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Business accounting refers to the financial management of a company, whether a small neighborhood grocery store or a huge multinational corporation. The focus of business accounting is on the economic comings and goings of the firm— each time money goes in or out, the business accountant must keep track of what has happened and why, to be able to predict what will happen in the future and prepare for it. Business accounting, thus, has three major functions: (1) identifying financial transactions by the company, (2) recording those transactions in a manner that makes it easy to keep them up-to-date, and (3) reporting the transactions to stakeholders in the business so that they can use the information to steer the business into the future.
Depending on the physical location of the business, there are different sets of standards that must be followed by business accountants. These standards are known as GAAP, which stands for Generally Accepted Accounting Principles. GAAP is essentially a collection of best practices followed by most practitioners in a particular area. Not surprisingly, this method of following only local standards has encountered difficulty because of the pressures of globalization for companies located far apart to trade with one another. More and more, companies are turning for guidance to the
International Financial Reporting Standards produced by the International Accounting Standards organizations in an effort to keep their records in formats that are not only useful to their own decision makers but also organized according to standards that will be readily comprehensible the world over.
Business accounting has the goal of providing reports that are reliable, informative, timely, and of good value—that is, saving more than they cost. The information reported must be reliable because decision makers will use it to determine the future course the company should take. The reports need to be informative by presenting complex information in straightforward ways that highlight important trends in ways that do not require an accountant’s knowledge to comprehend. Timeliness is critical because in the modern world the economic landscape can change from moment to moment; depending on the sector of the market, status reports on the state of the market and the company’s performance may be needed weekly, daily, or even several times a day. Finally, accounting systems and software come in all shapes and sizes, so a company must be careful to choose ones that are a good fit for its culture and budget.
Within the larger categories of transaction identification, recording, and reporting are a number of more specific tasks common to most businesses. The most obvious of these are cash inflow and outflow—that is, sales and payments. Another major task is payroll; to issue employee paychecks, the company must use many different kinds of financial information in its files: salaries, personal deductions, taxes to be withheld, and retirement withholdings, to name only a few.
One of the more complicated tasks is keeping track of capital accounting, which requires records to be kept not of financial transactions but for the value of assets such as machinery and equipment, office furniture and supplies, real estate, vehicles for personal transportation and for shipping of goods, tools and computers, and many other items. These assets are not as fungible as cash or investments, but they are still assets the company has control over, and therefore their value must be accounted for. This is also true for the company’s unsold stock of products—the accounting unit must monitor inventory for insurance purposes and as part of its responsibility for tracking purchase orders received from customers and making sure that the orders are filled in a timely manner.
In most cases, a business accountant will conduct these common tasks according to a regular cycle, moving through each task and generating each report until the end of the cycle is reached at the end of the fiscal year. The cycle starts with the receipt of source documents such as invoices and purchase orders; these are then posted as journal entries, which are later posted to ledgers; periodically, the ledger is used to generate trial balances, and ultimately, the cycle concludes with the production of financial statements. At the end of the fiscal year, the ledger for the past year is closed, and a new ledger for the coming year is created.
Businesses also work with different groups of people, and each of these constituencies has its own record-keeping requirements. To begin with, there are the employees of the business itself, whose salaries, benefits, and retirement packages all have an impact on the finances of the company, and this impact must be recorded. The company also has customers, and each time there is an interaction between a customer and the company, there is likely to be a need for documentation, whether it takes the form of a receipt for a simple cash transaction or a purchase order received for a huge shipment of goods to be delivered. In addition to having customers of its own, the typical business will also find itself in the role of customer when it interacts with its own vendors to purchase supplies, raw materials, and services.
There are also several groups that produce accounting records related to the business through means other than day-to-day buying and selling. The government is one such body, because its role in collecting taxes and providing funding through grants requires a large amount of documentation. Another group consists of those who provide capital to the company by investing their own money, in the hope that they will eventually realize a profit on their investment, in the form of dividends; such investors are sometimes known as sources of equity capital. There are also debt sources of capital, but instead of investing their funds, these sources lend money to a company and charge interest on the loan until it has been repaid. All three of these groups—government agencies and regulators, investors, and creditors—demand precise records of the transactions that the company conducts with them, to ensure that their own goals remain well aligned with those of the company.
Business accounting involves a number of tasks that occur cyclically in what is known as the accounting cycle or bookkeeping cycle. The first part of the accounting cycle is focused on the need to identify the transactions that need to be recorded. Usually, a transaction will be documented in some form that leaves behind a paper trail; this could be a purchase order that was generated as part of obtaining goods or services from an outside vendor, a receipt from a purchase, or an invoice received from a vendor after submitting a purchase order.
