The Purpose of Accounting in Small Businesses | SMB Compass
Ezra Cabrera | November 3, 2020
Accounting plays a crucial role in the overall development and growth of a small business. In most cases, small businesses and start-ups have a limited budget, and accounting is essential to managing their incoming and outgoing cash flow each month. Every year, accounting records allow companies to evaluate their overall financial performance so they can create forecasts for the year to come and make important decisions and adjustments to maximize profitability.
What is Accounting?
Accounting is considered the language of finance and the lifeblood of a business. It’s what tells the story of a company’s profitability. It stores financial information such as assets and liabilities as well as profit and loss reports, which are critical considerations if and when a business owner seeks additional funding to grow their company.
With transparent and accurate financial records, business leaders can make informed decisions about things like: hiring and firing people, reducing operational costs, expanding their product portfolio, and moving their headquarters to a new location, to list a few.
What is the Purpose of Accounting in Business?
Small businesses need to keep accounting at the forefront of their day-to-day operations. Many companies prepare different accounting reports for different purposes, like for tax requirements or in-house record-keeping. Accounting goals will vary depending on who’s looking at a company’s financial health. For instance, accountants themselves will have different goals than potential investors or loan officers at banks.
Accounting is vital to:
Make better economic decisions
Everything from product pricing, operation costs and overhead expenses are tracked, managed and analyzed through accounting. Accounting information allows business owners to evaluate their incoming and outgoing cash from month to month so they can make adjustments to their budgets as needed.
Up to date accounting reports and efficient bookkeeping that follows the latest, best practices will also guide business owners and other stakeholders in determining whether a company is profitable enough for growth.
Plan and maximize the company’s budget
A company’s budget is all encompassing and effects every facet of the business. Creating a comprehensive budget, therefore, requires a business owner to sit down with all department heads to discuss each of their plans and how it would play into the larger budget. For instance, how much money does the marketing department predict they will need for the upcoming year, and what for? How much does the sales department need and what for?
Accounting plays a critical role in this process. Previous financial records will be the best indicator as to whether or not the company can increase its annual budget based on each department’s performances. It also allows business leaders to anticipate the cost of tools that are needed in generating sales.
Evaluate the financial position
Generating accounting reports is the only way to determine if a business is financially healthy enough to continue operating. All financial statements reveal critical information like profit and loss, assets and liabilities, and how much of the annual budget is remaining in each quarter.
Accounting also helps determine a business’ liquidity or ability to convert its assets into cash so it can pay-off its liabilities. Doing so reduces the risk of bankruptcy or permanent closure.
Comply with legal requirements
Registered businesses need to share records of their transactions with shareholders and tax officers. Tax filing is mandatory, and failure to comply with tax obligations in a voluntary and timely manner will result in legal implications.
Different Types of Accounting
Tax accounting
Tax accountants handle the preparation of tax returns and payments, working to make sure that a company doesn’t pay more than what is legally required by the Internal Revenue Service.
Managerial accounting
All financial statements recorded for in-house purposes are handled via managerial accounting. Managerial accountants produce reports to provide company management with regular updates on the organization’s financial status – typically on a monthly or quarterly basis.
Financial accounting
The primary purpose of financial accounting is to generate financial reports for parties outside the company, like government agencies, auditors, or investors. Financial accounting, typically done on an annual basis, can help determine whether a company is financially healthy enough to invest in.
Cost accounting
Cost accounting records all of the costs a company incurs, and is most often used to make improvements in management. For instance, cost accounting helps business owners determine if it’s time to increase their profit margin or not. Cost accounting reports will illustrate if it’s a good idea for a company to increase the price of its products or services, or which costs it can reduce to increase its profit.
Do small businesses need an accountant?
The job of an accountant is to collect, keep, and analyze the company’s financial information while adhering to the generally accepted accounting principles (GAAP). The GAAP ensures that accountants follow a strict set of protocols when creating and disclosing a company’s financial statements.
Yes, small businesses need accounting, but that doesn’t always mean they need to hire an in-house accountant. Some growing organizations prefer outsourcing their accounting needs from an external party to control costs, or utilizing specialized accounting software. Bottom line, organizations need to properly manage their accounting needs to stay on track to meet goals, prevent potential lawsuits, and make better decisions that will bring the business to new heights.
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