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The Importance of Accounting

Updated on May 27, 2013
Accounting is Important to the success of a business
Accounting is Important to the success of a business | Source

Running a successful business requires having a product or service that consumers need and want at a price that they are willing to pay for it. They also need great marketing and sales strategies to keep growing. Another critical area that is necessary to the success of a business is the accounting department. Let us take a look at why accounting is so important to the success of a business.

Accounting 101

Accounting is the system of recording financial transactions and providing analysis of those results. Each transaction must net to zero and have at least one debit and one credit entry. All of the transactions are recorded on the trial balance, which is made up of all the general ledger accounts. Revenue, liability, and equity accounts all should have credit balances, which are commonly recorded as negatives. Expense and asset accounts should all have debit or positive balances. The trial balance as a whole must equal to zero when debits are subtracted from credits. The trial balance can be broken into two distinct sections: income statement (revenue and expenses) and balance sheet (assets, liability, and equity) accounts.

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The Importance of Ethics in Accounting

If you have ever seen lottery numbers being picked on television, they always make a statement regarding an accounting firm that has overseen the results. Why? It is because the accounting profession is known for having high ethical standards. High ethical standards are critical in accounting because management and outsiders make important decisions based on the accuracy of financial results. If you remember several years back, Enron was busted for fraudulently keeping their books. An outside CPA firm typically audits a business once every year to verify that the results are reasonable. What made the Enron scandal even worse, is the CPA firm Arthur Anderson was actively involved in covering up the fraud.

The Importance of Accounting Standards

Establishing a set of accounting standards that everyone follows is critical. In the United States, Generally Accepted Accounting Principles (GAAP) have been put into place to ensure that everyone is following the same set of standards. This allows financial data from one company to be easily compared to another company. It also helps to protect investors because an outside CPA firm can come in and use those standards to make sure that the financial results are being reasonably reported.

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Importance of Accounting in a Business

The importance of accounting related to a specific business cannot be discounted. A business needs to have accurate financial statements in order to make proper decisions and meet government compliance requirements.

Financial Results

The main importance of accounting to a business is the generation and reporting of financial results that include an income statement, balance sheet, and cash flow. The income statement gauges whether the business is making a profit or losing money. The balance sheet sheds light on the over all health of the business. Finally, the cash flow sheds light on how cash is flowing through the business. This is a critical measurement because most businesses fail for a lack of capital.

Enables Proper Decision Making

Accounting’s role is so much more than just recording financial transactions and producing financial reports. It is to provide all different kinds of analysis so that management has the right information to make the proper business decisions. Manufacturing and service companies spend a lot of time doing cost analysis of their products or services. The process of assigning cost to your product or service is called cost accounting. It is vital to know how much it costs you to make your product or perform your service. This information can be used to know which products that you should look at and try to reduce cost or raise your selling price. All of the financial information used to generate any kind of report should only come from the accounting department so that it can be verified.

Governmental Compliance

Another reason that accounting is important for a business is complying with all of the governmental red tape that includes federal, state, and local taxes. Publicly owned companies have to comply with the Sarbanes Oxley regulations that many times require a position to be created just to deal with them. Business income taxes have become so complicated that it makes sense to have a CPA firm handle them for your business.

Internal Controls

Another vital function of the accounting department is to put into place strong internal controls. Internal controls are checks and balances that are put into place to safe guard a business. They limit a single person’s ability to complete an entire process without someone else knowing what is being done. A good example of an internal control is that the person who enters payable into an accounting system, should not be able to cut checks and sign them too. Too many businesses have weak or non-existent internal controls that help to create an environment that is susceptible to fraud and embezzlement.

Accounting is often overlooked when it comes to what it takes to run a business, but it is a vital part of any business. Accountants provide financial reports and all different kinds of analysis that allows management to make the right decisions.

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    • rfmoran profile image

      Russ Moran 5 years ago from Long Island, New York

      Solid basic principles here. I have known business people whose idea of accounting is to balance a checkbook. Voted up and useful.

    • BusinessTime profile image

      Sarah Kolb-Williams 5 years ago from Twin Cities

      I honestly don't know much about accounting -- that's why I hire an accountant! -- but this article was a great overview. I already know more than I did before!