Whatever the nature of the document that records the transaction, the business accountant must review that document and decide which accounting category it belongs to. The categories that are traditionally used in business accounting are assets, liabilities, expenses, and revenue. An asset is something that the company or the other business entity owns or has control over as a result of a previous transaction and that the owner expects to produce further income or benefits in the future. Examples of assets include stocks, real estate, patent rights, and so forth. Liabilities are the opposite of assets—they come from past transactions, just like assets, but instead of expecting additional income from them, the company bears an obligation related to them. This obligation could take the form of a monetary debt that must be repaid, a service that must be performed for another party, or some other duty to be fulfilled.
Somewhat related to liabilities are another category of business accounting transactions— expenses. Expenses are caused when funds flow from the company or individual outward to another entity, usually in payment for goods or services. Examples of expenses that a company might incur include costs of advertising in various media outlets, salaries paid to the employees and contractors of the company in exchange for their labor, and money paid for the raw materials needed to produce the company’s products for sale to customers. An expense can take one of two forms: Either the company pays the expense with cash that it has on hand, or it takes on debt by promising to pay the expense in the future. Thus, when a business incurs an expense, it either uses up an asset (e.g., cash) or takes on a liability (debt—an obligation to pay the expense later).
The fourth and final category of transaction entry in business accounting is that of revenue. In some parts of the world, revenue is known as “turnover,” but regardless of what term is used, revenue refers to the income that a business receives from customers in exchange for the goods or services that the business has provided to them. It is also possible for businesses to earn revenue from sources other than direct payments by customers, for example, royalties and interest earned on existing assets. By tradition, accounting ledgers usually place revenue near the top of the page on an income statement, so revenue is sometimes referred to as the “top line,” meaning that it is the amount of money flowing in to the company, before deducting expenses from it.
Keeping an accurate and complete record of the financial transactions of a business is a highly complex task—far more complicated than the simple balancing of a checkbook, which is the closest analogy most people are familiar with. Unlike a system of personal accounting, business accounting must keep track of transactions made by many different entities—individuals, departments, work groups, and so forth—each of which may have its own types of transactions and processes for completing them. Recording of transactions for a business must also be done in multiple ways, so that different kinds of reports can be generated. It is not enough to simply have one long list of credits and debits leading to a bottom line; the company’s decision makers need to know the date and time of each transaction, whether it is income or an expense, whether it is a one-time event or part of a recurring series, and many other points of data. With such information recorded, the company can analyze its performance and make projections about future performance and levels of demand. For example, a company that manufactures school supplies might review its past sales figures and note that each year in August sales of pencils go up an average of 3 percent compared with sales at the same time the previous year, occasionally leading to shortages when the company runs out of pencils to sell. This information could be used to increase pencil production in advance of August in order to take advantage of the traditionally higher demand—but only if the information had been captured in the accounting system in the first place.
To make sure that all information is recorded, rather than being misplaced or forgotten, business accountants use several strategies to preserve information. One strategy is to record the information more than once—when this is made into a standard practice, it increases the chances that the transaction information will be preserved and not lost. Transactions are first recorded in a prime entry record (sometimes the prime entry records are referred to collectively as the books of prime entry). Then, sometime later, the transactions are also entered in the company’s ledger. Recording transactions first in the books of prime entry is a precaution to make sure that they are entered into the ledger, which is the most important set of records in business accounting.
The books of prime entry have several different categories, each with their own types of entries. There is a cash book, which is used to record payments made to and from the company’s bank account; there is also a petty cash book to record smaller purchases; usually, these are for things like office supplies. Other types of transactions are recorded in what are known as day books. There is a purchases day book, where invoices received for purchases the company has made are recorded, and a sales day book, which is used to record invoices that the company sends to customers when it makes a sale. Finally, the books of prime entry also include a journal, which is used to record annotations and corrections to other entries.
The ledger takes its name from the type of book that was used to record financial information, long before the arrival of computers and accounting software. Much like the books of prime entry, the ledger has several parts to it. The general ledger records information such as payables and receivables, wages, utilities, sales, assets that are not current, and purchases. The general ledger is sometimes called the nominal ledger, and it includes entries for cash and for bank accounts. There is also a receivables ledger, separate from the general ledger. The receivables ledger includes information about what is owed to the company by various customers. This information also appears in the general ledger, but in the receivables ledger, there may be additional details recorded about the circumstances of the transaction: Perhaps a customer purchased an item but received the wrong item in the mail and had to return it, generating a credit; this could be entered in the receivables ledger. Each of the company’s customers will have its own account within the receivables ledger, to make it easier to locate information about that customer’s orders. The receivables ledger is also sometimes called the sales ledger or the debtors’ ledger (this term was more common in the past). Finally, there is also a payables ledger, which is the complement to the receivables ledger. The payables ledger records what the company owes to others, and each payee has its own account, as in the receivables ledger. The calculations in the receivables and payables ledgers should tally with those in the general ledger.
