We very well know what is accounting about. We have been accounting since we were kids. Remember, when we helped in household work and mom rewarded us with cash? Or when we planned to save enough to buy our wished toy. Or went to the ice cream parlor to buy our favorite sundae and asked for the balance change to be returned. Or when we took our bicycles for repair, but first asked the mechanic how much it’ll cost. All this is part of accounting and bookkeeping services only.

What is Accounting

To define accounting, it is a process of recording, cataloging, analyzing and reporting the financial transactions of a business. Proper accounts allow the management to better understand and take care of the financials of its business. Accounting is used to keep the financial information organized in a more formal, efficient and easy to decipher version of such processes. This helps the management in making sense of the financial data and they can strategically plan its future expenditures and maximize profits. The books are also kept in compliance with financial regulations.

You will know at a glance whether or not you’re making a profit, what the cash flow is, what is the current value of assets and liabilities in your company’s accounting, which products (or services) are actually making money, and such.

Accounting vs Bookkeeping

While accounting and bookkeeping overlap somewhat, they are both distinct professions involving different work & responsibilities. Though some feel bookkeeping is just one aspect of accounting. Bookkeeping is basically about recording and categorizing financial transactions of your business, whereas accounting is using that financial data for interpreting and reporting.

In other words, good bookkeeping is all about accurately recording financial data, while good accounting means maximizing revenues & compliance through analysis, strategy, and tax planning, through that data. Bookkeeping is essentially laying the groundwork for preparing accounts. Providing the data that is necessary to perform their role.

To know the difference between bookkeeping and accounting in detail, please check: Bookkeeping vs. Accounting: Difference a Business Owners must Know

Accounting Cycle

Accounting begins the moment you make the first transaction towards company formation. Any financial activity or exchange that involves your business—is to be recorded into your company’s ledger.

Recording business transactions is the role of a bookkeeper. And the first step of what is generally known as the “accounting cycle”. The accounting cycle is basically the steps of the process of recording the raw financial information and produce accurate and meaningful financial reports.

What is the Process of Accounting

what is accounting
  1. Analyze and post transactions via journal entries (involving invoices, bank statements, etc.)
  2. Post transactions to the ledger (according to the rules of what is popularly known as double-entry accounting)
  3. Prepare an unadjusted trial balance book (this involves listing all your business’s accounts and working out their balances)
  4. Document the entries that are the other side of the transaction under the double-entry, at the end of the period
  5. Arrange the adjusted trial balance with the help of the above
  6. Ready the financial statements
  7. Close temporary accounts by closing entries
  8. Prepare a post-closing trial balance

Financial statements

Financial statements are summary reports prepared to provide to the investors an overview of how the business is doing, financially.

There are mainly 4 types of financial statements: the balance sheet, income statement, cash flow statement, and statement of retained earnings. With their help, you’ll know where your business’s money is, and how it got there.

Let’s say you’re a freelance surfing instructor who is hired by clients for surfing lessons. Reviewing your financial statements would tell you which months are the most profitable ones, how much money has been spent on supplies, and what is the total value of your business.

** Do read more about financial statements: Beginners’ Guide to 4 Basic Financial Statement

Generally accepted accounting principles (GAAP)

Every business is different but to make accurate financial comparisons between two businesses, a common language that describes each of them is required. That’s what generally accepted accounting principles (GAAP) are: a set of procedures & standards that all business accountants must adhere to for preparing financial statements.

GAAP was set by a nongovernmental body called the Financial Accounting Standards Board, and though no laws are enforcing them, still most lenders and business partners in the United States require that these be followed.

What are Types of Accounting

Financial Accounting

Every year, the company has to generate financial statements so that its associates—investors, lenders, government agencies, auditors, potential buyers, etc.—would know about your company’s financial health.

Preparing the company’s financial statements, annually, in this way is called financial accounting.

This type of accounting focuses on presenting the financial information in the form of general-purpose financial statements that are distributed to outside parties. These external reports must be prepared by following GAAP.

Managerial Accounting

Managerial accounting is quite similar to financial accounting, except for:

  1. Managerial accounting statements are prepared for internal use only.
  2. They’re prepared much more frequently—say, on a quarterly or even monthly basis.

When your business has grown to the level where you a full-time accountant is unavoidable, most of their time will be spent in managerial accounting. They will mainly be hired to produce reports that provide regular updates on the company’s financial health and would help you understand those reports.

Even though most of the information is derived from recorded transactions, many of the analyses and reports include estimated and projected amounts based on various assumptions. Generally, this information is not distributed to those associated with the company from the outside. Some examples are budgets, standards for controlling operations, and estimating selling prices when quoting prices for new work.

Tax Accounting

When your accountant advises you on how to record various expenses and get the maximum advantage from business tax deductions, that’s tax accounting.

Tax accounting is regulated by the Internal Revenue Service (IRS), and the IRS requires that your bookkeeping adheres to the Internal Revenue Code (IRC).

Tax accounting is all about making sure that no extra taxes are paid than what is legally necessary by the IRS.

Cost Accounting

Cost accounting makes it possible to figure out how to increase your margins, deciding how much to price a new product or if raising prices is a good idea. This type of accounting involves analyzing all the costs involved in producing an output (whether it is a physical product or service) to decide better pricing that covers all expenses made towards it.

Costing serves managerial accounting because managers use the reports to make better business decisions. And because costing data is often required while compiling a balance sheet, this accounting also serves financial accounting.

Credit Accounting

Credit accounting involves separating and examining all the unpaid bills & other liabilities of the company and making sure that the cash flow is consistent & the company’s cash isn’t constantly tied up in paying for them.

