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Accounting 101 – An Introduction to the Field
Accounting is one of the most important internal aspects for any business to be financially successful in today’s market. It is the process of documenting all relevant financial information about a firm and communicating that information to key players. Managers and executives need accounting information to make decisions and run their business to maximize profits. Shareholders need accounting information to make informed investments.
There are many types of accounting that all have different roles in the business world. Perhaps the best known and most ‘classic’ type of accountant is the CPA or Certified Public Accountant. CPAs have a very diverse client list. They can serve anyone, including individuals, private companies, large publicly traded corporations, governments, or non-profit organizations. They may perform the role of independent auditor, tax advisor or financial advisor.
During an audit, a CPA will prepare an independent auditor’s report that will tell the client four important pieces of information. First it identifies the documents audited and describes that the purpose of this report is to express an opinion about the documents in question. Next it explains the criteria used to analyze the data. Third is the auditor’s substantive opinion with respect to the financial documents reviewed. Finally, auditors express their opinion on the effectiveness of the firm’s financial reporting.
Another type of accountant is the CMA or Certified Management Accountant. A CMA provides a smaller client base, as they typically work for the same firm. A key role is to advise the company on their financial management, accounting procedures and budgetary issues. A CMA may work with individual employees of that company, but their primary function is to advise executives on the overall financial structure of the company. They are usually involved in major decisions for the company.
A subset of managerial accounting is cost accounting. A cost accountant works closely with the company’s budget structure. They are usually involved in determining the internal costs of several functions and the profitability of the company’s regular operations. Cost accountants have a future-oriented job because they are primarily concerned with using historical data to estimate what a company’s likely financial strength will be.
The third major type of accounting is financial accounting. Financial accountants are primarily responsible for the preparation of financial documents for review by corporate decision makers. Management accountants, cost accountants, top management and stakeholders use these documents to make key business decisions. Financial accountants put together annual reports, including balance sheets, income statements, cash flow statements, and statements of changes in owners’ equity (or retained earnings). These documents are usually targeted at an external audience.
Financial statements are critical to the success of any profitable business. Their purpose is to formally record all financial activities of a company or individual. These statements summarize the company’s financial position in the short term and long term in standardized form. There are four main types of financial statements.
First, the balance sheet summarizes a company’s total assets, liabilities, and owners’ equity at a given point in time. This report is also known as statement of financial position. The balance sheet is used as a starting point at the beginning of the year. A new balance sheet at the end of the year will end the financial cycle. Other financial statements that will be discussed are used to fill in the gaps, because a lot can happen in a year.
The income statement summarizes revenues and expenses for the year and highlights if the company is operating at a profit or loss. This report defines the total gross income as well as all expenses incurred along the way. The top line of the statement is net sales and the bottom line is net income.
A statement of change in owners’ equity or a statement of change in retained earnings also analyzes data over a period of time. Usually it is more than one financial year. The two major components of owners’ equity are paid-in capital, or cash invested, and retained earnings, or net income less dividends. If retained earnings are negative because dividends exceed net income, this is considered a deficit.
The final major financial statement commonly used by shareholders is the statement of cash flows. The purpose of this report is to follow the cash activities of the company during the year. It mainly deals with cash transactions related to operations, investments and other financial activities.
Shareholders use four key financial statements to make investment decisions and see what the company is doing with their money. Executives and top management use the statements to make internal budgeting decisions and predict the future success of the business. There are many factors that go into a company’s financial reporting, and all information is essential to its continued financial health.
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