Business accountants generate reports for a variety of reasons, so the contents of the reports tend to be driven by the information needs of the business at the moment. Typical functions of a financial report include determining if the business reinvested all of its profit for a given period, explaining the sources of the business’s capital, comparing assets with liabilities, estimating whether the business has adequate capital reserves to permit it to grow in the future, and describing whether the business is currently generating a profit or operating at a loss.
One basic report is the determination of total profits and losses within a given period of time, to show how well or how poorly the business performed within that period. Many businesses prepare these profit-and-loss statements on a quarterly basis, having found that reviewing such figures annually often does not allow a company to identify problems quickly enough to address them before they spiral out of control. For example, if a company’s research and development division was spending far beyond its budget to meet a deadline, the company would want to know about this sooner rather than later so it could take corrective action to adjust the deadline, adjust the budget, or postpone the project altogether.
Another type of reporting focuses not on the inflow and outflow of cash during a fixed period but on the overall financial position of the company until the present moment. This type of report is similar to a “state of the union” address given by a governmental figure—it tells decision makers in the company how things stand, so that they can determine what actions to take next. Having this type of information readily available is crucial, especially in high-stakes situations, such as when the company is deciding whether or not to merge with another entity. In that case, both companies will want to know what they are getting themselves into, and the best way to tell this is by reviewing each other’s balance sheets (another term for a statement or report of financial position). The balance sheet lists liabilities, ownership equity, and assets as of a fixed date and is often called a “snapshot” of the company’s financial health.
While reports such as those describing the company’s financial position are essential, there is also a need for reports that focus on more specific issues. One of these is the statement of changes in equity. Equity is, put simply, ownership interest in an asset after the debts related to that asset are accounted for. In finance, equity is usually the sum of the funds that have been contributed by the owners and the earnings of the company. The statement of changes in equity, then, is a report that covers a fixed time period and explains how and why equity changed during that period. For example, a company that paid out a large amount of money in the spring quarter to settle a lawsuit would show a corresponding reduction in equity for that period. Some of the information available in the statement of changes in equity is not available elsewhere in the company’s financial records, and this can include changes in reserves of capital shares, net profits and losses stemming from shareholder actions during the reporting period, equity changes due to changes in accounting policies, and changes due to the correction of errors in previous reports.
Changes in equity are often related to the cash flow of the business, so a separate report documents changes in cash flow. Like the report on changes in equity, the statement of cash flows covers a fixed period, and as its name suggests, its emphasis is on how much money came in during the period, how much went out, and how much there was at the beginning of the period (the opening balance). With these three pieces of information, the report can calculate the amount of cash on hand at the end of the period. This is done by adding to the initial cash on hand the cash earned during the period and subtracting the amount of cash spent during the period. The result of this calculation is called the closing balance.
Given the amount of detail in these reports, it is not uncommon for additional explanation to be necessary, especially when there are discrepancies in the data or changes that have been implemented to the accounting processes used. For this reason, another form of reporting used in business accounting is the presentation of notes to the financial statements. While these notes may or may not contain actual figures and calculations, their main purpose is to provide additional details that the formats of the other reports cannot accommodate. In some cases, the notes also provide an interpretation of certain aspects of the reports that might not be immediately apparent to those unfamiliar with their purpose.
The security of business accounting processes and the computer systems used to maintain them has gained a significant amount of attention in recent years. Companies must be wary of threats from within and without. Threats from within can take forms ranging from simple fraud to rogue employees manipulating the accounting system to conceal illegal or unethical activity, as happened with the Enron scandal of the early 2000s, which resulted in the demise of the world famous accounting firm Arthur Andersen. The best way to mitigate these threats is to distribute responsibility for various functions across different people or departments and to require multiple internal reviews of records from each accounting department on a regular basis.
In recent years, external threats have taken the form of online attacks directed against the company’s network. While the company’s accounting system is not always the specific target of such attacks, it remains just as vulnerable to them as other network resources. The danger of being hacked is especially troubling because it is damaging in two ways: Not only may the attack interrupt the normal operation of the business by making data temporarily or even permanently unavailable, but the company may also be held liable if its customers’ financial information, such as credit card numbers or personal information, is compromised during an attack. To avoid such liability, business accounting departments must consider options for increasing the security of their computer networks, and many firms also choose to purchase insurance policies to reduce their potential liability in case of a successful attack.
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