Why is Accounting Important?
There’s a common misconception that accounting is a dull science. Many people avoid getting into this field of Finance because they think it’s all about numbers and nothing else, thus missing out on solid career opportunities. By the end of this article, you’ll have a clear sense of the extraordinary potential of accounting, and maybe find out you’ve had a liking for it it all along!
What is Accounting?
A baseline accounting definition would go something like this: Accounting is an information science that is used to collect and organize financial data for organizations and individuals. In other words, it is quantitative in nature and measures money. It isn’t an abstract science by any means and is best learnt by doing.
Why is Accounting Important?
As one can imagine, every firm needs to be able to organize the financial information related to its business. Companies need to know how much of a product they were able to sell, how much it cost to produce the product and how much money they will find in the bank.
Similarly, an individual needs to be aware of their personal finances. If they don’t pay attention to how much comes in and how much goes out, they may soon be in deep trouble.
Accounting helps us organize and represent financial information. It aids corporations and individuals in understanding their financials and making decisions about the future. It’s the science of using the past in order to take action in the present and change the future.
Main Branches of Accounting
There are four main areas of accounting:
First, we have bookkeeping. Without bookkeeping, we wouldn’t be able to do anything, because bookkeepers are responsible that all the information is collected and taken into consideration. It is a fundamental activity as it ensures that financial information has been gathered systematically.
It is prepared for the company’s ownership, its lenders, financial analysts, and for other external stakeholders. It follows a set of strictly defined accounting principles and is highly regulated given that the information is prepared for third party users who should be able to read it without recourse to insider knowledge. The fact that accounting information is prepared according to a specific set of rules also renders it comparable with the one prepared by other companies, which in turn facilitates investors and lenders.
The third type of accounting is Managerial Accounting. It is available only for insiders. It is not defined by accounting principles and is in most cases more detailed than financial accounting. Managerial Accounting deals with strategic information that shouldn’t be seen by the firm’s competitors. It looks into topics like pricing, competition, marginality, budgeting, and so on.
Of course, managerial and financial accounting are often interrelated, and it is a frequent practice to reconcile figures obtained through both. But there are many differences as well.
The fourth type of accounting that we need to mention is tax accounting. It is used to determine the amount of taxes a company must pay. Tax accounting is a very technical field that varies for every single legislation in the world.
Each of these different types of accounting plays a vital role in one or more spheres of public life. To gain a better sense of the importance of the field as a whole – let’s look at two of its branches in individual detail.
The World without Bookkeeping – a Doomsday Scenario
To be able to appreciate the importance of bookkeeping, try to imagine for a second that tomorrow you wake up and all the financial records in the world are gone.
The first thing that you realize is that you don’t have any electricity at home. The electricity company shut it down because they didn’t have any records of you paying the bill.
You then decide to go to the nearest supermarket and buy some juice, butter, and bread, but when you get there, they tell you that they don’t have any. They didn’t know that they were out of stock because all their records are gone.
You’re starving and you don’t have any electricity at home. Miserable situation.
Perhaps some shopping in the city center would cheer you up? You decide to withdraw some money from the nearest bank, but when you get there, you find out that the bank doesn’t have a record with your name. They’ve lost the information about your savings. They are gone.
You get the point, right?
Modern society as we know it, cannot function without bookkeeping.
Bookkeeping is fundamental for corporations, banks, investment funds and even individuals.
Let’s look at another example. Think about GE – the General Electric Company.
GE has over 300,000 employees and operates in more than 170 countries in the world. The company operates in businesses like Appliances & Lighting, Aviation, Financial Services, Energy Management, Healthcare, Oil & Gas, Power& Water, and Transportation.
Can you imagine how complex its operations are?
Is GE going to be able to monitor its businesses without a proper bookkeeping system in place?
Is it going to be able to understand whether its operations in a given country are profitable or not?
Whether there is a product that is not profitable and should be discontinued?
Recording every single transaction that takes place within the firm is paramount at this level of complexity. It is proper bookkeeping that ensures all necessary information has been recorded and is ready to use.
Bookkeeping is the cornerstone around which all of accounting is constructed. Because it is so fundamental, a world without it is almost unthinkable. But other branches of accounting also play major roles in the modern world.
The World without Financial Accounting – a Second Doomsday Scenario?
Take Financial Accounting—the set of financial reports that a company prepares for people that are outside the organization enabling them to make reasonable judgments about its business.
Why is this important? Why should a company go through all the trouble of complying with regulations to prepare its reports?
Think of the opposite situation. What if the company did not provide financial information? What would have been different in that case?
Is there a bank that would be willing to issue a loan without knowing how you’re going to repay it?
Is there an investor who would be willing to put up their money without knowing anything about the financials of the company?
The answer is “No”. And that’s why companies prepare their financial reports – it enables them to communicate their financial performance to those who are interested. Without financial reporting as we know it, most businesses would have been denied the capital that they need.
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