Accounting Basics and Why They Are Important for Business Owners

Accounting
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Fincent Team

The US economy is evolving, with numerous small businesses coming into the picture. These small businesses are venturing into new segments and are also making a positive impact on the economy. However, starting a business can be cumbersome as it involves various functions like marketing, staffing, financing, etc.

When you start your own creative business, you will have to be at the helm of affairs. Small business owners can find handling all the verticals of the business extremely daunting at times. While you can always hire multiple people to take care of your verticals, not every company has the financial bandwidth to hire so many people.

There are functions like graphic designing, website creation, etc., which you, as a small business owner, can easily outsource. You can often lower your costs by a decent margin by benefiting from the services of another organization with the required expertise. Accounting is one such function.

What is Accounting?

Accounting is a process that involves identifying, measuring, recording, and analyzing a business' financial information. No business can survive without money as it forms its backbone.

However, with money, you also need to keep track of your expenditures and income to understand your company's performance and position in the market.

The definition of accounting remains the same across all kinds of organizations. Multinationals and small businesses maintain their book of accounts as it is essential in keeping track of their financial health. These books of accounts help you in tracking your cash inflows and outflows more efficiently.

Businesses are not social entities. Any business, large or small, works to earn profits. With accounting, you can efficiently manage and monitor its profits and losses.

Why is Accounting Important?

Accounting is a process by which small business owners keep track of their finances. Tracking your business' financial performance can help you decide its next course of action.

For example, if your business is making losses, you will have to devise a plan to bounce back and break even. On the contrary, if your company is profitable, you will have to develop a strategy to maintain and improve its profits.

Accounting, however, is not just limited to profits and losses. A company has several assets and liabilities. Accounting provides you with all the information related to assets and liabilities and how they contribute to your company's performance. As a small business owner, you must emphasize maintaining a proper book of accounts.

What Is the Purpose of Accounting?

Accounting is the language in which a business interacts with its multiple stakeholders. It serves various purposes, some of which include:

1. Recording Transactions

Accounting aims at maintaining systematic and accurate records of all financial transactions and expenses your business makes. Maintaining a book of accounts also comes in handy when an auditor needs to look through your finances in the event of a mishappening.

2. Planning and Preparing Budgets

A business will cease to exist without a plan in place. You need to allocate your funds to various departments or goals to achieve all your business objectives. Budgeting and planning form an essential part of any business, and they cannot be done without accounting.

3. Decision Making

Accounting gives a business an idea of its financial health, based on which decisions are taken. These decisions include making a change in the way business is conducted or revisiting the costing. A business sets new goals like increasing profitability, reducing trade payables, etc., based on the book of accounts.

4. Legal Requirements

A company is legally required to maintain its book of accounts. You should maintain accurate financial reports as they have to be shared with the respective stakeholders, apart from playing a significant role in filing taxes.

5. Business Performance

To understand how your business is performing, you need to analyze the accounting reports. Financial reports are the only credible source that will give you an accurate picture of your business' health. You can also compare your financial reports with your competitors to understand your position in the market.

Who Is an Accountant?

An accountant is a person who handles the book of accounts of a business or any other enterprise. They are responsible for various functions like the analysis, preparation, and auditing of financial reports. An accountant can choose to work with a company or independently.

You can focus on your creative business and hire an accountant to help with your financial statements and other documents. If you don't want to hire an in-house accountant, you can outsource your accounting needs for a hassle-free experience.

Accounting vs. Bookkeeping

Accounting and bookkeeping might sound similar, but they are different in various ways. Bookkeeping basics forms the base of accounting. It involves the administrative part of accounting like record-keeping, data entries, vouching, account reconciliation, etc.

Bookkeeping also covers the management of invoices and processing payrolls. All the operational aspects of accounting are taken care of by bookkeepers. The best part is that you can easily outsource this function if you want to focus on building the other aspects of your business.

Accounting takes a holistic approach to managing finances and preparing and analyzing financial reports. Accountants take care of your finances by making sure that you are ready with all kinds of documents. They also make several budget recommendations like making cuts, acquiring an asset, etc.

The Accounting Cycles

If you are a small business owner, you must ensure that the accounting cycle is being followed. The accounting cycle defines when and in what order the accounting procedures should take place. The cycle repeats itself every fiscal year.

There are various stages in an accounting cycle. Listed below is the sequence in which all the activities take place in a small business' accounting.

  1. Transactions
  2. Journal entries
  3. Posting
  4. Trial balance
  5. Worksheet
  6. Adjustment of entries
  7. Financial statements
  8. Closure of the book of accounts

You can make slight changes in the sequence based on the situation at hand. However, the book of accounts has to mandatorily be closed as soon as the financial year ends.

Financial Statements

As a small business owner, you need to prepare and analyze all kinds of financial statements. This is important as you want to get an accurate picture of your financials and the position of your business. The three financial statements are:

1. The Income Statement

The income statement will show the revenue generated by your company through the sale of goods and services. The cost of goods sold is then subtracted to calculate the profit earned in the financial year. The statement also shows all the revenues and expenses of the business.

2. The Balance Sheet

The balance sheet is a statement that you should prepare at the end of the year. It shows an accurate picture of the company's assets, liabilities, and equity at the end of the year. The assets should be equal to the sum of liabilities and equity if you prepare a balance sheet for your small business.

3. The Cash Flow Statement

This statement keeps track of your cash inflows and outflows. The net income is adjusted after considering all the non-cash expenses. Then, the change in the balance sheet from the previous year is checked to determine the inflow and outflow of the business.

Generally Accepted Accounting Principles (GAAP)

GAAP are certain principles put in place to maintain uniformity in the ways people conduct accounting operations. GAAP governs how your company will treat a transaction and how that particular transaction will be recorded.

As a small business owner, you should seek the expertise of a professional who knows all the Generally Accepted Accounting Principles inside-out and can implement these in your business' accounting practices.

The Different Types of Accounting

Accounting is a branch of finance that can be further divided into multiple sub-branches. You might have to adopt one or two of these branches based on the industry you work in. Some of the popular accounting types are:

1. Financial Accounting

This accounting aggregates only the financial information which is present in the company's financial statements. You or your accountant must understand GAAP or IFRS to perform the activities that come under financial accounting.

2. Management Accounting

Here, the information is collated to serve the purpose of internal operational reporting. Management accounting involves cost accounting, wherein you factor in the various costs involved in developing an offering.

3. Public Accounting

Here, the accountants analyze the financial statements of different client companies. Public accounting involves cross-verification of financials by revisiting a company's financial statements. The purpose of verification is to check if the reports present an accurate and clear picture of the business.

There are other forms of accounting too. Among the three mentioned above, financial accounting is most likely to suit your needs best.

Why Accounting Matters for Your Small Business

As a small business, finance is always one of its critical components. You need to keep track of where you spend and where you earn to run your business smoothly. However, as a small business, you don't need to micromanage everything.

You can hire an expert to handle the how to do bookkeeping for your business while you focus on growth and building it better. Ensure that you hire someone good enough so that you never have to worry about your business' bookkeeping again.

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