manufacturing necessities directly impacts the cost of an item. Products with scarce essential ingredients may have higher prices. Similarly, items with effortlessly natural ingredients have lower production costs.

Examples of cost and price

Here is a typical example of the difference between cost and price: If a T-shirt costs $20 to produce, its price must be higher than $20. Otherwise, the business cannot earn a profit on its sale. 

So, before determining the appropriate price for the T-shirt, the business first had to determine the cost of producing the T-shirt. This cost includes material expenses, labor expenses, location expenses, delivery expenses, etc. 

Another common example of cost and price is that costs are subtracted from prices to arrive at a business’s profit, either for individual products or in aggregate for the entire business. For example, if a company generates $1,000 of sales from its product prices and incurs $800 in costs, its profit is $200.

You might also be interested in: 

The bottom line 

Though similar in everyday language, cost and price are related but different terms. It’s crucial to clarify the difference between cost and price, especially when it comes to conducting financial analysis or making investment decisions. By that, you will have a better understanding of how they impact a business’s financial profile and be able to make accurate business decisions.

Don’t forget to subscribe to the Shoeboxed blog if you’d like to discover more accounting and bookkeeping knowledge and best practices for small businesses! 

About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

Essential Accounting Principles and Practices for Small Businesses

Accounting principles are the rules and guidelines that companies must follow when reporting financial data. These standards are implemented to improve the quality of any business’s financial report. This article will give you a detailed look at small businesses’ essential accounting principles and practices. 

What are accounting principles and practices?

Accounting principles are the standards and criteria that businesses must stick to while presenting accounting transactions. 

In the US, the Financial Accounting Standards Board (FASB) produces the Generally Accepted Accounting Principles (GAAP), a defined set of accounting principles.

Each set of accounting principles’ actual objective is to guarantee that a statement of financial position is accurate, uniform, and consistent. This makes it easy for shareholders to examine and obtain information from its financial statements, such as historical trend data. 

The accounting principles also make it easier to compare financial information between organizations and help reduce fraudulent activity by boosting openness and identifying red flags.

Some of the most basic accounting principles are the following:

  • Accrual principle
  • Conservatism principle
  • Consistency principle
  • Cost principle
  • Economic entity principle
  • Full disclosure principle
  • Going concern principle
  • Matching principle
  • Materiality principle
  • Monetary unit principle
  • Reliability principle
  • Revenue recognition principle
  • Time period principle

Why understanding accounting principles and practices is important

These accounting principles and practices are critical in enhancing the quality of a business’s financial reports. They produce logical and improved accounting statements that accountants can follow and readers can understand easily. 

They also facilitate the comparison of financial statements and serve as the foundation for calculating taxable income. Accounting principles and practices also help investors, lenders, creditors, and shareholders make more accurate decisions for the business. 

Examples of the most common accounting principles and practices

In this part, we’ll take a closer look at the most common accounting principles and practices. 

Revenue recognition principle

The revenue recognition principle requires you to only record revenue when the business has completed the earnings process, not when the associated cash is collected. 

For example, a snow plowing service completes the plowing of a mansion for its standard fee of $500. It can recognize the revenue immediately upon completion of the plowing, even if the house owner hasn’t paid the company yet. This concept is also included in the accrual basis of accounting.

Cost principle

The cost principle requires that a business should only record its assets, liabilities, and equity investments at their original purchase costs. Furthermore, the amount recorded will not be adjusted for inflation or market value changes.

The only exception to this principle is a change in the market value of short-term investments in a corporation’s capital stock that is actively traded on a major stock exchange.

For example, a business purchased an office building for $280,000 in 2015. In 2022, the property is appraised at a value of $400,000. The business may not change the cost principle since this increase relates to the increase in market value. Instead, the business might credit the difference in value to an equity account. Therefore, the actual cost principle still reflects the initial purchase price of the building and not the increased value.

Matching principle

The matching principle requires that when you record revenue, you should record all related expenses in the same reporting period. 

For example, your employee earns a 5% commission on an $8,000 contract signed and recorded in February. The commission of $8,000 is paid in March. In this case, you should record the commission expense in February so that the expense is recognized in the same reporting period as the associated contract.

Full disclosure principle

The full disclosure principle requires businesses to include in or alongside their financial statements all of the information that may impact a reader’s interpretation of those statements. 

For example, business owners don’t want to reveal the real situation of their business to outsiders, such as customers, investors, or competitors, as it can lead to bankruptcy. However, according to the Full disclosure principle, the business is required to disclose such situations in its financial statements.

You might also be interested in: 

The bottom line

Understanding the accounting principles and practices helps complete and strengthen your business’s financial statements, making it easier to analyze and extract necessary financial information from these reports. From that, business owners and investors can make more accurate decisions, manage cash flow, and improve their businesses in the long run. 

Don’t forget to subscribe to the Shoeboxed blog for more helpful accounting and bookkeeping knowledge and best practices for small business owners! 