Credit accounting is the most difficult type of accounting, generally, because it involves trying to tell, advice, and convince someone about taking more loans or that the business operations may suffocate due to less cash flow.

Importance of Accounting for Your Small Business

Planning for Growth

The best way to predict the future is to plan well and work towards creating it. When you’re planning your company’s growth, it’s essential to set goals and devise a comprehensive roadmap. What should your turnover and profits be one year from now? Or five years?

Financial statements enable you to make a good assessment of the development of your business. Without properly drawn financial statements, you may have to fall back on easy metrics like “sales growth,” which don’t give you a complete financial picture.

Has your cost of goods sold increased? Are margins thinner? Are overhead reasonable? Are your growth goals achievable? Without financial statements, you won’t have a realistic answer.

To Borrow

Up-to-date financial statements illustrate where your company stands. They are essential if you want to fund your small business with a loan.

For instance, let’s say you want to apply for a loan through one of the big banks. You, generally, would have to provide financial statements for the past 3-years, at least, plus a 1-year cash flow projection. Without thoroughly maintained account books, it wouldn’t be possible to successfully deliver any of these.

Get Investors or Buyers

Attracting more investors may not be on your agenda as of now. Or for that matter, even the idea of selling the business would be met with a why. But it’s a good idea to have the options open. And the best way to do that is to work with a proper accounting system in place now. Well prepared is half done.

Potential investors or buyers will expect well-kept account records that’ll help them estimate whether investing in your business would be profitable for them or not. These records are to be provided by a CPA.

You Receive On Time

When a customer owes you money, it appears as Accounts Receivable (AR) on the asset side of your balance sheet. This would be prepared by your bookkeeping services or your accountant.

The balance sheet tells you how much of your AR has already been encashed during the month, and how much is still outstanding.

By reviewing your balance sheet, you can track how effectively the payments are being collected, which customers or associates are paying on time. This way you can put in place processes—more stringent payment deadlines, or better follow-up with certain clients—to make sure you that the money you’ve earned is with you when you need it.

Good Books of the IRS

As your business grows, it can become difficult to track all your tax information reporting obligations and tax deadlines. What is more, if there are any mistakes in your financial account reports, you run the risk of being penalized due to misreporting your income. Either mistake could land you in trouble with the IRS.

Stable and sound accounts give complete, accurate financial records, reducing the risk of violating tax laws. Moreover, with an accountant on your side, especially employed to file the right amount of taxes for you, you can be sure they’ll be done accurately and on time.

Optimize on Tax Deductions

Accounting helps you to assess the right amount of taxes, so you don’t end up paying any extra dollar. The IRS will find out and penalize you if you don’t pay your full tax bill. But you won’t get in their good books for paying too much. You can tell you’re paying excessive taxes if your business is receiving large and consistent tax refunds.

Remember, a tax refund doesn’t mean free cash from the IRS. It’s money that you had paid extra while filing your estimated tax returns quarterly, that was held by the government while it should have been invested in the business instead.

Refunds are often the result of miscalculated estimated taxes that are mandatorily submitted every quarter. To accurately calculate quarterly estimated tax payments, you need to predict your income before it happens. It’s almost impossible to do so without solid financial records generated through accurate accounts.

What are the Golden Rules of Accounting

The “Golden Rules of Accounting” are also commonly known as the “3 Golden Rules of Accounting”. They specify the types of accounts listed above, and how transactions in these accounts are recorded.

Debits and credits are used in a company’s bookkeeping so that the final statement, that is the balance sheet balances out well. Debits and credits form the very basics of accounting. They operate like this: when recording a transaction, every debit entry must have a credit entry corresponding to it, for the same dollar amount, or vice-versa. This is how debits and credits balance each other out.

The golden rules, that help people to understand how debits and credits are applied to the three types of accounts, are:

Debit what comes in, Credit what goes out – Real Accounts

This rule applies to the assets of a business, such as cash, furniture, equipment, land, building, intellectual property of Trademark Registration, etc.

Debit the Receiver, Credit the Giver – Personal Accounts

This rule applies to the transactions involving people or businesses, for instance, a bank transaction.

Debit all expenses and losses. Credit all income – Nominal Accounts

This rule is for expenses and incomes such as salaries, sales, purchases or commissions.

What is the work of an Accountant

A skilled accountant will simplify the financial books to let you interpret the actual state of your business’s financial health. He (or she) would save your time that would otherwise be wasted in breaking down the complex technicality of figures into easier language.

They can also provide you knowledge and insights into what is generally inaccessible to persons not belonging to the field of accounting. Small business tax deductions you didn’t even know you can easily and should claim, tax rules you didn’t know you were breaking, and best practices picked up while working for other companies in your industry.

If those are things your business can benefit from right now, it might be time to hire professional accounting services. An accounting service such as AutoFilings.

So why wait? Fill up the form given above quickly and simplify your life.

Related Articles:

Understanding debits and credits in accounting
How to Hire the Right Accountant for Your Start-up

Frequently Asked Questions

What is accounting?
What are the types of accountants?
What are online bookkeeping services?
Why outsource my accounting?
What is a CPA?
Who needs a CPA?
When to hire a CPA, if I’m just starting up?
What is an accrual?
In the balance sheet, where is TDS shown?
What is Service Tax or Excise?
How are inactive and dormant accounts different?
What is departmental accounting?
What are fictitious assets?
What is the difference between accounting and auditing?
What is meant by the dual aspect of accounting?