The Power of Accounting by Lawrence D. Lewis

This article was inspired by Lawrence D. Lewis's The Power of Accounting . If you enjoy this article then consider purchasing or borrowing the book.


How to Understand Accounting

“You cannot consistently make good decisions without relevant, reliable information, and the single most important role of any accounting system is to provide that information.”

There are two types of accounting—financial and managerial. While financial accounting requires a universal language and addresses the concerns of individuals outside a company, managerial accounting uses variable language to provide companies with the information to consistently run a business.

Accounting allows you to measure the progress of your firm. By knowing where your expenses lie, you can address problems with your business. It also gives you the data needed to make a good future financial decision.

In order to organize your company’s spending, all your transactions will be placed into appropriate accounts. Accountants use five types of accounts:

  1. “Revenues” – In coming money flow, as well as changes to other assets.
  2. “Expenses” – Out going money flow.
  3. “Assets” – Provide “future economic benefit.”
  4. “Liabilities” – Required payments or services offered to “another entity.”
  5. “Owners’ equity” – The value of net assets to the owners.

Accrual accounting catalogs revenue when a deal is made instead of waiting for the actual payment. Cash accounting waits for money to have been received or paid before recording a revenue or expense.

Expenses subtracted from revenues equals the net profit, according to the “income equation.” To demonstrate a business’s activities over time, accountants use an income statement. A balance sheet acts as a snapshot of this data, presenting the assets and liabilities on a specific date. The total assets of your company must equal the total liabilities and owners’ equity, according to the “balance sheet equation.”

Instead of income statements and balance sheets, a cash flow statement demonstrates how, when and to what degree your company makes money. A cash flow statement, also called a “source and use of funds statement,” gets its information from the income statement and balance sheet used during a specific period of time.

With accurate accounting data, you can make informed managerial choices. Use accounting information to compare and contrast the benefits and possible risks of your decisions.

Your budget can tell you how the company is performing and what can be improved. Gather all relevant input before making decisions. Never set goals that are too high or too low for your budget.

Accounting can help you allocate funds to the right activities or products. Activity-based costing (ABC) decides what affects the costs of the actions that shape a product. After your accountants interview employees and glean what activities will create a better final product, you can allocate funds to the actions that customers would also appreciate.

With the help of accounting, you can better manage your business, maximizing profits and avoiding debt.

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