Why Is Accounting Important for Business?

by Devra Gartenstein ; Updated June 06, 2018
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Accounting is important for business as a way to document financial activity and learn from the numbers. Your business needs basic accounting to report income on tax forms and keep track of funds flowing in and out of your bank accounts. But accounting information also provides valuable insight into operations, showing trends and opportunities that can help make your company more profitable. Tax reporting agencies require you to keep books at a minimum level that tracks income and expenditure. But if you have the drive and interest, you can take your accounting processes to an entirely different level, and use them to create a smarter and more financially viable business.

Types of Accounting Businesses Need

Tracking income and expenditures: Your business is required to fill out tax forms based on both gross revenue and net income. State and local excise taxes are calculated as a percentage of revenue. City, state and federal income taxes are based on your net profit after subtracting deductible expenses from gross revenue. To calculate these amounts correctly, your business must track and tally gross receipts as the basis for revenue numbers, and add up all expenditures as the basis for business deductions. When reporting gross revenue, you'll need to break down your earnings into categories such as wholesale and retail. When calculating net profit for income taxes, you'll need to divide expenditures into categories as well, such as materials, payroll, rent, utilities and auto expenses.

Payroll accounting: In addition to calculating how much to pay each employee based on wage or salary and hours worked, your business must also withhold and pay the Social Security, Medicare and income taxes that your employees owe, along with matching employer contributions for Social Security and Medicare. You'll also have to pay unemployment insurance and industrial insurance into your state's funds, based on how much your employees work and how much they earn. Your business will need a comprehensive and up-to-date payroll accounting system to keep track of these numbers and to pay all payroll taxes and file all payroll tax reports when they are due.

Cash flow accounting: Your accounting system should also include tools for tracking the availability and need for cash. If you use a cash-based accounting system, your weekly and monthly figures will give you a reasonably good idea of how much you have coming in and going out. If you use the accrual system of accounting, you may record a sale as revenue before you've actually been paid for it, so you need another way to monitor the availability of cash. Whether you use a cash or accrual system, your cash flow may also not directly correlate with your reported income and expenditures if you're paying back loans, or if you're depreciating equipment that you've already bought.

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Balance sheets: A balance sheet is a snapshot of your financial picture at a particular moment in time. It includes information about what you own and what you owe. Your list of assets will include cash in the bank, equipment you've purchased minus the amount it has depreciated and accounts receivable or sums that are owed to you for sales you have already made. The list of liabilities on your balance sheet will include balances due on loans and credit cards, and shorter-term debts you've accrued such as accounts payable and outstanding utility bills. By subtracting your liabilities from your assets, your balance sheet shows your company's current net worth. When you create balance sheets over time, you can see how your earnings and expenditures have played out and created wealth or debt. A balance sheet also shows how much of your net worth is liquid, and how much is tied up in assets that don't provide readily available cash.

Operational reports: In addition to the accounting reports that your business is required to complete by tax agencies and lenders, you can create customized reports that track everything from the dollar value of the product your line produces in an hour, to the sales figures for each of your sales personnel. These numbers are critical to making strategic decisions. They can help you to identify which aspects of your business yield the most profit and are most worth nurturing. They can also call your attention to difficulties that can be corrected, such as aspects of production that take too long and cost too much.

How Businesses Can Do Accounting

Your business can either do your accounting in-house or hire an outside professional to help with the process. Many companies use a hybrid of these two approaches, having internal personnel complete some tasks such as basic bookkeeping, and then contracting with an outside accountant to complete annual taxes.

In-house accounting offers the benefit of having someone who knows your business in-depth, recording your earnings and expenditures. A bookkeeper who is deeply involved with your business will be able to identify and categorize items on receipts, determining whether they are materials included in your cost of goods sold or supplies that you need for behind-the-scenes organizing. However, an in-house bookkeeper may not have the professional expertise that an outsider can bring to the mix. This knowledge is useful for creating systems such as your initial bookkeeping setup, and also for catching nuances such as expenditures that aren't legitimately deductible.

