What is accounting?

Accounting is pertinent to all business owners. It is the process of  recording, summarizing, analyzing, interpreting and reporting the  financial information of an organization. This financial information  gathered is key to assist managers and executives to make business  decisions.

Importance of accounting

Information derived from the process of accounting help serve both internal and external stakeholders of a company.

  1. Internal stakeholders
    Internal stakeholders can be split into two major groups, which are  the stewardship and decision-making process of a business. A steward is  responsible for managing the economic resources of a business to ensure  these resources are optimally utilized to maximize profitability.

    For decision-making, senior management is dependent on the  information summarized in financial reports to make decisions relating  to the business. A show of growing revenue but stagnating profit would  prod management to evaluate the expense components incurred by the  company. Further analysis of the expenses might provide a clearer view  of what are the specific cost drivers that are adversely affecting the  firm’s profitability, allowing managers to pinpoint the source and  resolve it.
  2. External stakeholders
    External stakeholders are individuals or entities that are situated  outside of a company but are affected by the financial performance of  it.

    Shareholders and investors of the firm, who are considered the  company’s owners, rely on the financial information from accounting to  make their investment decisions. Investors would cleverly avoid  companies having recurring losses or high debt ratios in case of the  risk of bankruptcy.

    Banks and other lenders would utilize financial information to assess the business’s ability to repay its loans.

Forms of business entities

When an individual incorporates a business, the business itself is  considered an entity and its activities are separate from the personal  activities of its owner. What forms of entity should one incorporate  then? Forms of entities are dependent on a few factors, such as number  of owners, how the businesses are managed, the amount of reward and the  level of investment risk for the owners.

The three common form of entities are sole proprietorship,  partnership and company, each with their own characteristics, advantages  and disadvantages.

  1. Sole proprietorship
    Usually established only with one owner and it’s the least expensive  and easiest to incorporate. The sole owner is entitled to all the  profits of the company. Speaking of profits, any losses, debt incurred  or liabilities are borne by the owner. This makes it risky for the owner  as he is personally liable for all the debts that the company  undertakes.
  2. Partnership
    It can only be established with a minimum of two owners. These  partners share the profits and losses of the business. However, if the  business fails, some partners may have to pay all the debts.
  3. Company
    A company is a legal entity on its own, separate from its  shareholders. Articles of incorporation must first be filed with the  state to establish a corporation. There is no limit to the number of  owners and provides limited liability to shareholders, up to the amount  of investment they have made.