What are the two main ways that businesses use accounting information to maintain financial control

6 Min. Read

January 2, 2020

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.

RELATED ARTICLES

The term accounting is very common, especially during tax season.

But before we dive into the importance of accounting in business, let’s cover the basics – what is accounting?

Accounting refers to the systematic and detailed recording of financial transactions of a business. There are many types, from accounting for small businesses, government, forensic, and management accounting, to accounting for corporations.

Why Is Accounting Important?

Accounting plays a vital role in running a business because it helps you track income and expenditures, ensure statutory compliance, and provide investors, management, and government with quantitative financial information which can be used in making business decisions.

There are three key financial statements generated by your records.

• The income statement provides you with information about the profit and loss
• The balance sheet gives you a clear picture on the financial position of your business on a particular date.
• The cash flow statement is a bridge between the income statement and balance sheet and reports the cash generated and spent during a specific period of time.

It is critical you keep your financial records clean and up to date if you want to keep your business afloat. Here are just a few of the reasons why it is important for your business, big or small!

It Helps in Evaluating the Performance of Business

Your financial records reflect the results of operations as well as the financial position of your small business or corporation. In other words, they help you understand what’s going on with your business financially. Not only will clean and up to date records help you keep track of expenses, gross margin, and possible debt, but it will help you compare your current data with the previous accounting records and allocate your budget appropriately.

It Ensures Statutory Compliance

Laws and regulations vary from state to state, but proper accounting systems and processes will help you ensure statutory compliance when it comes to your business.

The accounting function will ensure that liabilities such as sales tax, VAT, income tax, and pension funds, to name a few, are appropriately addressed.

It Helps to Create Budget and Future Projections

Budgeting and future projections can make or break a business, and your financial records will play a crucial role when it comes to it.

Business trends and projections are based on historical financial data to keep your operations profitable. This financial data is most appropriate when provided by well-structured accounting processes.

It Helps in Filing Financial Statements

Businesses are required to file their financial statements with the Registrar of Companies. Listed entities are required to file them with stock exchanges, as well as for direct and indirect tax filing purposes. Needless to say, accounting plays a critical role in all these scenarios.

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