Why accounting is important?

Accounting provides the business the information to take decisions, that is the basics of accounting. The summary of all transactions that you have in a year or in a period, could be a month or a quarter and instead of having bank transactions or invoices or records you have an orderly set of financial statements, and those financial statements will allow the business to see the picture, what is going on. Why or what is the result of the decisions that the owners of the business have taken and how those decisions have impacted the business.

What are the types of accounting?

There are 2 types of accounting, one is accrual accounting and the other one is cash accounting.

When you do cash accounting you don’t report accounts payable and accounts receivable. It means that whatever you collect is income and whatever you pay is expenses, that’s the basics of cash accounting. Cash accounting is for example when you do a payment of a check, when you receive a payment from a client and you at that point you consider that as income for your company. That’s cash accounting means you only go by what you pay and what you receive or you collect from your clients and based on that you do your reporting, your balance sheet, your profit and loss and your cash flow.

Accrual accounting is a little different, in accrual accounting you are going to report yours accounts receivable and my accounts payable. Now remember, accounts payable and accounts receivable they are not collected, you have not collected your accounts receivable and you have not paid your accounts payable. But even though you have not paid them or collected them, you are reporting them and that is the basic difference between cash accounting and accrual accounting.

Those are the types of accounting companies do, here in the US, companies with over 50 million dollars are obligated to do accrual accounting and small business no, small businesses up to 25 million they are able to do cash accounting. So the basic difference is how you account for the accounts receivables and accounts payable.

Accounts receivables is basically for example, if you’re consulting with me, you send me a bill but I don’t pay you and you don’t collect it yet. For you, it will be an accounts receivable and if you do accrual accounting for you it will be income but you have not collected the income yet, even though you haven’t collected that income you are reporting that on your financial statements in account known as accounts receivable. For me, your bill is going to be an accounts payable but I have not paid it yet, but because I do accrual accounting I am going to report the bill as an accounts payable and for me it’s going to be an expense on my profit and loss report. For me, in the balance sheet it’s going to be an accounts payable but in the profit and loss report it’s going to be an expense. For you, it’s going to be an account receivable in the balance sheet and also in the profit and loss statement is going to be income. That is the nature of the two types of accounting.

Who needs accounting?

Everyone who owns a business, every individual who wants to know where his or her money is going too. If you don’t have accounting, say for example you only have your bank statements and that is what you do, you only go by the balance of your bank statements. And you’re an individual not a company and you only go by your bank statements and you decide based on that. The problem is that you never know what the category or the classes of your spending is, what do you spend on, what is the classification of all this expenses that you have, because you don’t have accounting, you don’t have control, you don’t know if you need to reduce one particular category of expenses, let’s say utilities, payments for subscriptions, payments for commissions, let’s say payments for salaries, you don’t know because you only go by the balance of your bank statements.

But if you have accounting, you will have control, that is the most important thing in accounting, that you have control of the expenses. That’s why accountants and personal financial advisors they insist that not only the company must have accounting but also the individual, they will control over the most important thing you have after your life, money. Because once you have control, you can act and those actions are taken to improve yourself that’s why accounting is so important, because it will give you control.

Same thing if you don’t know who your clients are, you don’t know how much you are receiving for each client, you don’t know to whom to give a promotion for example. You only know that you have collected X amount from clients, from an X number of clients that have paid you but you don’t have a list of clients, you won’t have control, you will not be able to create promotions and not be able to create strategies, you won’t know what markets you are attending. Control is, you have to put in writing and in writing you will have to show it to someone to help you to take decisions, that is why every single person not only businesses need to have a accounting process to provide for their financial statements and to take control of their money. That’s why accounting is important and why every person in the world needs accounting.

What is the accounting process?

The accounting process is the transformation of the transactions into financial reports, financial reports as balance sheet, profit and loss and cash flow. The balance sheet is a representation of all your assets like cash, inventory, accounts receivable and like fixed assets, liabilities, all your accounts payable and your debts and your equity, the capital that you have provided for your business. That is the balance sheet, assets, liabilities and equity. For the profit and loss is only income minus expenses, is how much money you make. The cash flow is the report that few people use it or require, but it’s very handy when you want to know what the source of your cash is and what are the uses of your cash. So, this is not about assets or liabilities, this is the sources of your cash and how you have used that cash.