If you own a small business, it’s vital that you have an intimate understanding of your numbers. Accounting is the study of how this data is gathered and reported, but there is, interestingly, more than one way to do this.
Your business not only makes its financial decisions based on accounting data, but outside agencies also need this information. These might include lenders and government agencies that collect taxes. As a small business owner, there are three major areas of accounting that you should understand for your operations.
Financial accounting refers to the area of accounting focused on parties that are external to your business. Formal statements such as your balance sheet, income statement, and statement of cash flows are prepared in a standardized format (according to FASB rules) so that anyone with an interest in your company can review them.
External stakeholders that might want or need these statements include investors as well as creditors. Investors will use the data to make investment decisions, and debtholders are interested in the financial viability of the firm.
There are no estimates with financial accounting since the reports are based on actual transactions only. Figures are reported at the end of a particular period, such as a quarter or fiscal year.
Managerial accounting is the area of accounting that focuses on giving the company’s management the information it needs to make key business decisions. It can be compared to financial accounting in some respects, but the data is being provided to internal stakeholders.
The main difference between financial accounting and managerial accounting is that information provided to internal stakeholders will often include forward-looking statements. In other words, managers receive valuable forecasting figures as opposed to just historical data.
Cost accounting is the area of accounting focused on the company’s profitability. While there are some overlaps with financial accounting, cost accounting seeks to apply costing techniques and principles to the processes, products, and projects of the company to improve profitability.
Cost accounting isn’t based on a particular time period but is rather a calculation based on transactions. In other words, it compares the estimated cost of a transaction or operation versus the actual cost. This method of accounting can help an organization identify inefficiencies and improve its margins.
While these are three main areas of accounting for small businesses, they aren’t the only ones available. Some other examples include tax accounting, fund accounting, forensic accounting, fiduciary accounting, and government accounting. Businesses also conduct internal and external audits to certify the accuracy of their data.
Which type of accounting method your firm uses will depend on a combination of its requirements and goals. Using a combination can help a business achieve greater efficiencies as well as have the best data available about its current financial picture, allowing it to make the most effective business decisions.
Chicagoland CPAs is a certified public accounting firm that provides a wide selection of services for small business clients. Whether you need small business accounting or tax services, contact us today to learn more about how we can help your business.