Starting a business doesn’t just involve getting all the legal papers ready, hiring staff and then sitting down for the company to run on its own. There are a lot of responsibilities that come along the way. And before you can focus on hiring or even operating your business, it is important to think about the accounting system in your company.
There are lots of businesses out there that spend their precious time and money in recording their financial transactions. And if you are in doubt if these painstaking efforts are actually worth it or not, then this article will help you understand all about accounting and why you need to spend a little time in the beginning to set up an accounting system.
What is Accounting?
To begin with, let us get an idea on what accounting is all about. Basically, accounting is the practice of systematically maintaining the financial records of a company. This is done to summarize the records for compiling the financial statements of the company.
With this said, here are some of the reasons why you would need an accounting system:
- Bank & Lenders: If you are looking for a loan, the bank or lender would ask for your company’s financial statements. With a proper accounting system in place, you would be able to offer them with what they are asking you.
- Planning Your Budget: With a budget, a company can focus on saving money for expansion. Budgeting helps in letting you know when you are spending more than you can afford. Accounting would help you keep all the historical records in creating a budget for your company.
- Reporting Profits: The main aim for any company is to earn profits. And for the earnings in a company, there is a mandatory income tax paid to the government. For a company to be able to report profits for the tax calculation, accounting is needed.
- Information for the Investors: When you are looking for funding for your company to expand, you would have to show your company financial report to outside investors. Keeping your financial records with accounting is what would need.
It is normal for everyone to keep track of the day to day account of their expenses and income. It helps us manage things in our lives better. Businesses need this too to become successful.
Let us now get deeper into the concept of accounting and budgeting.
Difference of Accounting vs Bookkeeping
There are many business owners out there that are still not sure about the difference between bookkeeping and accounting. But it is an important difference that everyone should know about and would help you hire the right professionals for your business.
In the business world, we can find many people who use the words bookkeeping and accounting interchangeably. This is mostly because these two work together to fulfil the clients needs. As a matter of fact, both have to work with the financial reports and statements in the company.
Both accountants and bookkeepers often do not get any time off between January and April. Although their goal is the same – which is to keep the financial health of the company good, they are not in charge of the same tasks in a company. There are a few key differences between them.
The development in the industry where bookkeepers have started performing accounting tasks, and accountants have begun to take care of their client’s complete financial situations, has made things more blurred. This is the main reason why people are not able to differentiate between the two easily. And that is why we have gathered everything to help you understand all the key differences between them.
What Does A Bookkeeper Do?
Normally, a bookkeeper manages all the daily financial transactions in the company and records them. They are the ones who are responsible for recording the transactions in accounting software like Quickbooks, creating the preliminary financial statements, and reconciling the bank statements at the end of the month for the company.
Additionally, bookkeepers normally take care of the complete back-office support which includes paying bills, invoicing clients and processing the payroll. In short, a professional bookkeeper is a person who would have at least two years of experience along with a degree in accounting of an associate. Some of the other tasks that a bookkeeper takes care of include:
- General record keeping
- Cash flow forecasting & management
- Advising clients on recordkeeping methods and requirements
What Does An Accountant Do?
On the other hand, an accountant has more of an advisory role with the business owners. An accountant is the one responsible for creating the financial reports and statements in the company, used for government agencies and banks. In short, accounting involves offering quarterly or monthly insights into the financial health of the company.
Utilizing the financial statements prepared by a bookkeeper, the accountant can work on preparing strategies that would help the company grow. Not to mention, CPAs (certified public accountants) are accountants that are regulated by their state board of accountancy and are also accountants.
These professionals have to meet the minimum experience and educational requirements and complete any ongoing annual continuing education so that they can stay at the top of all the new regulations and laws. Some of the other tasks that are done by CPAs and accountants are:
- Income tax planning
- Verifying the completeness and accuracy of the accounting records
- Advice on tax law, key financial decisions, and entity structure
In short, both accountants and bookkeepers offer strategic advice to clients. The difference is that a bookkeeper would tell you how to streamline your accounts process or in budgeting your business, while the accountant would suggest different ways to minimize your tax liability or if you should incorporate a business or not.
