Accounting allows businesses to translate raw numbers into an understandable statement about profitability and performance. Because all accountants follow the same generally accepted accounting principles, the language of a business's account books should be comprehensible to anyone in or outside the company.
Follow the Money
Businesses rely on accounting to track the flow of money. When the business makes a sale, that goes in the accounts. If the sale is on credit, the accounts note when the actual cash payment arrives. If the customer takes too long to pay the bill, the account shows that. Other accounts track payroll and company purchases
Two of the basic statements in business accounting are the income statement and the cash-flow statement. Income measures revenue and expenses, while the cash-flow statement tracks the actual money coming into the company. If a business runs on credit, it's important to know both, because a business that's made lots of credit sales can still have a shortage of cash.
Business owners use accounting to analyze how well their company performs. If customers are consistently paying late, or the business has a huge number of deadbeat accounts, accounting spots the problems. Accountants can monitor and compare different aspects of a business: If sales revenue is up but manufacturing costs are up more, for instance, the business may be losing ground.
Accountants can also compare the financials of one business to another, as both companies use the same standard. Accounting metrics can measure profitability or the rate of return on investment and compare the results. Even if one company is worth $20 million while the other is only valued at $200,000, the right accounting metrics can show which one is earning a better return on the money it has to work with.
Both internal and external users rely on accounting information. Internal users include employees, managers and business owners. External users are investors, suppliers and lenders. For instance a supplier might want to know how good a risk a company is before extending it credit.
Managers rely on accounting information to make informed decisions by answering key questions:
•Is the company able to pay its debts? Which debts are most urgent?
•How efficient is the company? Are some branches particularly inefficient?
•What is the projected cash flow and income over the next year?
•How much can the company afford to invest in expansion?
The answers to such questions help management make the right judgment calls.
Accounting helps businesses avoid legal trouble. When tax time rolls around, the financial issues, particularly for a large corporation, can become incredibly complex. Accounting helps steer the business straight and keep it out of trouble with the Internal Revenue Service. Corporations that file financial statements with the federal government have to rely on accountants to keep them accurate. Filing with inaccurate accounting is a legal disaster.