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.
- 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.
- 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.
- 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.
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.
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.