Here is a summary of what each professional can offer you:
- Bookkeepers normally have on-the-job training experience. Some also get training and certification through bookkeeping training programs.
- They are knowledged with a variety of software solutions which enables them to make recommendations on the technology for the company, employees, as well as the bookkeeper.
- Bookkeepers cannot perform independent audits or attestations.
- They normally know all about the daily details of the business.
- They are increasingly taking on the business strategy and advising roles.
- Bookkeepers normally are only aware of the finances of the business.
- They normally do not file tax returns other than payroll and sales tax.
- Accountants normally have an accounting degree. A lot of accountants are CPAs, though all do not pursue this designation.
- They often (not always), use mid-level accounting solutions designed for accountants. These solutions help them offer tax planning and all the other financial insights in the company. The company’s owners typically do not work within these programs.
- CPAs and certified auditors can perform attestations and audits. They can also create certified financial statements.
- They normally have a much higher-level of view of the client’s business.
- Accountants are increasingly taking on roles in tax resolution, tax coaching, and financial planning.
- They normally have insights of the business owner’s personal and company’s finances.
- Accountants normally file the business and personal income tax returns.
With this clear, let us more ahead and talk about the parts of accounting.
Financial reporting is a huge part of accounting and corporate governance. It involves the disclosure of financial information to the management of the company and the public, if the company is publicly traded. This would show how the company has been performing for a particular period of time.
Not to mention, the financial reports are issued on an annual and quarterly basis. And so that you do not confuse yourself, financial reporting is not the same as management reporting, that is the disclosure of financial information to make decisions for the company.
Let us get deeper into the idea.
Financial reporting, which is a part of accounting, has two main purposes. First, it assists the management to undergo effective decision-making related to the overall objectives and strategies of the company. Basically, the data in the reports can assist the management detect the strengths and weaknesses, and the overall financial health of the company.
Secondly, the financial reporting offers important information regarding the financial health along with the activities that take place. These details are given to potential investors, government regulators, consumers, and shareholders. The financial report is a way of making sure that the company is being operated properly.
In fact, proper interpretation and the analysis of cash flow statements, income statements, and balance sheets to analyse the investment qualities of the company allows investors to make smart investment choices. Nonetheless, it is important for everyone, especially the owners and investors, to be familiar with certain financial statements that the accountant would prepare.
Below are the statements that you would get from your accountant:
The income statement is also called the Profit and Loss Statement. This statement reports the financial performance of the company. In short, it tells us about the net profit or loss that the company has had in a particular period. There are two things that make up the income statement:
- Income: This is what the company has earned over a period of time, such as sales revenue, dividend income, etc.
- Expense: This is the cost that the business incurred over a period like the purchases, wages and salaries, rental charges, overhead, etc.
Just to be clear, the Net profit or loss is determined by deducting the expenses from the income.
The balance sheet is also called the Statement of Financial Position and displays the financial position of the company at a given date. There are three things in the balance sheet, as below:
- Assets: The things that the business controls and owns, like the plant and machinery, investory, cash, etc.
- Liabilities: This is the amount that the business owes to someone, which includes bank loans, creditors, etc.
- Equity: This are the things that the business owes to the owners of the business. It is the total amount of capital that is left after all the company’s assets are used to pay off its outstanding liabilities.
The next thing is a general ledger, which is used to store the financial data of the company, along with the credit and debit account records that is validated by a trial balance. The general ledger offers the record of every transaction that has taken place since the company was incorporated until the current period. It has all the financial details of the business needed to prepare the financial statements of the company. But before this can happen, the data is divided into various accounts – revenues, owner’s equity, liabilities, assets, and expenses.
Statements of Cash Flows
Another financial statement that makes the list is the cash flow statement. This displays the movement of cash and the bank balance over a period of time. There are three segments that the movement of cash is classified into, as below:
- Operating Activities: This is the cash flow that comes from the primary activities of the company.
- Investing Activities: This is the cash flow from the sale and purchase of assets other than those in the inventories. For instance, it can be the purchase of a factory plant.
- Financing Activities: This is the cash flow that is generated or spent on repaying and raising share capital and debt along with the payment of dividends and interest.
