The Five Ws of Business Accounting

What Does Accounting Do for a Business?

Accounting has been called the language of business. The primary outputs of a business accounting system are the financial statements, including the Profit and Loss Statement (P&L) and the Balance Sheet. These statements reveal exactly how a business is doing, providing answers to such fundamental questions as:

1) Did we make money last year?

2) How much money did we make or (gulp) how much did we lose?

3) How much cash do we have?

4) How much do we owe?

5) Where do our revenues come from?

6) Where do we spend money?

Where Should a Business Do Its Accounting?

Every business, regardless of size, needs to have an accounting system of some kind, a place where business income and expenses are recorded and reviewed. A small business might keep track of its financial results on a simple legal pad or using Excel spreadsheets. There are also several accounting software programs available, including Quickbooks Desktop and Quickbooks Online, which are the most popular options for small business owners. No matter which option a business chooses, the important thing is that accounting is done on a regular basis.

When Should a Business Do Its Accounting?

Besides having a system for recording income and expenses, business owners need to have an accounting process too, to make sure financial results are recorded on a regular basis. These financial entries should be maintained on a monthly basis, at the very least. Weekly or daily entries are better. For those that use accounting software, automated bank feeds can make this process easier.

Why Is Accounting Important to Business Owners?

One of the primary goals of an accounting system is to provide useful financial insights to help owners run their business better and the more quickly those insights can be gathered, the more useful they are. For example, imagine that at a certain price, a business can sell every widget that it produces and more. One possible option for that business would be to expand its capacity, by adding people and office space and/or manufacturing space to produce more widgets for sale. Alternatively, the owners may not want to expand capacity but would prefer instead to raise prices and make more money by serving fewer customers. But in order to decide between those options, the owners need to know they have those options, something they learn by studying their financial statements. If an owner has to wait a year to get the business financial statements and see how the business is doing, clearly that information is much less relevant.

On the other hand, if a business is losing money selling its widgets at the current prices, it has different options to consider. Is the problem the level of fixed costs, in which case expanding sales might be the appropriate solution? Or are variable product costs actually higher than product prices, meaning higher sales equals higher losses? Yikes! Again, these options are determined by studying the information contained in the financial statements and the shorter the feedback loop, the more powerful the financial information is.

Who Should Do the Accounting for a Business?

There are many possible answers to this question and each has its own pros and cons. Often, a small business owner does his/her own accounting. The main advantage of this option is that the owner is the primary user of the financial statements and in this case, he/she gets immediate financial feedback when doing the accounting, as opposed to waiting for someone else to report results. This also saves the cost of hiring someone to do the accounting. On the other hand, hiring someone to do the accounting can make a lot of sense. Management guru Peter Drucker famously advised businesses to “Do what you do best and outsource the rest!” A small business owner can very often make more money by using their time to grow sales and paying someone else to do the accounting.

If an owner does decide that hiring someone else is the right solution for their business, the next choice is between an internal hire (staff accountant or bookkeeper) and an external hire (accounting or bookkeeping firm). The key advantages of an internal hire are availability and familiarity with the business operations. The drawbacks are that many small businesses do not need a full-time staff accountant or bookkeeper and part-time positions can be hard to fill in a healthy economy. Some owners address this issue by assigning accounting duties to a full-time employee in another area, such as the business receptionist. Such an individual is unlikely to have much, if any, accounting training and/or experience though and this option can result in inaccurate financial statements and bad information provided to the owners. Hiring an accounting or bookkeeping firm to do the accounting addresses the drawbacks of the other two options, freeing up the owner to grow sales and providing just the necessary amount of accounting services from qualified professionals. This is often the most cost-effective solution for a small business. The main drawback is that a regular schedule of communication between owner and external accountant or bookkeeper needs to be established, to allow for review and analysis of the financial statements. Such a schedule can sometimes be challenging to establish and maintain.

By Tom Porter, CPA

Tom Porter, CPA is a partner with ProActive Tax & Accounting, a full-service CPA firm located in Gainesville, Florida.

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