Why You Need Accounting

In the previous post, we said that accounting is the process of keeping financial records of the business. But is it really important to do accounting on your business operation? Even for the small and medium enterprises (SMEs)?

There are actually many reasons why accounting is important to your business.

  

1.       To know how your business has performed 

2.       To raise money for expansion by taking new investors 

3.       To raise money through borrowings
4.       To project your future performance

How your business performed

If you install an accounting system, you will know how your business performed financially during a particular period, (say a month, a quarter, semi-annual, annual). You will also know how you were able to manage your business’ assets especially your cash. You will understand this by knowing how to read and interpret your financial reports or statements generated from your accounting records which includes statement of financial position (commonly known as the balance sheet), income statement and statement of cash flows. Your accountant can help you interpret these data correctly so you can make appropriate decisions for your business.

Let us briefly describe these financial statements:

1. Statement of financial position – it is a formal statement showing the three elements comprising financial position, namely assets, liabilities and equity. Analysis of this statement would provide investors, creditors and other statement users information as to your business’ liquidity, solvency and its need for additional financing. 
2. Income statement – it is a formal statement showing the financial performance of your business for a given period of time. It is also known as the results of operations. This statement is basically the total of your income less your expenses. 
   
3. Statement of cash flows – this statement summarizes the operating, investing and financing activities of your business. Simply stated, this statement provides information about the cash receipts and cash payments made by your business during a period.

Accept new investors

When business is doing well, it is always good that you plan to expand it. But expansion is always associated with additional capital. One option is you put in additional personal funds, if more is still available. However, that is not always the case. So, another option is to take new investors. These investors would look at your financial statements which we mentioned earlier.

More importantly, you need to consult your accounting records to determine the net worth of your business. The net worth is simply the residual value or capital after you deduct all your liabilities from all your assets. Your net worth becomes your basis for deciding how much of your business you are willing to offer your prospective investors.

Let say your net worth is P500,000.00. If you decide to take another P500,000.00 as capital infusion from investors, your total net worth would become P1,000,000.00. As a result, your ownership share will be diluted from 100% to 50% (P500,000.00/ P1,000,000.00). But in order to know your true net worth, you need to properly account your assets and liabilities.

Borrow money

Another option for raising capital for expansion is by borrowing money from the bank instead, especially if you’re not willing to give up part ownership of your business. However, you would still have to prepare your financial statements because these bankers will want to know your present financial standing. Normally, the banks will only lend you based on your capacity to pay. They will also check how much is your business assets. Further, they will be interested how much cash will be generated from your business operations.

In some instances, banks will require you to submit your business plan.

Future projections

To prepare your business plan, you need to make projections of the future performance of your business. In order to make realistic and achievable projections, you need to have reliable historical data which you can get from past financial statements, and which can serve as basis for future actions. By doing this, you can discover a lot of information on the performance of your sales, costs and expenses.

Of course, your past performance will not mean the same future results especially if you make some changes in your business policy. For example, you may decide now to implement strong advertising and promotional campaigns. This decision could lead to higher sales outcome than expected based on normal operating conditions.

You need accounting

Without accounting, it is impossible for you to know how your business is doing, and where your business is going. It is accounting that will help you understand the financial activity of your business. By knowing the behavior of your business, you are in a position to better manage your business by making the right decisions at the appropriate time. Hence, you can minimize the risks associated with hasty and erroneous decisions. Your accounting system will help you through.