An outside bookkeeper can bring experience and perspective to your company's accounting processes. As a professional, this bookkeeper has likely seen the books of a range of businesses and can show you how to update your systems so they provide the information you need and can be understood by other professionals such as bankers and tax auditors. However, an outsider may not do as good a job as an insider at understanding how your business works and what information you may find most useful. For example, your accountant probably won't understand the types of inventory you carry from the point of view of a merchandiser. Yet information about how different categories of merchandise are moving can be vital for fine tuning your purchasing.

Types of Accounting Software for Businesses

Online Accounting Software: Online accounting programs offer you the advantage of syncing your accounting system with your bank accounts. This approach makes it easy to enter transactions by simply finding them in your bank feeds and then clicking the right buttons. This feature lessens the possibility that you will miss an expenditure, as you might if you were starting with paper receipts and lost one. Using online accounting software also allows you to access your accounting program from any computer, rather than having to use your own desktop. However, online accounting programs take longer than desktop versions to process each transaction, and this time adds up when you're making dozens of entries. Also, the practice of matching receipts with bank feeds can be slow and cumbersome, and this step is necessary if a single purchase includes items in multiple categories such as materials and supplies. QuickBooks is the most popular and most highly rated online accounting software. Xero is highly regarded for Mac users, and Zoho works especially well for very small businesses.

Desktop Accounting Software: Although online accounting programs have been growing in popularity, desktop versions still offer advantages for many users. You can buy a desktop accounting program with a one-time purchase, while online programs charge an ongoing monthly fee. When you use a desktop program, all of your information is readily available on your own computer, rather than situated in the cloud where it is vulnerable to security issues and widespread system failures. Desktop accounting systems tend to be much simpler than cloud-based systems, making it easier to locate and identify errors and inconsistencies. Because of their relative simplicity, desktop systems are also easier to adapt to your company's individual needs.

Custom and Manual Accounting Systems

You actually don't need accounting software at all if your business is small and your needs are simple. You can design spreadsheets with Excel or Google Sheets that help you track and add the variables you need to know, such as categorized expenditures and ongoing earnings. These programs will help you to keep and organize your information in whatever way makes sense for your business, and homegrown spreadsheets make perfectly legitimate accounting systems as long as they tell you what you need to know to pay your taxes and understand your operations. For example, you may set up a payroll system that logs hours spent on specific tasks such as production. Then you can then use these figures to calculate the average dollar value of a product manufactured per production hour and you can watch the way this figure changes week-by-week.

But you don't even need a computer to do business accounting. It's perfectly legitimate to keep handwritten ledgers, as business owners have done for centuries. Office supply stores sell accounting books with appropriately-sized columns, and you can use these to list and categorize income and expenditures. With a manual accounting system, you have to add up all figures by hand, which dramatically increases the amount of time you spend on accounting. However, manual accounting systems aren't vulnerable to the kinds of computer glitches and risks of lost data that you encounter with computerized systems. True, your house could burn down and you could lose your ledger, but hardware failures are considerably more common than house fires.

Single-Entry Versus Double-Entry Accounting

If your business is small and relatively simple, you can also choose between single-and-double-entry bookkeeping. A single-entry system simply tracks what you've spent and earned, and tallies these sums. If you use a handwritten ledger or if you've created your own spreadsheets, you're most likely using single-entry accounting. A double-entry system syncs your accounting information with your bank accounts and other information relevant to your balance sheet. Every time you note that your company has earned revenue, you'll make (or your accounting software will make) a corresponding entry showing where that money shows up in your business, such as in a particular bank account. Similarly, every time you pay for an expenditure, a double-entry system shows how your company has spent the money. There's no legal requirement that you maintain a double-entry bookkeeping system, but if you keep single-entry books you should develop a way to compare and reconcile your accounting system with your current assets.

Choosing the Right Accounting System

There is no accounting system that is right for every business. When choosing how to set up your company's books, consider what type of information you need most, and what resources you're willing to devote towards getting it. If you hate working with numbers and they barely make sense to you, hire an outside professional but still try to learn as much as you can to understand the reports you receive. If you have the time and interest, do as much of your own accounting as possible. The information you compile will be relevant and meaningful, and you'll gain valuable insights into how your business can be most successful.

About the Author

Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.

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