29/05/2024

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What Is Accounting? Definition, Types, Importance, and Example

What Is Accounting? Definition, Types, Importance, and Example

Keeping accurate financial records is the most important thing you can do to establish, grow and maintain a successful business. But it isn’t enough to simply track your business’s finances — you also need to interpret the data stored in your financial records so you can make smart, informed decisions that propel your business forward.

The process of tracking and interpreting financial data is known as accounting. Below, we explain more about what accounting is, why you should care about it and how you can build accounting into your day-to-day business operations.

What is accounting?

Accounting is the process of keeping accurate, detailed financial records, then analyzing and interpreting those records to draw conclusions about your past and future financial decisions.

Accounting vs. bookkeeping

While accounting and bookkeeping may be used interchangeably by laypeople, bookkeeping actually refers solely to the aspect of financial record keeping. Accounting as a whole is a more comprehensive process that involves not just keeping financial records but interpreting them to draw dynamic conclusions that impact real-world decisions.

Put another way, it’s possible to do bookkeeping without accounting, but it’s impossible to do accounting without bookkeeping. Similarly, professional accountants perform both bookkeeping and accounting tasks, but professional bookkeepers focus on bookkeeping alone.

Why is accounting important for businesses?

As a business owner, your top priority is establishing a profitable business and maintaining positive cash flow year over year. While bookkeeping can show you how much money you’re making and losing, only accounting can help you understand where that money came from, where it’s going and what results you can anticipate down the road. Thanks to the information you glean through accounting, you and other business stakeholders can craft strategic plans for business growth.

For instance, based on the insights you get from crucial accounting statements, you can hone in on unnecessary expenses and work toward eliminating them entirely. Simultaneously, you might decide to invest in certain aspects of your business that show the most promise. The accounting-informed decisions you make can help you chart a course for positive cash flow.

SEE: The Best Accounting Software and Services (TechRepublic)

Along with helping business owners make smarter financial decisions, accounting data helps external stakeholders — such as lenders, investors and creditors — decide whether your business is a good investment or not. Accounting also helps businesses maintain financial transparency, which can reassure stakeholders and help companies avoid legal trouble.

What are the main types of accounting?

There are four key types of accounting used by businesses in every industry and of every size.

Financial accounting

Financial accounting refers to using your business’s financial information to generate financial statements that you can share with external, third-party entities like government bureaus, banks, lenders, shareholders and auditors.

Most commonly, these financial statements include cash flow statements, income statements and balance sheets, which are created and reviewed at least once per year. All publicly traded companies in the U.S. must make these documents publicly available, and they must also adhere to federally regulated, nationally standardized Generally Accepted Accounting Principles (GAAP).

Managerial (management) accounting

Managerial accounting (also known as management accounting) is more or less the same as financial accounting with one key difference: Instead of generating financial statements for outside parties, managerial accounting creates statements used by decision makers within the business itself. Because these documents inform internal financial strategy, they’re usually drawn up more frequently than just once per year, ideally on a monthly or quarterly schedule.

If you’re a sole proprietor or the owner of a very small business, you might use accounting software to draw up these documents yourself. You could also work with an accountant, specifically a CPA (Certified Public Accountant), who will also use accounting software to generate financial statements and share them with you.

Figure A

Using accounting software like Wave, business owners can draw up customizable financial reports like balance sheets with the click of a button.
Image: Wave Accounting. Source: Kylie McQuarrie. Using accounting software like Wave, business owners can draw up customizable financial reports like balance sheets with the click of a button.

Eventually, your business could be big enough to justify an in-house accounting team — which could use robust enterprise accounting software to track and analyze your business’s finances.

Cost accounting

Cost accounting specifically refers to the recording and reporting of costs related to day-to-day business tasks and processes. For instance, cost accounting lets you know how much money it takes to create a physical product or deliver a service.

Based on the information you get, you might decide a certain item is too expensive to produce and discontinue it. Alternatively, you could see that a particular service earns your company the bulk of your money, so you might want to allocate more resources toward that department to maximize profits while minimizing losses.

Tax accounting

Tax accounting refers to recording and reporting financial information that relates to your business taxes. Crucially, tax accounting ensures you understand your tax liability so you don’t end up owing money to the IRS at the end of the year.

How do most businesses do accounting?

Accounting software

Accounting software is one of the easiest, most cost-effective ways for solopreneurs and small-business owners to get the hang of accounting. Using in-house accounting software, business owners track their finances, organize their income and expenses and generate accounting statements that inform their business decisions.

Accounting software can cost as little as nothing a month to thousands of dollars a year. It’s worth noting that next to no one offers accounting services without software: Whether you choose to keep accounting in house or outsource it to a full-service accounting firm, you and your accountants will be relying on either desktop or online accounting software to automate, streamline and simplify financial analysis.

In-house accountants

While many business owners start out doing their own accounting, this solution usually becomes impractical as they hire more employees and their business finances become more complicated. Some business owners choose to employ in-house accountants who use accountant-friendly software to manage the business’s finances.

Working with a full-time accountant can be cost prohibitive for small-business owners, which is why some of them prefer to work with accountants on retainer instead.

Outsourced accounting firms

Business owners who don’t have the time or money to keep accounting in-house may also outsource accounting services to external firms. These firms also use accounting software (whether popular software from providers like QuickBooks or proprietary in-house software solutions) to track and analyze your company’s finances.

Top accounting software solutions

If you’re new to business ownership and plan to manage most of your business’s finances yourself, at least initially, accounting software is a good starting point. (We also recommend meeting with an accountant one on one who can help you understand accounting basics as they pertain to your unique organization.) Our piece on the top accounting software for small businesses can help you find popular online accounting products and take control of your business’s financial health.

Below, we list three of our top accounting software recommendations for business owners who don’t know much about accounting — yet — but are eager to get started.

SEE: Best Practices for Choosing the Right Accounting Software (TechRepublic)

QuickBooks icon.
Image: QuickBooks

QuickBooks Online

Our star rating: 4.6 out of 5

Intuit QuickBooks Online is considered by many to be the gold standard of cloud-based accounting software. In fact, Intuit has spent decades crafting user-friendly financial software that’s just as accessible for non-accountant business owners as it is for corporate accountants. QuickBooks Online’s simple setup and straightforward dashboard make it a great first software option for brand-new business owners.

After a 30-day free trial, QuickBooks Online starts at $30 a month.

Xero icon.
Image: Xero

Xero

Our star rating: 4.4 out of 5

Xero may be a much newer entrant in the accounting software sphere than QuickBooks Online, but it’s at least as accessible, fully featured and easy to use as its top competitor. With unlimited users and useful inventory management features, Xero is a good pick for new entrepreneurs who are trying to get the hang of selling products and establishing a personal brand.

After a 30-day free trial, Xero starts at $15 a month.

Wave icon.
Image: Wave

Wave Accounting

Our star rating: 4 out of 5

Wave Accounting is completely free for life. You can set up an account online with just a few clicks (and with no credit card entry required), then start exploring the software immediately to learn the basics of financial management. Financial statements are easy to generate, and you can link as many businesses to a single Wave Accounting account as you’d like.

Read next: Double-Entry Accounting: What It Means and How It Works (TechRepublic)