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6 Min. Read

What Is Accounting & Why It Is Important for Business?

What Is Accounting & Why It Is Important for Business?

One of the most important responsibilities for any business is accounting. It can feel overwhelming from time to time, but good accounting measures make a business run more smoothly. If you’re starting a new business, or have been running your small business for some time, you’ve probably looked into accounting. In this article we’re covering what accounting is, and why it’s important for your business.

Here’s What We’ll Cover:

What is Accounting?

Understanding the Accounting Cycle

The Three Main Financial Statements

The Generally Accepted Accounting Principles

Five Different Types of Accounting

How Accounting Can Help Your Business

Key Takeaways

What is Accounting?

The definition of accounting is the way that your business handles its financial information. This includes keeping accounting records, organizing finances, and interpreting financial data. Financial accounting covers a broad range of topics that all make an impact on your business.

Visualizing accounting is similar to visualizing a large assembly line. When you put all of the pieces together, it gives you an idea of the financial health of your business. The pieces are specifically financial information pertaining to your company. This includes:

  • Financial transactions
  • Financial records
  • Taxes and tax accounting
  • Financial statements and projections

Accounting indicates your business’s profitability, cash flows, liabilities and assets. By looking at all of this, as well as the data that goes alongside it, you can determine how and when your business is making money.

Understanding the Accounting Cycle

The accounting cycle happens in 6 major steps. It starts with recording business transactions in the general ledger. This is also known as bookkeeping. However, it’s much more than that. Ultimately, the accounting cycle aims to prepare financial statements about your business. Take a look at the 6 major steps of the accounting cycle below.

1. Analyzing and Recording Transactions

This step involves bookkeeping, as previously mentioned. In this first step, invoices, bank or credit statements, and receipts from transactions. Analytical skills are necessary in this first step. Duplicated information can skew the entire accounting cycle.

2. Posting Entries to the Ledger

Journal entries should be posted to the general ledger throughout the accounting period. Ledger entries should consist of three different components for each transaction. It should detail when the transaction happened, what it was for, and how much it was for. Entries can be posted using two different methods; single-entry accounting and double-entry accounting. Double-entry accounting is more common. It shows where money is coming from and where money is going. This is far more useful when reviewing financial statements.

3. Unadjusted Trial Balance

At the end of a financial reporting period, you’ll need to list all of your business’s accounts. You’ll also need to calculate their balances.

4. Prepare Adjusting Entries

If you need to adjust any of the journal entries you’ve already recorded, you can prepare adjusting entries. Adjusting entries would be entered for entries that need discounts, or that need to have charges added.

5. Adjusted Trial Balance

After adjusting entries have been added into your ledger, the adjusted trial balance can be calculated. This information is ready to be used for financial reporting and turned into financial statements.

6. Preparing Financial Statements

All of the information collected during the accounting cycle is turned into financial statements. These financial reports are used to analyze a business. Many accounting systems will prepare these for you automatically.

The Three Main Financial Statements

There are three main financial statements used to describe a business’s financial health. These statements are the balance sheet, the income statement, and the statement of cash flows. When reviewed together, they tell you more about your business’s money. These statements can show you where your money is coming from, as well as where it’s going to.

Using these financial statements you can determine things like:

  • When your business is most profitable
  • What your business’s expenses are
  • How much your business is worth

The Generally Accepted Accounting Principles

One of the ways that businesses communicate with one another is through accounting. The language of accounting is how this information is standardized. Using this language adheres with the generally accepted accounting principles (GAAP). All of these standards and procedures are what accountants must abide by when doing their work.

Five Different Types of Accounting

There are five different types of accounting that you’ll find in businesses. Each of these is used for different purposes, and has slightly different reasons for use.

Financial Accounting

Financial accounting prepares a company’s financial data for financial statements. These statements are generated for several different parties, including investors and government agencies.

Managerial Accounting

Managerial accounting is similar to financial accounting. However, statements produced through managerial accounting are for internal use only. They also are generated on a monthly or quarterly basis. Financial accounting statements are produced annually.

Tax Accounting

Tax accounting is a method that ensures you aren’t paying more taxes than you should. An example of this is when a tax professional tells you how to get the most from your tax returns.

Cost Accounting

Cost accounting is a method that analyzes all associated costs with an output. It helps businesses determine if prices should be raised, or how to increase a profit margin.

Credit Accounting

When your company grows to a certain size, its liabilities need to be reviewed frequently. Credit accounting deals with unpaid bulls, and helps a business from having all of its cash tied up in debts.

How Accounting Can Help Your Business

Accounting is important to your small business. It brings with it a number of benefits that you can use to make your business the most it can be. Take a look at them below:

  • Accounting helps you plan your business’s future, and allows it to grow.
  • Accounting documents are required for securing business loans.
  • Financial statements generated through accounting attract investors when your business is doing well.
  • The accounts receivable that are tracked through accounting allow you to follow up on owed debts.
  • Efficient accounting helps you manage and eliminate your outstanding debts.

Key Takeaways

Accounting is an essential operation for any business, no matter the size. Through accounting you can maintain the financial health of your company, and help it reach its full potential. If you’re looking for more accounting information and articles, be sure to check out our resource hub! There are plenty of helpful guides and articles there to help your small business.