Accounting is a broad discipline that focuses on the current state of an organization’s financial activities. But today’s accountants are a far cry from the stereotypical “numbers person” who’s more comfortable with a spreadsheet than a strategic business plan. In fact, the insights produced by accountants—and finance teams overall—inform and shape strategy for all corners of the business.
Accountants work closely with stakeholders including executives, investors and boards as well as human resources, IT and sales and marketing teams and act as liaisons between their companies and government, tax and regulatory agencies.
Startups, nonprofits and small companies may work with fractional CFOs—an experienced CFO who works on a contract or part-time basis—or accounting partners, but whether internal or outsourced, the accounting function is vital to success.
What Is Accounting?
Accounting is the process of recording and categorizing a company’s transactions, and then summarizing, analyzing and reporting on these activities. The resulting information—in the form of the balance sheet, income and cash flow statement, forecasts and other reports—is used to inform business leaders as they:
- Evaluate staffing and payroll
- Balance or assess inventory levels
- Investigate new business opportunities
- Maximize profitability
- Manage cash flow
- Analyze the financial health of the business
The reports and other information that accountants produce are also used outside of the company, by lenders, investors, auditors and, in the case of public companies, investors.
- Accounting encompasses a broad set of activities, from basic bookkeeping to analyzing the company’s financial health, forecasting revenue, preparing taxes and ensuring legal compliance.
- Businesses use five main types of accounting: managerial, cost, project, tax and financial accounting.
- U.S. public companies must use Generally Accepted Accounting Principles (GAAP).
How Does Accounting Work?
Every business needs some form of accounting function. Deciding when to hire an in-house accountant is a major decision for entrepreneurs. For small businesses, a single person may perform all accounting tasks and act as the CFO. Alternatively, hiring an outside accountant may make sense, especially for tax purposes. Many small businesses use software to keep track of income and expenses and then send that information to an outsourced accountant for review.
Regardless of whether the company uses outside accounting partners or in-house employees, the accounting functions include recording, categorizing, analyzing and reporting financial activities. Internally focused reports help managers allocate funds and make business decisions such as how much to charge for products. Other reports are used for compliance, taxes, attracting investors and applying for loans.
What Are the Types of Accounting Practices?
There are many accounting specialties. Businesses use five main types: managerial, cost, project, tax and financial accounting.
Managerial accounting provides the reporting, analysis and interpretation of financial data that decision-makers need to create and refine business strategy. Managerial accountants support planning by performing cost-volume-profit analysis, weigh in on organizational structure and analyze variances.
Cost accounting, a specialty within managerial accounting, is focused on how much a business spends to create its products, including labor and supply costs. The information gleaned from cost accounting is used to optimize operations—to value inventory, set selling prices for products and create budgets for similar projects.
Tax accounting, which is governed by the U.S. Internal Revenue Code, deals with preparing tax returns and making tax payments. Accountants ensure that companies comply with complex and changing laws.
Professionals such as project managers and accountants use project accounting to integrate key financial tasks on a project-by-project basis and report their progress and success to management.
Project managers rely on project accounting to inform them of the status of direct costs, overhead costs and any revenues in a specific project. Project accountants generate these figures in financial reports. A project manager uses these reports to determine if they need to adjust the project’s budget and work breakdown structure (WBS).
This discipline focuses on providing information to outside parties interested in the business. A financial accountant typically prepares balance sheets, income statements and cash flow statements to help investors understand the company’s performance or to make a case to a bank to loan money to the business.
Why Is Accounting Important?
Accounting supports several critical business functions. At a basic level, it enables the business to track revenue, expenses, assets, liabilities and shareholder equity, and manage cash flow and know whether customers have paid, and whether the company has paid its own bills.
Accounting provides a business with insights that can help it plan for the future. For example, managers can use inventory accounting methods to learn whether the cost to produce a product has increased and adjust the price or change suppliers accordingly. They can examine sales data to inform decisions on what new products to add and which customers should get more attention.
Accountants also help their companies secure financing and find investors. Most lenders, whether they’re loaning money to small businesses or large corporations, need to see proof that the business is viable. Investors also want to assess the potential return they’ll get on their investments.
Finally, accounting helps with taxes and compliance. Producing accurate financial statements is necessary to report income to the IRS for public companies, while both private and public companies are required to provide quarterly tax estimates and a yearly tax return. If reports are incorrect, a company could be under-reporting and subject to an audit or fines from the government or, conversely, over-reporting and paying more than it should. Other compliance issues include reporting for loan covenants and for U.S. Securities and Exchange Commission (SEC) reporting regulations for public companies.
