6 Min. Read

Why is Accounting Important?

March 27, 2023

Accounting is important for small business owners as it helps the owners, managers, investors and other stakeholders in the business evaluate the financial performance of the business. Accounting provides vital information regarding cost and earnings, profit and loss, liabilities and assets for decision making, planning and controlling processes within a business.

The main objective of accounting is to record financial transactions in the books of accounts to identify, measure and communicate economic information. Moreover, tax reporting agencies require you to keep books at a minimum level that tracks income and expenditure.

What this article covers:

NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.

What Is the Purpose of Accounting?

Accounting is often referred to as “Language of Business”. It is a means of communicating financial information to different users for decision making.

The main objectives of accounting are:

RECORDING TRANSACTIONS

The primary role of accounting is to maintain a systematic, accurate and complete record of all financial transactions of a business. These records are the backbone of the accounting system. Business owners should be able to retrieve and review the transactions whenever required.

BUDGETING AND PLANNING

Business owners need to plan how they allocate their limited resources including labor, machinery, equipment and cash towards accomplishing the objectives of the business.

An important component of business management, budgeting and planning enable businesses to plan ahead by anticipating the needs and resources. This helps in the coordination of different segments of an organization.

DECISION MAKING

Accounting assists in a range of decision-making process and help owners in developing policies to increase the efficiency of business processes. Some examples of decisions based on accounting information include the price to be charged for products and services, the resources needed to make these products and services and financing and business opportunities

BUSINESS PERFORMANCE

Using the accounting reports, business owners can determine how well a business is performing. The financial reports are a reliable source of measuring the key performance indicators, so business owners can compare themselves against their past performance as well as against the competitors.

FINANCIAL POSITION

The financial statements generated at the end of the accounting cycle reflect the financial condition of a business at that time. It shows how much capital has been invested, how much funds the business has used, the profit and loss and the number of assets and liabilities of a business.

LIQUIDITY

A common reason for small business failure is the mismanagement of cash. Accounting helps in determining the liquidity of a business which refers to the cash and other liquid resources at your disposal to pay off financial commitments. The information reduces the risk of bankruptcy through detection of bottlenecks.

FINANCING

Accounting helps business owners prepare historic financial records as well as financial projections which can be used while applying for a loan or securing investment for the business.

CONTROL

By placing various checks across the organization, accounting helps in avoiding losses caused by theft, fraud, errors, damage, obsolescence and mismanagement. The internal controls safeguard the business assets and avoid long-term losses.

LEGAL REQUIREMENTS

Law requires businesses to maintain an accurate financial record of their transactions and share the reports with the shareholders, tax authorities and regulators. The financial statements and information are also required for indirect and direct tax filing purposes.

Why Is Accounting Useful for Small Business Owners?

Poor financial management is one of the primary reasons for small business failure especially in the first year of the business. Since small businesses have a limited budget and other resources, accounting plays a crucial role in providing information that helps businesses in its growth and development.

For small business owners, accounting is crucial due to the reasons below:

Keep a track of the cash flow. To prevent your business cash flow from running dry, you should implement policies for efficient record-keeping and a sound financial strategy.
To understand the concepts of fixed costs, variable costs and how to accurately cost your project, small business owners can rely on cost accounting. This way you don’t end up losing money on a project you thought would be a big earner
Accounting gives you a better grasp of the well-being of the business. You can do this by learning to read a balance sheet, income statement, and cash flow statement
Helps you detect and avoid frauds and theft by customers, employees and suppliers
When you understand the business finance and dealings, you are better equipped with facing audits
Bankers are more confident when dealing with business owners who have a handle on the business finances and actually understand financial implications

Whether you are a solopreneur or employ staff, the key to growing your small business is to review your financial statements regularly and establish a detailed budget that will allow you to discover operational inefficiencies. Saving a little bit on several expenses can add up to big results over the long run.

Why Is an Accountant Important?

Accounting necessitates huge amounts of data collection and organization of information in a way that can easily be interpreted by the management. Business owners need to keep tabs on the operating costs, changing revenues and dividends to make strategic decisions.

As a small business owner, it might be tempting to manage the business finances yourself, but financial matters can be delicate and may require a trained professional to handle them correctly. Professional accountants assist business owners in making smart fiscal decisions while adhering to the compliance requirements.

Here are some of the key reasons to invest in an accountant for your small business:

Analyze the financial data and determine areas for improvement. This is crucial for the long-term health of the business
Prepare financial statements based on the Generally Accepted Accounting Principles (GAAP)
You will get customized advice based on your unique business needs
Using a third-party accountant ensures that you’ll receive unbiased information that is verifiable and objective
The accountant acts as a financial advisor and helps you with budgeting and monitoring cash flow on a steady basis. This will allow you to navigate any hurdles that occur in real time
It helps you during tax season as accountants can identify potential deductions and help avoid audits

Along with hiring an accountant, business owners are increasingly using online accounting software. The software syncs the accounting system with the banks and helps you understand your real-time cash position. It can also be used for viewing various accounting reports, creating expense claims and sending invoices on the go.