What is Accounting?
Accounting is the process of recording a business’s financial transactions. It is important because it offers insight into the finances of a business and helps with pinpointing problem areas and measuring growth.
A transaction is an exchange between a buyer and a seller. Sometimes, a transaction can happen without any cash involved.
Why is it important for a business to record these financial transactions?
Importance of Accounting
Recording where the money goes is important because it gives stakeholders insight into the growth of the business.
Let’s take the example of Company X, which recorded revenue of Rs 4,00,000 this quarter.
If Company X had recorded a revenue of Rs 3,50,000 lakh last quarter, X’s revenue rose by Rs 50,000. So we know that the company is on the right track!
This would not be possible if Company X did not record its financial transactions in books of accounts.
Pinpointing Problem Areas
This is the other side of growth. Recording transactions and comparing them over time also gives founders insight into areas that could be improved. Let’s say Company X could have made an extra Rs 1 lakh this quarter if it had used a different, cost-effective kind of paper.
The founder of Company X only knows this because he had recorded how much money the company spent on paper over the quarter.
With insight into growth areas and problem areas, founders will now be able to make decisions guaranteed to help the business. The founder of Company X might start purchasing paper that is cost-effective, and save Rs 1 lakh!
A business has multiple stakeholders. The founders, investors, employees, consumers – all these people have a vested interest in the well-being of the business. Recording and sharing financial information of the company to selected stakeholders helps build trust and credibility in the business.
Now that we’ve established what is accounting and its importance, let’s look at how it’s done.
There are two ways of recording the movement of money. The generally accepted and widely used method is the double-entry system of accounting. There are many, many advantages of this method over the other, simpler single-entry system of accounting.
Read more: Single Entry Accounting & Double Entry Acccounting
In India, Accounting is regulated by the Accounting Standards Board (ASB) and the Institute of Chartered Accountants of India (ICAI). The ASB determines a standard format for accounting to be followed in India. The ICAI ensures that this format is followed properly.
Businesses in India and most of the world follow a standard flow of accounts through various “books”. Each book has its own purpose and reveals specific information. We will decode each book in the coming blogs.
It is important to understand each book in the series since the same information is taken from one book to the next.
Why should a founder learn what is accounting?
Founders who take an active role in their business’s financial health and performance are more likely to succeed. In this study by CB Insights, the top reason why startups failed is that they ran out of cash or failed to raise new capital.
Allocation of resources, most importantly money, is a founder’s primary responsibility. The best way to make insightful decisions is to first understand the money movement.
Accounting allows the stakeholders of a business to answer questions like:
The Bottom Line
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1. What is accounting?
Accounting is the process of recording a business’s financial transactions. Businesses in India and most of the world follow a standard flow of accounts through various “books” called Books of Accounts.
2. Why is it important to maintain books of accounts?
Recording financial transactions in books of accounts is important because it helps the founder track the business’s growth, pinpoint problem areas and make decisions that will benefit the company. It is also helpful in communicating to the stakeholders of the business and building trust and credibility.
3. What is the process of accounting?
There are two ways of recording the movement of money. The generally accepted and widely used method is the double entry system of accounting. The other way is the single entry system of accounting which is much easier but impossible to scale up.
4. Why do founders need to understand accounting?
Founders who take an active role in their business’s financial health and performance are more likely to succeed. Allocation of resources, most importantly money, is a founder’s primary responsibility. The best way to make insightful decisions is to first understand the movement of money.