About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

The Accounting Cycle Explained: 5 Simple Steps

The accounting cycle is a must-know for all bookkeepers. It divides the entire process of a bookkeeper’s work into multiple steps. Though accounting software can help, small business accountants working on the books with less technical support should still know and use these processes manually. 

While other versions of the accounting cycle cover more detail, in this article, we’ll bring you an overview of the standard process that includes the five main steps needed to ensure the integrity of a company’s accounting process.

What is the accounting cycle?

The accounting cycle is a straightforward process for carrying out a company’s financial activities. It provides step-by-step directions for recording, examining, and analyzing a company’s financial activities.

The accounting cycle duration will vary depending on the reporting requirements. In general, most business owners strive to close their books on a monthly basis. On the other hand, some may prefer completing the accounting cycle on a quarterly or annually basis. 

What is the purpose of the accounting cycle?

The accounting cycle’s primary goal is to ensure that all the money coming into or going out of a business is accounted for and all financial records are accurate. While preparing financial reports, the accountant will examine accounting entries and processes to be aware of the business’s financial position day-by-day. 

Each step in the accounting cycle works as a check and balance along the way, preventing errors and inaccuracies from occurring in the previous step. Thus, the accounting cycle is an indispensable base or stepping stone for creating financial statements.

You might also be interested in: 

What are the five steps of the accounting cycle?

Step 1 – Collect and analyze transactions

The first step of the accounting cycle is to collect documents of your business transactions, like receipts, invoices, bank statements, etc., for the current accounting period. These documents contain raw financial data that will then be entered into your accounting system before being converted into something meaningful.

You need to keep details of every transaction, including the date, amount, and location. Then, you’ll break down (or analyze) the purpose of each transaction. For example, if you received a receipt from Target, you’ll need to clarify if it was office supplies. If you received a gasoline bill, was it for the company vehicle? It’s essential to collect as detailed information as you can. 

Step 2 – Posting transactions to the general ledger

In the next step, you’ll use the general ledger to record all financial information gathered in step one. The ledger is a comprehensive, detailed list showing all your company’s transactions and how they affect each of its individual accounts. 

The ledger includes various journal entries, which chronologically document all of a company’s financial transactions. Journal entries must follow the rules of double-entry accounting. Whenever a transaction occurs, it must be recorded in the journal entries in two sections: a debit (to state what it’s going towards) and a credit (to state where your money is coming from).

After converting all of your business transactions into debits and credits, it’s time to move them into your company’s ledger. Keep in mind that uploading journal entries to the ledger as soon as possible helps ensure that the business’s records are always up to date. 

Step 3 – Preparing an unadjusted trial balance

You’ll prepare an unadjusted trial balance after posting transactions to the general ledger. The unadjusted trial balance gathers all of these totals together and calculates the total credits and debits in each of your business’s accounts. From that, you can determine individual account balances.

Here’s what an unadjusted trial balance looks like: 

The Accounting Cycle
Example of an unadjusted trial balance (Source: Wikiaccounting)

According to the double-entry accounting rules, all of a business’s credits must be equivalent to the total debits. If the sum of the debit balances isn’t equivalent to the sum of the credit balances, it means that either the step of recording or posting journal entries is incorrect. 

If you do bookkeeping with accounting software, this usually indicates that you entered information incorrectly. The process of searching for and fixing these errors is called correcting entries.

Step 4 – Preparing adjusting entries at the end of a period

You’ll prepare adjusting entries after you’ve finished correcting entries. Adjusting entries ensure that your financial statements only include data that is relevant to the time period you’re working on. There are four main types of adjustments, including deferrals, accruals, tax adjustments, and missing transaction adjustments.

Deferrals are revenues and expenses that have been received or paid in advance but have not yet been earned or used. For example, unearned revenue is money received for goods that have yet to be delivered.

Accruals are unpaid income and expenses that have not yet been recorded through a standard accounting transaction. For example, rent paid at the end of the month is an incurred expense, even though a business can occupy the premises at the beginning of the month if the rent is not yet paid.

  • Tax adjustments help you address expenses that lower your tax liabilities like depreciation and other tax deductions. For example, if you have spent a lot of money on new equipment, you may be able to deduct a portion of the cost this year. Once a year, your CPA will most likely guide you through the process.
  • Missing transaction adjustments allow you to account for financial transactions that you may have overlooked when bookkeeping, such as business purchases made on your personal credit card.

Step 5 – Preparing an adjusted trial balance

After posting all of your adjusting entries, it’s time to create an adjusted trial balance. This adjusted trial balance takes all of your adjusting entries into account.

The main purpose of the adjusted trial balance is to prove that all of your ledger’s credits and debits balance after all adjustments. Once you finish this step, you have all the information you need to start preparing your company’s financial statements!

The bottom line

Understanding the accounting cycle helps bookkeepers and small business owners simplify their accounting processes, and makes financial performance analysis more consistent, accurate, and efficient.

Subscribe now to the Shoeboxed blog for more helpful accounting and bookkeeping articles, success stories, entrepreneurship, DIY accounting, and the latest Shoeboxed product update! 

About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!