Lesson 1: What is Accounting?

Lesson Overview 

Welcome to lesson one, what is accounting. This lesson introduces you to basic accounting concepts and discusses the importance of accounting for your business.

In this lesson, you will:

Define accounting, and

Describe basic accounting concepts

What is Accounting? 

How do we define accounting? Accounting is the language of business because it can communicate the financial information of a business to all interested parties. In terms of a formal definition, accounting is the art of recording, classifying, summarizing, and analyzing the financial events of a business.

Why is it Important? 

Accounting is called the language of business because it deals with understanding and communicating information about a company’s operations and finances.

Accounting is important to any business because the financial information allows entrepreneurs to make informed business decisions. Economic events are measured and described by financial processes. We all work with and use accounting principles, whether we are managing a business, investing money, or just deciding how to spend our paycheck.

It’s easy to just say, “I’m a craftsperson and I know my craft and that’s all I need to know. I’ll just hire someone to take care of the numbers for me.”

The bottom line is this: Whoever is making the decisions for the business needs to understand the basics of accounting, what each of the financial reporting statements mean, and how to choose the right accounting resources for your business.

Therefore, as a business owner, you need to at least understand the numbers even if you let someone else keep the books for you.

Uses and Users of Accounting 

There are many uses and users of accounting and as an entrepreneur, it is important to understand how each one can affect your business.

Uses

Accounting provides you with various pieces of information regarding your business operations.

Here are some accounting use examples:

Tax planning should not be a once-a-year task. It needs to be an ongoing process. Business owners should look at various tax options to help decide when and how to conduct business transactions to reduce or eliminate taxes.

Performance management measures the performance of different business operations. Using financial statements is a good way to assess business operations and performance. The accounting information reported on financial statements can be broken down into segments and then these segments can be compared to other companies in the business environment. This helps business owners understand how well their business operates compared to other established businesses.

Accounting information from financial statements can help with making business decisions. Some business decisions include, purchasing new equipment, expanding current operations, estimating future sales, etc. Opportunities with low income potential and high costs are often rejected by business owners.

Accounting data helps those who need to make investment decisions, such as small businesses that rely on external financing to start up or grow. External business stakeholders often review the accounting information to assess the small business’ financial health and operational profitability. This informs them if investing in a small business is a good investment decision or not.

Users

There are two (2) types of users of accounting information: internal and external.

Internal users include management, employees, and owners.

Management analyzes the organization’s performance and takes appropriate measures to improve the company results. They forecast revenue growth and cash flows, and create, execute, and manage budgets. The employees assess the company’s profitability and consider future wages and job security. The owners analyze the capability and profitability of the business and determine bonuses, incentives, and rewards.

External users include creditors, who determine the creditworthiness of the organization; tax authorities, who determine the credibility of the organization’s tax returns filed; investors, who analyze the possibility of investing in the company; customers, who assess the financial position of its suppliers, which is necessary for them to maintain a stable source of supply in the long term; and regulatory authorities who ensure that the company’s disclosure of accounting information is in accordance with the rules and regulations set.

Types of Accounting 

There are two (2) standard accounting methods for keeping track of your business’s income and expenses: cash and accrual.

Cash Accounting

Cash Accounting is the more commonly used method of accounting for small businesses. In cash accounting, income is not counted until the cash is actually received, and expenses are not counted until they are actually paid.

Accrual Accounting

Accrual Accounting occurs when the transactions are counted when the order is actually made or the services occur regardless of when the money for them is actually received. You don’t wait until you have the money or pay out the money to record a transaction.

Example

Let’s say that you purchased a printer on credit in February and paid five hundred dollars ($500.00) for it in May. Using cash accounting, you would record five hundred dollars ($500.00) for the month of May, when the money was actually paid. However, using accrual accounting, you would record the five hundred dollars ($500.00) for the month of February, when you purchased the printer.