November 09, 2011

Understanding Accounting - An Introduction to the Language of Business

This is a guest post by Josh Kurtz. Josh recently started working in the tax department of an accounting firm after graduating from Drexel University in June 2011 with a Bachelor's and Master's degree in Business Administration with an Accounting concentration. In his free time, he enjoys reading, writing, listening to music and learning in general.

Whether it’s a relatively low-scale activity like a lemonade stand, with its lemons, sugar, cups and cash from customers, or a complex business featuring scores of cash, customer accounts, loans, stock and more, an organization needs a way to keep track of its many resources and obligations. If an organization cannot do this, after all, outsiders like customers and investors may not trust it, and members of the entity itself, like employees and owners, may not fully understand its situation or goals. In order to avoid these potential problems, organizations use accounting – sometimes referred to as the language of business – to understand and keep track of a variety of financial information and transactions.

There are many different branches of accounting, each with its own specific goals. Each branch, however, shares a focus on organizing information. Some of the specific branches and responsibilities of accounting are outlined below.

External Uses
Financial accountants in an organization often compile financial information to tell a story about how their business performed during a set period of time. Stakeholders, such as customers, investors and other interested parties, then use this information to learn about the company’s performance and prospects. For instance, if an investor is interested in purchasing a business’s stock, he or she can read the business’s financial information to help gage if the company has been successful in the past and if its current position is a strong one.
An organization’s financial information can include a balance sheet and income statement – two stalwarts of external accounting. A balance sheet shows a snapshot of an organization’s assets, liabilities and equity as of a given date, and it always follows the formula ‘assets = liabilities + equity.’ Assets are all the resources an organization has access to, such as cash and inventory, while liabilities are everything the company owes others – such as a mortgage or other debts which have to be paid back. Equity includes all that belongs to the company itself, such as stock outstanding and profits from previous years that were reinvested in the company.

In addition to a balance sheet, an income statement is another key piece of financial information that people outside the organization use to piece together a story about the company’s past and present. An income statement is like a video recording of a certain period of time for a company. It shows all the revenues, expenses and profit or loss from a time period, and it follows the formula ‘profit = revenues – expenses,’ or ‘loss = expenses – revenues.’

Internal Uses
Cost accountants can help organizations plan for the future through the creation of budgets and other financial forecasts that are used inside the organization itself. For instance, a manufacturing company could create a cash budget to show how much cash it expects to spend and receive during an upcoming period, or it could create a production budget to project how much of a product it plans to make. These plans can help members of an organization understand what is expected of them, and help them more effectively organize their objectives.

Other Uses
Cost accounting also illustrates how accounting can be used by people outside the business world. For instance, a family could create their own budget to help plan cash expenses during a given period, perhaps allocating some money to groceries, some to utility bills, and some to other purposes. Then, at the end of a period, they could evaluate how accurate their budget was and how closely they followed it.

In addition to reaching into the everyday lives of families, accounting also shows its malleability in other ways – for instance, through the many different jobs accountants can hold. While some accountants become financial accountants or cost accountants, many enter the fields of tax or audit. Among other tasks, tax accountants help people or organizations figure out what taxes they may owe, a process which in turn helps the government receive tax revenue, while auditors evaluate the accuracy of organizations’ external financial reports, thereby increasing stakeholders’ confidence in the reliability of the financial information.

Thanks in part to the variety of accounting tasks, and to the subject’s importance to running an effective business, accounting can lend itself to a number of career opportunities, while also affecting many other parts of the business world and beyond.
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