Why is Understanding Accounting Important?

Updated: December 1, 2022

For any business owner, it is critical to understand how accounting works, the value it holds, and how to use it to make wise financial decisions.

For starters, it is an essential part of every business. As the old adage goes: “Only two things in life are certain. Death and Taxes.” Accounting won’t help you with the former, but when it’s time to pay the latter, you’ll find that having reliable financial records will be worth every penny.

When it is fully understood and applied, accounting can serve as a valuable tool, unlocking important information you need to grow your business.

Understanding Accounting Helps You Understand Your Business

When you utilize accounting methods properly, you are able to track your business’s income and expenses. This is often referred to as financial performance and it is a great way of assessing how your operational decisions translate to your financial statements.

These reports provide you with information on the financial health of your business. They can help you make decisions and pinpoint areas where you are struggling and find areas where you are performing effectively. This way you can track your decisions and do more of what makes the most positive impact on your business.

There are three primary financial reports tied into your accounting. Each of them provides different information you can use to inform your decision-making process. Let’s take a closer look:

Cash Flow Statements: This is critical for cash flow management and overall business success. It outlines the money flowing in and out of your business. Keeping a keen eye on this statement ensures your business is operating correctly without the risk of running out of money. There is a good reason why cash flow is often referred to as the lifeblood of every business.
Income Statement: An income statement outlines the profit and loss of a company over a period of time. It outlines your total expenses and revenue which is essential because even with solid sales, your business may not be profitable. And profits are one of the most important figures to know since it will have a big impact on just about every aspect of your business operations.
Balance Sheet: The balance sheet is a comprehensive statement that provides a list of all assets, liabilities, and capital for the business. Essentially, it is an overall snapshot of your financial position. Your balance sheet will give you an overall indicator of the financial condition in which your business is at the moment.

You can derive meaningful information from each of these reports to gain an overall understanding of the financial state of your business.

Helps You Meet Government Regulations

Understanding accounting also helps you with meeting compliance requirements set by local, state, and federal agencies.

Every business needs to follow the rules and regulations to run legitimately. If you fail to meet those rules, you’ll face fines and risk losing your business.

One key area of this is tracking your income tax, sales tax, and other tax obligations. Proper tracking makes tax season significantly easier. Also in case you get audited, you’ll be confident that your financial records will hold up to be reviewed by the tax authorities.

Not only does it provide you with the tools you need to complete your taxes and pay what you owe, but accounting also helps you to plan ways to save on taxes. When you use it correctly, it can work as a tool to help you to estimate your tax liabilities and pinpoint opportunities to reduce them.

More so, your accounting backs up all of this information, so if you need to use the data later, you can.

Guides Cash Flow Management

Cash flow is king when it comes to running a business. Your business will likely fail if you do not have a strong cash flow. In fact, poor cash flow management is one the leading reasons why most businesses fail.

When you have cash flow problems, you:

Don’t have enough cash to pay your bills or cover costs in an emergency
Spend more cash than what is available to you and have to rely on credit.
You have a mismatch between the timing of bill payments and payment collection from clients

These common problems can be avoided when you understand your accounting. One of the reasons why profitable companies run into cash flow problems is because they don’t truly understand their cash flow cycles and other aspects of their finances.

For example, one of the easiest ways to improve your cash flow is to improve your accounts receivable days. This is a metric derived from proper accounting that measures the number of days it takes your clients to make payments to you.

Ideally, tracking this metric and following through with your plan for improvement will lead to a stronger cash flow.

This is just one of the many ways you can leverage accounting metrics to manage your cash flow.

Aids in Decision-Making and Financial Management

Accounting provides you with insight into the health of your business. With it, you can see what is doing well and correct financial issues before they turn into larger problems.

Without a strong understanding of accounting and how numbers tell the story of your business, it becomes much more difficult and even impossible to spot these mistakes.

However, when you are aware of how your numbers work together, you can use your accounting data to make decisions for your business. Decisions like…

Whether or not you can afford to make a new hire
If you can expand your business with a new branch
What’s the best time to introduce new products to your market
Whether or not to explore different business models.

All of these decisions should be supported by your key performance indicators. This way you have a clear picture of how every operational decision you make impacts your financial status.

Additionally, when you have robust accounting processes you can work on financial projections. This will open up new possibilities on how you can strategize your future growth for your business.

Want to Ensure You Are Fully Understanding Accounting for Your Business?

A strong understanding of your accounting can be the difference between a successful business and a business that barely stays afloat. Even if you are profitable on paper.

In addition to meeting government regulations, accounting helps you see the big picture of your finances, manage cash flow, track business transactions, and make the right business decisions.

If you are not leveraging your accounting to reap these benefits, it’s time to turn to an expert.

Vertical CPA will help you gain a greater understanding of your accounting and provide guidance for moving your business forward.