History of Accounting
Accounting has existed since ancient civilizations first began trading goods. The earliest evidence of accounting is found on clay tablets dating as far back as 3,300 BCE in Egypt and Mesopotamia.
Some of today’s accounting concepts emerged in Medieval Europe. Merchant Benedetto Cotrugli is credited with inventing the debit/credit accounting system in 1458. However, Italian mathematician and Franciscan monk Luca Bartolomes Pacioli is commonly known as the father of accounting and bookkeeping. He described double-entry bookkeeping in his 1494 book Summa de Arithmetica, Geometria, Proportioni et Proportionalita—“The Collected Knowledge of Arithmetic, Geometry, Proportion, and Proportionality”—a work that has influenced the teaching and practice of accounting to this day.
The Accounting Profession
Suffice it to say, the accounting profession has come a very long way since those days of ancient civilization and early accounting books. Today it is considering one of the best business jobs, according to U.S. News & World Report’s “2019 Best Jobs.”
What Does an Accountant Do?
An accountant generally performs a variety of financial duties. The most common include reviewing financial information, analyzing accounts, providing insights about the company’s finances and preparing budgets and reports. Accountants at small businesses may also be tasked with bookkeeping, in which case they may maintain the general ledger, pay bills, handle payroll and reconcile accounts.
A certified public accountant (CPA) is an accountant licensed by a state board of accountancy. Obtaining a CPA license requires a candidate to complete an appropriate education, obtain real-world experience and pass a CPA exam. CPAs typically provide business and tax advice and help create financial strategies that enable businesses to maximize profits.
Roles & Titles
|As a business grows, so too will its needs for a larger finance team to accurately manage its financial resources. Specific roles and responsibilities include the following positions:|
|CFO: A chief financial officer reports directly to the CEO and the board of directors. CFOs aren’t just about closing the books — they serve as reality checkers, strategists and risk mitigators for their companies. The CFO typically supervises a diverse finance/accounting team and is responsible for the overall financial health of the business. CFOs in publicly traded companies formally attest to the accuracy of financial statements and shareholder reports.|
|VP of finance: The VP of finance typically has a deep accounting background — essentially, a CPA with leadership skills — and understands in-depth the current and historical financial data of the company. Generally paid less than a CFO, VPs of finance may also be promoted into the CFO role.|
|Controller: The controller is a CPA and, often, holds an MBA. Controllers are senior accounting experts and oversee a company’s cash flow and AR/AP. In smaller companies, they may help with financial planning & analysis, though generally FP&A is a finance function versus accounting.|
|Accountant: These professionals hold CPAs and may be in-house or contractors who work with a number of companies, sometimes within one industry. They prepare audited financial statements and oversee financial records, such as tax returns, balance sheets, employee expenses, and cash flow and income statements.|
|Bookkeeper: This position is your first financial hire and, again, may be a contractor or an in-house staffer. These professionals have accounting backgrounds and they are responsible for putting together monthly income statements and balance sheets for the company.|
|Other staff roles: Within the finance team, companies may have specialists who focus on auditing, FP&A, human resources, bookkeeping, taxation, budget analysis, accounts receivable/accounts payable and inventory or other operational aspects.|
Accounting Areas of Expertise
Corporate finance encompasses several areas of expertise. Larger companies may hire accountants who specialize in one or more of these areas:
- Payroll: Ensure that employees are paid accurately and on time and that the appropriate deductions, like taxes and health insurance premiums, are withheld from their paychecks.
- Cost: Value inventory, set selling prices for products and create budgets using historical data.
- Accounts receivable/accounts payable (AR/AP): Focus on sending invoices, collecting payments and paying bills.
- Bookkeeping: Record transactions and balance the books.
- Collections: Track whether customers pay on time and take steps to obtain payment if they don’t.
- Tax: Ensure the business pays applicable taxes and maximizes the deductions to which it is entitled.
Accounting vs. Bookkeeping
Although the terms “accounting” and “bookkeeping” are sometimes used interchangeably, bookkeeping is just one function within the broad discipline of accounting.
- Bookkeeping involves maintaining systematic records of financial transactions in the appropriate accounts, or ledgers. These records are ultimately reflected in the company’s general ledger, a master accounting document containing a complete record of the company’s transactions.
- Accounting encompasses much more than bookkeeping. It includes advanced functions like summarizing, analyzing and communicating data; preparing taxes; and ensuring legal compliance. For example, a senior accountant in a business would manage the general ledger, prepare financial statements and work with external auditors.
