Accounting: Definition & Overview

KEY TAKEAWAYS

• Accounting is a critical function for every size of business. It helps with cost planning, decision-making, and understanding financial performance over the long term.
• Some of the main types of accounting include financial, cost, and managerial accounting.
• Professional accountants follow a specific set of standards. These are known as the generally accepted accounting principles, or GAAP.

What Is Accounting?

Accounting in business is the process used to record all your financial transactions, generate financial statements. This includes things like reporting, analyzing, and summarizing the transactions. Plus, it ensures financial accuracy and is a critical part of operating your business. Accounting is an analytical tool to ensure the business runs properly. It’s also vital to helping you as the business owner make important decisions, such as knowing if there is enough cash flow for financial obligations like paying employees.

Providing accurate accounting information to the proper authorities is critical. Even more than that, accounting is an effective way to get a better sense of your areas of operations by understanding the financial performance of your business as a whole. 

For example, you can gain insights into profit and losses, income and expenses, and even sales trends.

Financial statements will provide an overview of the business’ financial performance for a chosen period (e.g. month or quarter) or as of a specific date. Some common financial statements include the profit and loss statement or the statement of cash flow.  And through this, you develop an understanding of financial position, including cash flow.

How Does Accounting Work? 

The profession of accounting handles things like business transactions and daily transactions. 

No matter the type of business you operate, accounting will play a big role. Companies on the smaller side might only have one accountant or bookkeeper—larger companies, on the other hand, can have an entire finance department. 

Either way, accounting provides insights that let you make more informed business decisions. You can generate reports that summarize particular business operations—for example, income generated from a specific customer. This gives you a sense of your actual financial position. And you can also gain insight into cash flow over any given period. 

The fundamental functions of accounting can be handled by a single bookkeeper. But advanced accounting needs are often get handled by accountants with formal designations. 

For example, an accountant could get designated as a Certified Public Accountant (CPA). Or they might be a Certified Management Accountant (CMA). But whatever their designation is, an accounting degree is mandatory.

What Are the Different Types of Accounting? 

 There are different types of accounting depending on what kind of business and industry you’re in. 

Each business will have a slightly different approach to accounting entries, have varying processes, and demand specific requirements. So what are the different types of accounting? Let’s take a closer look at some of the more specific accounting types.

Financial Accounting

Financial Accounting is what most small businesses do. It involves recording of income and expenses, journal entries, and reconciling of bank statements. With financial accounting, you generate financial statements for your business that you can use to further analyze your business or give to other parties (like the bank when trying to obtain a loan). Financial statements can include an income statement, a balance sheet, or a statement of cash flow. 

To ensure compliance with accounting standards and other laws, some financial statements can get audited. This can be done in-house or by an external accounting firm when required. Some businesses (publicly traded corporations, for example) are required to have their accounting records audited.

Cost Accounting

In addition to financial accounting, many manufacturing businesses also use cost accounting. This type of accounting lets you make more informed decisions about the cost of the items you produce and the efficiency of your manufacturing process.

Cost accounting provides information for business owners, managers, and analysts. It’s an effective way to gain insights into how much certain products should cost and to help make decisions about future operations.

One of the main differences between these financial and cost accounting is in how money is considered. Cost accounting focuses on costs associated with creating products, whereas financial accounting looks at the overall financial performance of a business. Businesses that only provide services or resell goods will not typically employ a cost accountant.

Managerial Accounting 

Financial and managerial accounting use a lot of the same data. But, that data is organized and used in different ways. 

For example, both types have financial reports created monthly or quarterly. With managerial accounting, however, the report’s main purpose is to make better business decisions, rather than measuring economic performance. Reports can include budgets, cost analysis, and revenue projections. 

Managerial accounting is a useful tool for business owners to review current operations and plan future business goals. This type of accounting is mainly used by managers and other people involved in making critical business decisions.

Summary

Accounting is one of the most critical parts of any business. It involves reporting, summarizing, and analyzing financial records of your business. This might include recording financial transactions, creating financial statements, and other reports. Accounting provides information about your current economic performance. It can also help you forecast future revenues and expenses and plan your future business goals.

The three different types of accounting include financial, cost, and managerial accounting. The specific type you use depends on your business type and what kind of information you need to obtain. 

Accountants follow the generally accepted accounting principles (GAAP). These help ensure that financial information is  consistent and accurate. These accounting principles also set standards of professional conduct for the accountants and auditors.

Knowing how accounting works ensures accurate accounting records and easier tax preparation. And depending on the business, there might also be certain other corporate governance principles to follow.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.