Purpose of Accounting

There are two types of accounting, namely, managerial accounting and financial accounting. Managerial accounting is used by firms for decision-making about the firm itself. Financial accounting, has to follow the set accounting standards, according to GAAP, i.e. Generally Accepted Accounting Principles.

The primary purpose of accounting is to make financial reports regarding the performance of the company in a specified period, usually one year. These financial reports are later made available to the tax authorities, investors and creditors of the firm. These external parties, then make their economic decisions regarding the firm, on the basis of these financial reports. Let us understand the basic purpose of accounting, by understanding the financial statements maintained by business organizations.

Purpose of Accounting in Business

The main aim of any business is to earn profits and also to remain solvent, i.e., it should have enough resources to pay its employees, creditors and to carry on with the day-to-day activities of the business. The main purpose of accounting system is to prepare financial statements, that will help the various external and internal parties of the business to appraise the profitability as well as the solvency of the business. The three main financial statements that are prepared for the purpose of accounting information are as follows.

Balance Sheet
A balance sheet is the most important financial statement of a company. The balance sheet contains the assets and liabilities of a company as well as the owner's equity, which is the difference between these two. Analysis of the balance sheet statement has many benefits such as asset management decisions are based on the balance sheet statement. Also, in order to raise finances for the company, most lenders first analyze the last three years balance sheet statements and take decisions accordingly. Thus, the purpose of accounting is to have a data ready which will be used by such external parties as investors and government organizations to take their decisions.

Statement of Cash Flows
Cash flow statement presents both the cash inflows and cash outflows of a company in a given period of time. Cash inflows are the revenues earned by a company in a specified period, cash outflows are the expenses incurred in the production process of the company. Statement of cash flow, thus, represents the liquid position of the company in a given time. Analysis of the cash flow statements is very essential for proper financial management of the organization. Thus, accounting should help the firm in managing its finances in a better way.

Profit and Loss Statement
It is also known as the income statement. Profit and loss statement represents the profit of an organization in a given period. It represents the difference between the revenues, gains of the business and the expenses, losses of the business. Thus, the purpose of accounting, through this statement is to present before the investors and the managers, whether the organization has made money or lost money in a given period. Income statement is a major tool for financial planning in a business. Accounting is also to plan, how much and in what areas the company will be putting its available finances.

Purpose of Accounting in Society

The financial statements have immense utility for the society as well. The financial statements include the details of the salary and wages of the employees. They also indicate the deductions made from these salaries. Maintaining records of these ensures that the organization is being fair to its employees, who are a part of the society.

The tax authorities can keep a check on the business practices of various organizations by analyzing and keeping a check on the financial statements. The government agencies through the accounting statements ensure that the funds being raised by the company are from legal sources and that the company is not cheating the shareholders, investors or the general public in any way.

Lastly, financial statements will expose any fraud or wrong business practices of an organization, thus, the general public can refrain from using or buying or investing in products of such organizations who have been involved in malpractices.

Here's hoping that now you have understood the purpose of accounting. The process of accounting starts with bookkeeping, that involves the recording of the transactions of the company. Once the financial statements are ready, accountants, investors, and financial analysts evaluate them and then base their future economic decisions on them. Thus, for accounting to be beneficial, the financial reports should be timely, easy to understand, fair, relevant and objective.