- Accounting is the language of small business. Without proper insight into your company’s financial health, you’re paralyzed as a small business.
- An accountant keeps track of your business’s finances and profitability, including exactly how much money is coming in and going out.
- The three main types of accounting are financial, managerial and tax accounting.
- This article is for new business owners looking to improve their basic accounting skills and understanding of what accountants do.
What is accounting?
Accounting is how finances are tracked by an individual or organization, such as a small business.
As an individual, you may use an accountant only for submitting your taxes, which is handled by certified public accountants (CPAs), who must pass an exam to prove their mastery of accounting.
Business accounting is the process of collecting and analyzing financial information for a company. It can be done by an individual, business or accounting team. The information you gather helps you understand the company’s business activity and create financial reports.
For businesses, tax collectors, regulators and other oversight agencies want to see thorough and proper accounting records. If your business ever seeks investors or other shareholders, these agencies will review your accounting paperwork. For example, when you see a deal made on a TV show like The Profit or Shark Tank that later falls apart, it’s almost always because of accounting problems.
Why is accounting important for your business?
Business accounting is important for a number of reasons. As a business owner, you need to understand the types of assets, inventory and liabilities your business has. This is what is going to help you continue to grow your business and secure investors.
Here are the biggest benefits of small business accounting.
- Evaluating business performance: Financial statements help you understand how your business is doing. They can help you see areas where your business is performing well, as well as the things you need to work on. This information is crucial if you hope to bring on investors.
- Creating financial projections: Understanding your business’s financial data helps you make financial projections and make smarter decisions with your money.
- Filing annual tax returns: Staying on top of your business accounting will make things much easier come tax season. You’ll understand how much you owe on your quarterly and annual tax statements.
What do accountants do?
The American Accounting Association defines accounting as “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.” Accountants log a business’s accounts payable, accounts receivable and other financial transactions, typically using accounting software.
[Related: Best Accounting Software for Small Business]
“Accountants use the work done by bookkeepers to produce and analyze financial reports,” said Stan Snyder, CPA. “Although accounting follows the same principles and rules as bookkeeping, an accountant can design a system that will capture all of the details necessary to satisfy the needs of the business – managerial, financial reporting, projection, analysis and tax reporting.”
In the United States, most accountants abide by the generally accepted accounting principles (GAAP) to present a company’s financial information to those outside the company in a format that everyone can understand. There are different sets of accounting standards for companies that operate overseas, as well as for local and state government entities.
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Harold Averkamp, CPA and owner of AccountingCoach, said accountants also give a company’s internal management team the information it needs to keep the business financially healthy. Some of the information originates from the recorded transactions, and some consists of estimates and projections based on various assumptions, he said.
What are the different types of accounting?
There are tax accountants, financial accountants, public accountants, government accountants and others. Forensic accountants are employed by regulators and law enforcement to help track illegal activity. Diving even further, crypto accountants deal with cryptocurrency assets.
An accountant usually works for a person, a business or the government. However, accounting firms such as Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers are renowned for tracking and managing public and private financial data.
Here’s a breakdown of the main types of accounting.
- Financial accounting: This type of accounting is accomplished with investors in mind. It is used to assess the financial health of a business and helps management get an accurate idea of a business’s finances. This type of accounting is essential for companies to be transparent about their financial health.
- Managerial accounting: This type of accounting is used to generate financial statements for companies, including product costs, cash flow reports, profit and loss statements, and business acquisition reports. This type of accounting is essential for business leaders, as it provides accurate financial data and can help companies make decisions about their money.
- Tax accounting: Tax accounting focuses on how your business works with the IRS. Accountants can help you understand your financial picture when filing your yearly or quarterly taxes. This is an essential service that all small businesses should utilize.
- Forensic accounting: Forensic accounting involves auditing and accounting practices. This type of accounting is frequently used by banks, attorneys and businesses to examine financial transactions. Forensic accountants are often used when fraud or embezzlement is suspected.
- Cost accounting: Cost accounting examines the actual cost of doing business. This type of accounting is usually used for manufacturing and service-based businesses; it looks at the fixed and variable costs a business incurs.