Bookkeeping vs. Accounting
|Overall function||Keep accurate up-to-date records of all financial transactions.||Use the information provided by bookkeeping to determine a company's financial position.|
|Purpose||Maintain a systematic and chronological record of all financial activities and transactions.||Analyze and interpret data, make financial forecasts and advise business owners on financial decisions.|
|Result||Provide necessary information and data for the accounting process.||Prepare and analyze financial statements used to make informed decisions.|
|Key skills||Be accurate and knowledgeable about bookkeeping; work is reviewed by internal or external accountant.||Understand more complex financial matters and interpret data for business owners.|
|Typical tasks||Post journal entries, send invoices, record payments, manage payroll and reconcile accounts.||Prepare adjusting entries, analyze costs, perform audits, prepare and file tax returns, provide tax planning and advise business owners.|
What Is GAAP (Generally Accepted Accounting Principles)?
Generally Accepted Accounting Principles (GAAP) are U.S. accounting guidelines and standards issued by the Financial Accounting Standards Board(opens in a new tab) (FASB).
Public companies must comply with GAAP in their accounting practices, including when preparing financial statements. This helps investors and authorities assess and compare financial statements from different companies. Privately held companies do not need to comply with GAAP, but these businesses often choose to do so—especially if they plan to go public in the future.
Steps of the Accounting Cycle
- Identify and categorize transactions: For example, an accountant would categorize sales orders as income.
- Record journal entries: Individual transactions are entered in the appropriate accounts.
- Post journal entries in the general ledger: This task must be performed in accordance with the rules of double-entry accounting.
- Prepare an unadjusted trial balance: This report includes all the business’s accounts and their balances, comparing debits and credits. Debits and credits must balance.
- Adjust accounting entries: At the end of an accounting period, an accountant will add any entries that haven’t been recorded previously, such as interest from bank accounts.
- Prepare an adjusted trial balance: This report includes the adjustments made in the previous step.
- Prepare financial statements: Use the account balances from Step 6 to create financial statements, including an income statement, balance sheet and cash flow statement.
- Close the books: Prepare for the next accounting period.
Accounting for Small Business vs. Enterprise
While many principles of accounting are the same for a small business and a large enterprise, there are a few key practical differences—the biggest being the volume of financial activities. A small business may have only a few hundred transactions per month, while an enterprise may handle many thousands or even millions.
Another common difference is the method of recording transactions. There are two primary methods: cash basis accounting and accrual basis. Smaller businesses often use cash basis accounting, which is simpler. With this method, revenue and expenses are recorded when cash changes hands.
Businesses that need to comply with GAAP, such as public companies, must use accrual basis accounting. Accrual basis accounting is more complex but generally gives a more accurate picture of a company’s financial position. With accrual basis accounting, a company records income when it is earned and expenses when they are incurred, regardless of when money changes hands. For example, a company that is paid in advance for a multi-year contract would record a portion of the revenue in each year.
Accountants use the double-entry bookkeeping method to record transactions. Each transaction is recorded as a journal entry, with a credit to one account and a corresponding debit to another. These entries must balance each other. This method helps to ensure that each transaction is recorded in the appropriate amount and that the five major account types—revenue, expenses, assets, liabilities and equity—all balance.
Here’s an example of double-entry bookkeeping in accounting: A business sends an invoice to a customer. Using the double-entry method, the accountant records a debit to accounts receivable. The balancing credit is recorded in the sales revenue account.
When the customer pays the invoice, the accountant credits the accounts receivable account and debits the cash report.
The bookkeeping journal entries for this event are:
|To record sales revenue:|
|To record cash received and eliminate the amount owed by the customer:|
Managing an Accounting System
Using an accounting system helps businesses automate many routine accounting tasks, like paying bills and running reports. Accounting software can eliminate a lot of manual work, especially if the system is integrated with other business applications. That automation saves businesses money and reduces errors. Typically, the finance department will play a key role in setting up the system, particularly when it comes to creating custom reports and approval workflows.
The work involved in maintaining and updating the accounting software depends on the type of system you choose. Companies generally have a choice between on-premises and cloud-based accounting software. On-premises software typically requires IT expertise to install and manage on-site software and hardware. Cloud-based software or software-as-a-service systems are easier to manage because the provider updates the software automatically and users access the system over the internet using a browser.
No matter whether your business uses in-house skills or hires an independent provider, accountants provide expertise that’s essential to manage everyday financial activities, comply with tax and regulatory requirements and generate insights into the company’s performance.