Statement of changes in equity
Also known as the Statement of Retained Earnings, the Statement of Changes in Equity is the detail of the movement in the equity of the owners over a period of time. The movement in the equity of the owners is derived over time from the following:
- Dividend payments
- Share capital repaid or issued during the period
- Total loss or profit during the period is noted in the income statement
- Effects of a change in accounting policy or correction of accounting error
- Gains or losses recognized directly in equity (e.g. revaluation surpluses)
Moving ahead, there is a large part of accounting that has to be understood – it is called management accounting.
Management accounting is the process of preparing the accounts and reports that offer timely and accurate statistical and financial details. This is given to the managers of the company to make short and long-term decisions. In short, it has to work on identifying, measuring, analyzing, interpreting and communicating the information to enable the organization to pursue their desired goals.
To be clear, management accounting is very different from financial accounting. While financial accounting offers information to people normally outside the company, the management accounting is usually aimed to help the managers in the company with making any decisions.
Role of Management Accounting in a Company
To help you understand better, below are the different roles of management accounting:
- Helps in Understanding the Performance Variances: The business performance discrepancies are the variation about what was forecasted for the company and what was achieved. The management accounting process assists the management to build on the positive variances and manage the negative ones with the use of analytical techniques.
- Forecasts Cash Flows: It is important to predict cash flow and the forecast of cash flow in a business. How much would the company incur in terms of costs in the future? Where will the revenue come from? Will the revenue decrease or increase? Management accounting means designing the budget and trend charts, and is used by managers in deciding how to distribute the resources effectively.
- Helps in Forecasting the Future: Predicting the future costs in the company, helps in decision-making and to answer some questions like: Should the company purchase another business? Should it diversify into different markets? Should it invest in more equipment? Management accounting helps in answering these questions and making the right decisions.
- Helps in Make-or-buy Decisions: It helps the management in deciding if the company can easily produce the raw materials in house for cheap or get it from a third-party. The productivity and cost availability are the deciding factors in this choice that the management accounting helps with.
- Analyzing the Rate of Return: Before you can move into a project that would need an investment, it is important for the company to decide the expected rate of return (ROR). Between two investment choices, which one should the company choose? How long would the company take to get cover the amount put into the project? All these things are answered with the help of management accounting.
In short, management accounting is an important part of every company and hence, cannot be ignored. It is what helps a company grow and get better.
The Basic concepts
With the above clear, let us now talk about the other basic concepts of accounting and financial reports. Each part has been explained below briefly for your knowledge:
#1 Fixed vs Variable Costing
The first thing that you should know about in accounting is the difference between variable and fixed costs. Variable costs are those that change with the production volume or activity in the company. On the other hand, fixed costs are something that remains constant regardless of if there is any activity or product volume increase or not.
If you want to determine if a cost is a fixed or variable cost, you should ask whether or not the cost will change if the company stopped any primary business activities or its production. In case the company would continue to incur the cost, it is a fixed cost. And in case the company no longer incurs the costs, it is a variable cost.
Let us take an example to understand this idea better. A telephone company charges a per-minute rate, this is a variable cost. This is because a 30 minute call would cost more than a 10 minute call. On the other hand, an example of a fixed cost is rent. When a company rents a warehouse, they will have to pay the rent regardless of if the warehouse has inventory stored in it or not. In addition to this insurance expenses, depreciation, interest expenses, and executives’ salaries are also fixed costs. And examples of variable costs include direct labor and direct materials costs.
The next term that you need to know about is budgeting. A budget is an outline of expectations for what a company wants to achieve for a specific period. This is normally a one year period. The main characteristics of budgeting are:
- Expected debt reduction
- Expected cash flows
- Estimates of revenues and expenses
Budgeting represents the financial position, goals and cash flow of the company. And the budget is mostly re-evaluated once every fiscal year based on how the management wants to update the information. Once a budget is prepared, it is compared to the actual results for calculating the variance between the two figures. This helps in difference in the performance allowing the company to improve if it is low.
Plus, although many of the budgets in a company is prepared for the complete year, It is not a hard and fast rule that every company has to update the budget after a year only. In some companies and situations, it might be much more important to be flexible by allowing the budget to be adjusted throughout the year as business conditions change.
