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  • Writer's pictureShafinaz Shaikh

Accounting: Do we need it?

Before going on a one thousand word journey, let me start by quoting Warren Buffet, ‘Accounting is the language of Business.’ Communication might become an effortless chore for a person who has mastered language. Similarly, mastering accountancy might mean that a person can make analytical business decisions (and personal finance related decisions) with much more accuracy. Accounting has multiple subdivisions under its name, such as Audit, Tax, Managerial Accounting, Financial Accounting, Bookkeeping, and so on. In more general contexts, Accounting refers to the systematic and detailed recording of financial transactions of a business or an individual. But the question still remains, does it help someone? If yes, then how exactly?

The Role of Accounting in Business

The basics of accounting are keeping an ‘account’ of a business's financial transactions in order to draw financial statements that can help in the short AND the long term. No matter if you run a small coffee shop or a giant MNC, maintaining accounts holds the same importance.

Let’s assume that during all the several years that you’ve been in business, your café has only sold one type of coffee: Americanos. You’re amazing at selling Americanos and know that you’re making enough money to pay your employees, buy the cups and ingredients of the plain black coffee, and any other bills such as electricity. The best part, you also make enough money to pay your own personal bills. Things are going well, but then one day you realise that sales have started going down because of the rival business selling a range of coffees, while you only offer Americanos. This only means one thing; you need a massive change in your business. From buying chocolate to make a mocha to training employees on how to make the perfect latte, you’ve got a lot to work on. The worst part, you must spend money on all these activities, and you must spend it fast and at once. Spending such a large amount of money on just the product itself could cause other costs to pile up in a destructive manner. A situation like this means only one thing, you need to find a way to manage money. You need to look at your financial books and figure out things like how many cups of coffee are sold by your business in a set amount of time, and how much of the revenue gets invested back into the business. By strategizing hard enough, you might just strike a balance between your existing costs and all the new costs that have attacked you. Maybe you could reduce the amount of coffee beans you stockpile for the next 6 months, thus reducing your storage costs? Or you could shift to paper cups which have are not branded with your logo, thus lowering paper cup costs? Those are some strategies that might help you lower your existing costs and put you in a better place to tackle your new costs. Your main concerns in this scenario will remain ‘how much do I need to save and re-invest in order to keep the business afloat?’. To answer this, you need to carry out a financial and quantitative analysis of your business. You need to produce a financial forecast of what you expect is going to happen in the business, financially, and what changes are required in order to face those events and not go bankrupt. But what if you were so confident in your americanos keeping your business alive, you never thought about keeping a record of the transactions made because you were satisfied with the continuous flow of profits that kept entering your bank account? It might boil down to you being left with one option: getting a loan from the bank. But for that, you must convince the bank to lend their money to you. They will want to see your cash flow statement and forecast for the coming year/years so they can see how much profit you’ve been making and how much you’re expecting to make in the future in order to decide if it is a safe investment for them. Even if you manage to keep your business afloat, you need to make sure that all the financial documents that you’ve produced are an accurate representation of what your business has been doing. Not only this, but you also have to manage and pay tax results as well!

This may sound dreadful (and overwhelming) at first, but in its essence, an accountant's job is to resolve and help you, a business owner, out with all the problems listed above, and more! Keeping a record of your financial transactions and analysing it using different quantitative methods can help you decide on a strategy for every scenario. Whether it be preparing for a possible future event that might cause your business to take a hit, or to transform it into the most efficient version possible. A good accounting practice can help you find any areas in business that are causing you to lose money or are doing particularly well. It ensures statutory compliance and that other liabilities such as taxes and pensions are dealt with in an appropriate manner. Accounting may also enable you to hold a convincing financial statement, which is a document that could prove to be useful in many different scenarios such as convincing the bank to give you a loan or convincing investors to buy into your business.

These are only a few of the reasons why accounting is not only beneficial for a business, but also why it is crucial for a business to survive in the long-term.

The four major branches of Accounting

Now that we know what the overall function and importance of accounting in business is, let’s discuss how this field is further divided into sections which make it more efficient and solution oriented.

1) Managerial Accounting: This subdivision consists of techniques that are used to find, measure, evaluate, and interpret, and convey financial information to managers in order to achieve an organization's objectives. In the above example, this type of accounting would have proved helpful when trying to find a way to cut costs and reinvest internal finances (and external finances) in order to break even (I.e., not making a profit yet, but not making a loss either. Total costs are equal total revenue)

2) Financial Accounting: This is the branch of accounting that calls for documenting, summarising, and reporting to the public or lenders; the stream of transactions and monetary movement resulting from business operations across a short or a long period of time. In the above example, this type of accounting would prove to be a determining factor when applying for a loan as the documents produced under this subdivision is the one that will be used to convince lenders to loan money to you.

3) Audit: Audit accountants oversee examining financial records to ensure that they are correct and compliant. Internal audit accounting is a procedure that focuses on reducing risk and discovering cost-cutting opportunities. In contrast, external audit refers to independent auditors verifying the authenticity of a company's financial records in order to determine if there is any inaccuracy in the records resulting from fraud, mistake, or embezzlement, and then presenting the findings to the company's stakeholders.

4) Tax Accounting: Tax accounting is a branch of accounting concerned with the preparation of tax returns and payments. Individuals, businesses, firms, and other organisations employ tax accounting. Tax accounting is rather complicated for a firm, as it requires additional examination of how assets are spent and what is or isn't taxable.

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