In the most simplest of terms, Accounting is keeping track of your business transactions in a systematic manner using a certain method. In the United States, we use the method called Generally Accepted Accounting Principles (GAAP). Why do you need to know this? Why is Accounting and GAAP important? It's due to the various requirements that the government (federal and state) impose on taxpayers and businesses. The government requires its taxpayers to keep track of how much money they've made and to pay taxes on it either throughout the year or at the end of the year, depending on how much money you've made.
Taxes and Compliance
For businesses, Accounting is very important because while it's easy to know how much money you've made, it's not always easy to know how much you spent and on what. The reason you must know what you've spent your money on is that the Internal Revenue Code (Tax Law) has various rules about which items they consider to be business expenses. Further, the Tax Code has various methods of how a particular type of expense is accounted for. An example of this would be a small business owner, when they pay themselves, the Tax Code doesn't consider this an expense. Although the business paid money to the owner, the Tax Code considers this a withdrawal or distribution of profit and it is not tax deductible. Another example would be the purchase of an asset.
The purchase of assets (things like equipment, machinery, furniture, etc.) have very specific rules about how they are captured as expenses. In lieu of any special rules (there are several) assets are depreciated over time and that's how the cost of an asset is captured as an expense. To name a few other accounting nuances:
* Taxes paid by the owner are not deductible by the business
* Mileage is considered a business expense although no money was paid directly
* The purchase of inventory (goods) to be sold are not considered expenses until they are actually sold. Note: the business has to keep track of the inventory it's purchased, sold, and what it has remaining at the end of the year.
Business Management
These rules are important for various other reasons, the information gathered can be used to help make business decisions. You can use accounting information to see how profitable a particular good or service is when taking into account all of the cost components of that good or service. Often there are expenses associated with a product or service. This helps to determine if you should increase your prices, seek a new supplier, downsize, or scale up your business. Using accounting information can be an excellent business management tool that can drive accountability and efficiency and ultimately make your business more profitable for you and your family to increase your wealth for the next generation.
Financing Requirements
If you have a business loan or investors that require an audit or some sort of CPA sign off (attestation) of the activities of the business or organization, accounting rules/methods become even more important. Often, once a business applies for significant financing, the investors or debtors want to know the odds of getting a return on their investment as time passes. Further, prior to obtaining financing the business owner has likely made promises as to how they will utilize the money and the manner in which they will conduct their business. An attestation by a CPA regarding the accounting methods employed by the business to track their business activity is critical to facilitating capital to businesses that need it.
Conclusion
Accounting is very important to businesses for various reasons, so having a relationship with a competent accounting professional such as a CPA, is a smart business decision and investment. If you want to know more about how any of the topics described above relate to your business or even your personal financial situation, feel free to reach out to me. I'm happy to help.
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