The third term that you need to know about accounting and financial reporting is forecasting. Financial forecasting estimates the financial outcomes in the future for the company by examining the historical data. The characteristics of financial forecasting include:
- This is used for understanding how to allocate the budgets in the company for the future.
- The forecast is regularly updated mostly when there is a change in the business plan, operations, and inventory.
- It can be both long-term and short-term. If a customer is lost due to competition, revenue forecasts might need to be updated.
- The management team can easily take the financial forecasting data and take any needed action using it.
All in all, financial forecasting can help the management department to adjust the levels of inventory and production in the company. In addition to this, the long-term forecast can help the company prepare its business plan and reach its goals as well.
With all the main points clear about what accounting is and what the various things that affect a financial report are, let us move ahead and understand how you can handle the accounting part of your company. Not all companies have the funds to hire a professional accountant. And for such companies, accounting software can help.
From sending out invoices, having them paid, forecasting the cash flow in the company, along with obtaining detailed financial records, there are some accounting software that can be the best accountant for your company. In fact, many are cloud-based services allows you to monitor your business from anywhere and stay worry-free.
But which of the software is actually worth your money? From a pool of multiple applications available online, we have gathered the best ones and listed them below with their features. These would help you get started with the accounting part of your company:
1. Intuit QuickBooks
The most popular accounting software is Intuit QuickBooks which has been in the market for more than a decade. A very easy to use cloud based application that is great for every small business. Here are the plans (subject to change):
- Simple Start – $10 /mo
- Essentials – $20 /mo
- Plus – $35 /mo
- Advanced – $60 /mo
- Self-Employed – $5 /mo
If you decide to choose the essentials plan, it has many features including expense tracking, invoicing, payment handling (with a 2.9% + 25c transaction free), and it also permits you to easily track and calculate VAT. In addition to this, you can manage payroll and pensions for an extra $2 per employee per month.
Other than this, you can add more power to the app with other services like CRM, job scheduling, Shopify integration, inventory management, and more. QuickBooks also offers mobile apps for iOS and Android. If you feel that this application is calling to you, you can give it a try here at – https://quickbooks.intuit.com/
The second best accounting software that can help you with your company’s budgeting and financial statement is Xero. In fact, it is the application with the lowest price of $9 per month Starter account. And yes, the low price does bring in some restrictions. But for those who want full support can choose the Standard or the Premium plan.
Here are the plans for this accounting software (subject to change):
- Xero Starter – $9/mth
- Xero Standard – $30/mth
- Xero Premium 10 – $70/mth
This application is almost the same as the ones mentioned above. But the only disappointment with this is that it does not support multiple currencies. You can learn more about it here or sign up for it here – https://www.xero.com/
The third accounting software we will cover is FreshBooks. The best part about it is that it is completely cloud-based. There are a lot of features that the application offers including time tracking, expense tracking, invoicing, host of business reports, and also an option that allows credit card payments (for a 2.9% plus 30 cents transaction fee). And it is the best accountant any small business can have.
Here are the packages for application(subject to change):
- FreshBooks Lite – $15/mth
- FreshBooks Plus – $25/mth
- FreshBooks Premium – $50/mth
Not to mention, the application is very easy to use. You can bill customers in any currency through their credit cards, and set up invoices from any device. And if you want to add more power, you can integrate other services like Zendesk, Gusto, WordPress, Basecamp, MailChimp, PayPal and many more.
In case you want to give it a try, you can choose the first subscription – FreshBooks Lite for 30 days. You can handle invoices, estimates, time tracking, expenses, and have the option to accept credit card payments while you import expenses from your bank account. The only thing in this $15/month plan is that you would only be able to cover 5 clients.
On the other hand, the plus plan with $25/month gives you the support of 50 clients along with the ability to send proposals. It also saves your time by offering recurring invoices, and automatically send any payment reminder to clients. Learn more about it here – https://www.freshbooks.com/
With this clear now, it is time for your set up your company’s accounting system. One of the best ways is to use one of the mentioned softwares mentioned above. Also, hire a bookkeeper to handle all the recording keeping. All this would help you in staying ahead of all the accounting tasks then.
And if you have not started your company and need some help in incorporating your company online, IncParadise can help you with it. Not only this; we also offer virtual office services and mail forwarding services.