August 08, 2015

Why is accounting important?


Why is accounting important?

We do business because we want to earn. And accounting is the way to learn how much we earn through our business as it is all about keeping financial accounts. So accounting is always, and will always be part of running businesses.

What does accounting account for?

Accounting makes businesses a blueprint or a clear picture of the three significant financial statements: income statement, balance sheet, and the cash flow statement. Through accounting, the company realizes substantial figures reflecting profit, sales, revenues, taxes, credits, and other financial matters. To observe balance with the financial activities and resources of a business, these financial statements are released regularly to track its economic progress and management/mismanagement.

Kinds of Accounting (According to Purpose)

Generally, there are two kinds of accounting: financial accounting (recording and communication of economic information under the GAAP), and managerial accounting (the record and communication of economic information that may or may not be following GAAP).

Accounting Methods

Accounting can be done on a cash basis (or the cash basis accounting) or an accrual basis. Cash basis accounting and accrual accounting are some of the principles in accounting to guide financial institutions.

Cash Basis Accounting

Novice and veteran businesspeople alike, at least once in their lives, have tried cash basis accounting with or without them knowing it. Cash basis accounting is the traditional way of recording accounting transactions for revenues and expenses only when the corresponding cash is paid out and received.

Advantages of Cash Basis Accounting

Cash basis accounting is known to be the simplest method of accounting as you only record expenses and revenues. More often than not, this approach of accounting does not require business owners to hire an accountant as this can be quickly done and understood by them.

Cash Basis Accounting is useful for:

-small business

-personally-managed business

-low stock levels activity

Moreover, cash basis accounting will help entrepreneurs with their small businesses to be aware of their financial progress with ease as they diligently note their expenses and revenues on actual transactions.

Disadvantages of Cash Basis Accounting

As handy as it is, though, cash basis accounting is not the usual practice among more significant business entities. Here’s why:

cash basis accounting is not accepted under international accounting standards like the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS);

it does not keep tracking of your payables and receivables (no accounts receivable and accounts payable);

more significant business enterprises use more complex accounting principles that cash basis accounting doesn’t account for; and

it can give an inaccurate record of profits as revenues may be realized in a different period in which related expenses are achieved.

Who should try cash-basis accounting?

Cash basis accounting can be best practiced by small starting business entities and companies that would want to maintain low-key accounting measures. More notably, as the name suggests, “cash basis” accounting is tailor-fit for cash-based businesses.

If your business is time-bound and observes negotiations and financial transactions within a time-frame, accrual basis accounting is a more suitable accounting method for your accounting measures.

To cap it off, the cash basis accounting approach is the recognition of income when received regardless of when earned and recognition of expense when paid irrespective of when incurred.

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Author: Charles Lutwidge

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