Importance of Accounting: Basic Financial Concepts To Know
Why is accounting so important? Well, for starters, it’s all about the Benjamins. An important part of any business or organization is, arguably, the money that comes in and the money that goes out. The accounting department typically monitors this closely by recording transactions, analyzing transaction patterns and dealing with things like payroll and taxes. Overall, the accounting department can determine the health and efficiency of a business, and increase profitability just by studying this information. Learn a practical approach to all you need to know about accounting. Alright, you’re still wondering what exactly all this accounting jazz is and how it’s going to help you be successful. Let’s get to it.
Types of Accounting
In businesses there are typically two methods of accounting, cash basis and accrual. For smaller businesses, cash basis accounting is usually what is used. It acknowledges and records financial transactions when cash physically moves between involved parties. So, if Tiny Tim purchases inventory on a credit card from the North Pole in September but doesn’t pay on the credit card until December, using the cash basis method, Tiny Tim’s would record the transaction in December. The transaction would be recorded in December because that’s when the money actually left the business and is considered a payment.
For accrual based accounting, using the same example of Tiny Tim’s, the business would record the transaction in September even though no money was actually paid until December. The transaction, or intent to pay still exists. The accrual method tracks all commitments to pay or to be paid when the commitment is made, regardless if actual funds were transferred. This method is typically used for larger businesses.
Why does accounting matter?
Try and imagine your local grocery store sans an accounting department. At first glance, you may be thinking that they could get by because all the transactions are recorded in the registers and through other electronic means. Right, but wrong. What about all the inventory? What about the employees pay checks? What about federal, state and city taxes? What about cash flow patterns? The accounting department exists to ensure that a business isn’t losing unnecessary money, employees are being paid, obligations like taxes are correctly fulfilled, trends and patterns that effect the businesses profits and losses are being analyzed and inventory is being paid for.
Tracking business performance
Every bit of money that comes and goes from a business needs to be tracked and accounted for. By adequately recording this information and then studying it, accountants can determine the longevity of a business, financial forecasts and the overall business performance. Are you paying your clients on time? Could you find better deals on some of your products? Is there money being wasted on a third party when the tasks could be done in house for cheaper? It’s not enough to just run a business and “hope” that it’s successful. It takes a lot of time and effort understand the basic cash flow and how to improve functionality and efficiency.
So we know that tracking business performance is crucial to the health of your business, but how do we do it? Reports, reports, reports. Management accounting includes putting together cash flow statements, accounts payable, accounts received, budgets and expense reports. There is no real rule as to what reports you need to create or use to manage your business. It’s all up to you and determined by you, and your business needs.
If you have a considerable amount of customers who owe you money (like a payday loan business) you are obviously going to want to have very well-designed account received reports. Accounts received reports show you who has paid, when they paid, how much more they owe in addition to who hasn’t paid, who’s overdue and what the total amount you are owed is. Knowing this information can help you tremendously as you move forward with business decisions.
Don’t forget that having a profit on paper doesn’t ensure that you are in the green. The cash flow of a company can look good on the profits side but if you aren’t keeping good track of the accounts payable side of things, you could actually be out of cash in the bank, with a “profit” on paper and still owe several clients money. Are you a small business? This small business accounting 101 course is for you.
Types of Reports
Here are just a few of the reports you might want to consider involving in your every day, weekly or monthly accounting routine.
Cash flow (daily, weekly, monthly, quarterly, annually)
Budgets and cash plans
Accounts Receivable (who owes you money)
Accounts Payable (who you owe money to)
Income Statements and balance sheets
Owner equity statements
Debtors and creditors statements
There are plenty of accounting programs to choose from that can help you accomplish all of these tasks and then some. Don’t let the idea of tracking money be overwhelming – it should be exciting! This is the heart of your business and shying away from learning how it operates can be detrimental to your success and future. Here are a few to get you started:
In the end, without an accounting department your business isn’t going to go anywhere fast. You don’t have to hire people to do this for you, although that’s an option. If you’re a small business or a sole-proprietor you can teach yourself what you need to know to be an accounting success, but you’ll need to learn some skills and techniques; there’s no substitute for a complete introduction to financial accounting.
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