Business A to Z: What is Accounting?
So, you have a business. You have products or services and customers. When you buy and sell those products and services, cash is moved and exchanged between two parties. How do you track every dollar and make sure a budget is fully allocated to departments? Accounting!
Accounting? Yep. That’s a simple way to say the summarizing of cash flow between internal and external accounts related to a business. Oh, but Accounting is so much more than cash flow. It helps you track profit loss, balances, and costs of goods sold or commonly known as COGS.
Accounting relates with so much more than what I previously described. This part of business is typically so large and important that its divided into financial and managerial accounting, especially in larger organizations.
So, what’s the difference? Great question! Financial accounting is more of the external side of accounting in a business. These are the numbers that make up financial statements such as balance sheets and a statement of cash flows. Certain organizations such as public corporations are required to publish their financial data.
In comes GAAP or the generally accepted accounting principles. These are a list of rules and obligations that accountants are to follow in order to stay compliant within the law and prevent future scandals such as the one that happened at Enron. (Google Enron accounting scandal.)
Managerial accounting is more of an internal form of accounting and is most beneficial for managers. Because the public typically doesn’t see these numbers, there are no rules or obligations to follow when using managerial accounting.
This type of accounting can show managers anything from what products are selling best to how much each item or batch of items costs the business and the revenue that can be generated. FIFO (First in, first out) and LIFO (last in, first out) help managers price their stock so they can calculate how much they can earn from each product or even what products are selling or which ones may need to be discontinued.
Accounting also tracks well, the accounts of a business. This means each checking account, line of credit, or anything owned by the business should be tracked with accounting.
This is the magical accounting equation used for calculating most every accounting problem. Assets equal liabilities plus equity. SO, let’s break it down. Assets are anything the business currently owns such as cash, land, machinery. Think of liabilities as anything that they could be liable for like lines of credit or employee compensation. Equity is also referred to as shareholders equity. Revenue, expenses, and dividends all fall into this category.
Let’s pretend that your assets are $500, and your liabilities are $300, and you pay a $200 dividend. $500=$500 Checks out! Now let’s say our assets and liabilities are still the same, but dividends are only $100. $500=$400 Now we have a missing $100 dollars. With accounting we can simply look at each transaction and see where the discrepancy is using a horizontal model or t charts.
Accounting is essentially a businesses way of checking itself and making sure that all accounts and balances are accurate. Obviously, we don’t want any money to go missing within out organizations so by using both financial and managerial accounting we can see where every dollar is being allocated.
The A to Z series is a series of 26 articles on one topic. These articles are only meant to give basic advice on business topics and typically will not include every detail on a specific subject. To find more short articles on business, tech or other topics, check out my profile. Thanks for reading!