importance of accounting in business

The Language of the Rich

Aspiring businessmen should know the importance of accounting in business. One thing I’ve noticed is that there are a lot of entrepreneurs and investors alike who tend to shy away from one of the most important aspects of pursuing financial freedom. You’ll hear people talk all day about positive thinking, hard work, marketing strategies, and even a little bit about making money. But in today’s business world, a startling number of business professionals don’t even understand basic accounting.

importance of accounting in businessAccounting and finance are the language of the rich, and there’s no mistake why the individuals most fluent in this language tend to be a great deal wealthier than the average struggling marketer on the web.

Bookkeeping….

Bookkeeping is a pretty simple concept. If you make money, spend money, incur debt, or accept debt, you need to keep track of it. Thankfully it’s way easier to do it these days with user friendly software like quick book.
This isn’t a guide on how to understand bookkeeping. I just want to help you grasp some of the basic concepts. If somebody pays you for a product or service, you have to record the revenue. If you have to spend money in order to deliver on your product or service, those transactions get recorded as expenses. What’s left over is your net profit.
It’s your bookkeeping documents that allows you to put together the most important documents for tracking the progress of your business……

The Financial Statement….

The financial statement is broken into 3 main parts (4 parts if you have multiple investors).

The Income Statement –the income statement shows all sources of income and expenses. If the income exceeds expenses, you have a net gain. If your expenses exceed your income, you have a net loss. Pretty simple right?

It can get a little trickier, because with more complex businesses, you have to keep track of what’s owed to you, and what you owe. For example, you may have performed your service, but your customers pay you as a financing option. You have to record the full income, but that income gets recorded as accounts receivable rather than cash payments. If you took an insurance policy for your business which covers you for the year, you have to keep track of the full premium owed until it’s fully paid. This is called accounts payable. The idea is that income and expenses can be incurred without a direct cash exchange. This form of accounting is known as the accrual method.

The Cash Flow Statement –not only do you need to record income and expenses as they are incurred. You also need to keep track of the cash that’s coming in and out of your business. It’s not just from payments you receive, and expenses you pay. You also have to keep track of investment capital being fed into the business, or a loan that the business has taken out.

The cash flow has a separate purpose from the income statement as it gives us a clearer idea if business functions are performing properly. If income is being recorded, but cash isn’t coming in, it can mean that the business is having a tough time collecting. If the cash keeps going higher than actual income earned, it could mean that business is incurring more debt. A business has to be properly capitalized in order to keep running smoothly. Being able to pay employees and vendors timely is what keeps your business in operation.

The Balance Sheet– the Income Statement measures profitability over a period of time. The cash flow statement measures the cash inflows and outflows over a given time. The Balance Sheet doesn’t monitor a span of time, but rather is a snapshot at the health of the business. The balance sheet measures whether the business owns more than it owes. If the assets of a company are greater than the liabilities, the business has real intrinsic value. If the company owes more than it owns, then it the company may be having a hard time staying afloat.

Financial Analysis….

Why can’t we just hire somebody to take care of this stuff for us? Well you should do that, as it does get a whole lot more complicated than what I just explained. But you need to at least know what you’re looking at if you want to make good decisions in your business.

For example, if you see that there are expenses that are eating away at your income, you might be able to strategize how to cut expenses in certain areas. If your cash flow is lagging behind your net income, you can take a look at why you’re having a hard time collecting on your sales. If you’re debt is getting out of control, you can pay attention to where the leaks are in your business in order to start paying down debt.

There’s actually not that much difference between a healthy business financial statement, and a healthy personal financial statement. In either case, you have to keep expenses less than your income, find ways to keep your income increasing, and control your debt situation. And the biggest reason most people fail is because they do a poor job at managing both their business and personal finances.

In conclusion, learn the language. You can’t make growing your wealth a predictable process until you can track it and tweak it.

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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