Accounting ratios help to uncover difficult-to-find conditions and trends by inspecting the individual components of the ratio. Formulas like this help accountants determine a company’s status and projections. Accounting ratios are divided into five main categories:
- Liquidity ratios measure a company’s liquid assets versus its liabilities.
- Profitability ratios measure an organization’s ability to turn a profit after paying expenses.
- Leverage ratios measure total debt versus total assets and gauge equity.
- Turnover ratios measure efficiency by comparing the cost of goods sold over a period of time against the amount of inventory that was on hand during that same time.
- Market-value ratios measure a company’s economic status against other companies in industry.
Many accountants choose to become CPAs, which requires passing an exam and getting work experience. CPAs audit financial statements of public and private companies; serve as consultants in many areas, including tax, accounting, and financial planning; and are well-respected strategic business advisors and decision-makers, according to the Pennsylvania Institute of Certified Public Accountants. Positions CPAs hold include accountant, controller, chief financial officer and financial advisor.
Accounting vs. bookkeeping
While bookkeeping and accounting may seem like the same thing, they are actually very different. Bookkeeping is a record-based practice. It focuses on logging information, tracking important numbers and quantifying the important monetary aspects of your business. Accounting comes in when these numbers and reports are interpreted and extrapolated to help guide business decisions.
So while bookkeeping – and having proper bookkeeping systems in place – is extremely important, it is only half the work for building a financially healthy business. You need accounting practices in order to make informed decisions about the future of your business. What good is data without proper interpretation?
Basic accounting tasks
Here are some of accountants’ main job duties:
- Record transactions. Depending on the volume of transactions, an accountant may record each transaction daily or weekly (e.g., billing customers, receiving cash from customers, paying vendors).
- Document and file receipts. Accountants may copy all invoices sent, all cash receipts (cash, check and credit card deposits) and all cash payments (cash, check and credit card statements). They also may start a filing system that is easy to understand, track and maintain.
- Pay vendors and sign checks. Accountants may track accounts payable and have funds scheduled to pay suppliers on time and avoid late fees.
- Balance business checkbooks. Accountants may do this monthly to ensure that your business’s cash transaction entries are accurate and that you are working with the correct cash position.
- Process or review payroll and approve tax payments. You need to meet payroll tax requirements based on federal, state and local laws at different times. Accountants make sure you withhold, report and deposit the applicable income, Social Security, Medicare and disability taxes to the appropriate agencies by the required dates.
What is an accounting cycle?
An accounting cycle is the process your company has in place for recording and analyzing the various accounting-related events within your company. It’s important to establish effective bookkeeping and accounting practices in order to manage the financial health of your company.
There are eight main steps in an effective accounting cycle.
- Identifying transactions: This is the basic step of establishing accurate and correct recordkeeping practices. Accounting software and POS systems can often assist with this.
- Recording transactions: Much like step one, recording can be accomplished with cloud-based software systems. The key is for every transaction your business engages in to be recorded somewhere.
- Posting transactions: When a transaction is recorded, it should be posted to a general ledger, which holds the total transactions of the entire business.
- Listing unadjusted trial balance: This is the review of your company’s finances at the end of the accounting period, which could be quarterly, monthly or on another predetermined basis. Trial balances are established for each account within your business at the end of each period.
- Creating worksheets: These sheets identify where adjustments need to be made to each balance.
- Adjusting journal entries: Any necessary adjustments may be recorded as their own journal entries.
- Generating financial statements: Most businesses need an income statement, balance sheet and cash flow statement.
- Closing the books: The accountant wraps up the cycle with a closing entry, which resets the temporary account balances on the general ledger and serves as an overview of the given time period for future analysis.
Tools for businesses
If accounting isn’t one of your strengths but you have to manage this aspect of your business, there are numerous tools on the market that can help you. And the best place to start is by investing in accounting software.
To streamline accounting functions, you will need to research the best accounting software that’ll meet your needs. Check out our review of QuickBooks accounting software and our Zoho Books review for examples of top software providers.
Accounting software makes it possible to send invoices, reconcile bank transactions, pay your vendors and pay employees. The exact software you need will depend on the type of business you run and the specific features you want.
Jamie Johnson contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.