What is the importance of accounting in business? Imagine a world without language and communication, isn’t it in chaos? What would happen if there is no balance sheet or statements of financial position to show us the financial condition of our business? What can we do if there are no income statements that tell us if our company performs well or not? Accounting is considered the language of business. It is a service activity, which function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. It aids business owners and other users to make informed judgment and better decisions, through the financial information it provides.
What is accounting?
Accounting is basically defined as the process of identifying, measuring and communicating economic information to help its users make informed judgment and decisions. It also involves recording, classifying, summarizing and interpreting financial transactions and events about economic entities in a significant manner. Accounting revolves from the recognition of accountable events, valuation of these events, journalizing them in a chronological sequence, posting them to ledgers, preparation of financial statements, to financial statement analysis. These processes are also done in accordance with established accounting rules and standards.
Business owners as users of accounting
Accounting information has many users, which include business owners, managers, investors, creditors and the government (for tax and regulatory purposes). A businessman use financial statements to determine particular information that will guide him in making important business decisions. He can use a statement of financial position (balance sheet) to determine the financial condition of his business and determine its liquidity and solvency through the use of financial ratios, such as working capital ratio and debt to equity ratio. Working capital ratio helps users to determine whether the company will be able to meet its current obligations (e.g., payroll and trade payables). On the other hand, debt to equity ratio measures the company’s financial leverage calculated by dividing its total liabilities by equity. It indicates what proportion of equity and debt the company is using to finance its assets.
Income statements aid business owners in determining the performance of their companies. It shows how profitable a business is for a certain period of time (e.g., annual, quarterly or monthly). If you own a company, you need to check if it is performing well or not. Income statement shows your income and profit, which are generated from your business operation. It also shows your expenses, which measures the amounts of your spending. Moreover, the statement of income also helps you in computing your income tax to be paid to the government.
Cash is one of the most important assets of a company. Hence, it is very important that you get a clearer picture of where your cash and cash equivalents are going. The cash flow statement provides its users with information regarding the inflows and outflows an entity’s cash for one year or for shorter periods of time. It identifies the sources from where cash inflows have originated and where cash outflows are utilized. It classifies cash flows into operating, investing and financing activities. This financial statement assists business owners and management to properly plan and maintain a matching between cash inflows and outflows to preserve its liquidity.
Other financial information provided by accounting, such as statement of changes in equity and the notes to financial statements help its users to further understand the condition and performance of a certain entity. The journals and ledgers also give their users a more organized economic information that will guide them in making their day to day business decisions. Accounting has been around for thousands of years. The Assyrians (Mesopotamia) already used accounting to record their crops and herds. Today, as the business world advance to the modern age, business owners also utilize accounting to understand the more sophisticated business flows and systems.