Most people take accounting as just number crunching. However, it is not as true and simple as we say. It is something that gives or aids in the value addition of business, as it provides the foundation for business decision-making. From recording transactions to classifying and presenting financial data in the form of financial statements, accounting simply converts data into meaningful information. However, financial data in the form of meaningful information is something that most stakeholders look for in a business. In this article, we are going to discuss the role of accounting in business decision-making. But first, we need to understand what accounting is in general. Let’s dig down a bit.
What is Accounting?
For a layman, accounting is simply the recording of all the financial data. The accounting processes convert this data into information. For instance, sales and purchase data are recorded in the accounting system, so we can know the business performance (profit or loss). Professionally, accounting refers to recording, classifying, summarizing, and presenting financial data. We usually come across two different forms of accounting: financial accounting and management or managerial accounting. The two types are the same in some manner; however, there are key differences between the two.
Financial Accounting vs. Management Accounting – Role in Business Decision-Making
Financial accounting refers to recording and summarizing business transactions and reporting them to investors and other external stakeholders. On the other hand, management accounting involves measuring, analyzing, interpreting, and communicating financial information to managers. This aids management in setting goals for the business and other decision-making. So, in general, financial accounting has an external focus, while management accounting is only for internal use. However, there are other differences too. For instance, the format and structure of management reports depend on the requirements and goals of the management. However, the formatting and structure of financial accounting reports are regulated and governed by International financial reporting standards (IFRS) and generally accepted accounting principles (GAAPs). Furthermore, financial accounting uses historical data, while management accounting is more forward-looking.
Apart from a few differences, any type of accounting provides information for decision-making. Financial accounting gives more information to external stakeholders. For instance, if a business applies for a loan from a bank, the bank will assess the business’s financial performance and position from the financial statements. Thus, the decision-making of the bank’s grant of the loan will depend on the financial accounting reports (income statement, balance sheet, cash flow statement). Conversely, management accounting gives managers insight into how to make important business decisions. For instance, if a firm is thinking about buying an expensive machine, it will need an analysis of the future aspects of revenue, expenses, and related tax matters to make a purchase decision. A management accountant will provide such information in a detailed manner. Let’s discuss further aspects of how accounting contributes to decision-making in business.
Performance Evaluation:
Accounting information assists in quantifying the financial performance of the business over a specific period. With the help of financial ratios, management can assess the performance of a specific business segment, product, or service over some time. For instance, they will be able to measure liquidity, profitability, efficiency, solvency, and other aspects of the business.
Budgeting and Forecasting:
Accounting information provides the basic data that is necessary for budget and forecast creation. Thus, to estimate future revenues, expenses, and cash flows, historical financial information is necessary. Proper budgeting and forecasting enable businesses to make effective plans and allocate resources.
Cost Analysis:
An accurate estimate of the product or service cost is necessary for sales decisions, especially pricing. This is only possible when reliable accounting information is present. Thus, through accurate and reliable information, businesses can make decisions regarding pricing, product mix, and so on.
Tax Planning:
Through proper accounting records, a business can easily calculate its tax liability and settle the dues in time. Furthermore, enterprises can plan their tax liabilities based on historical information and adjust their business operations accordingly.
Conclusion:
The role of accounting in business decision-making is like the backbone of the human body. For any type of decision-making, the basis of information is only available if a reliable accounting system is present in a corporation. However, each type of accounting provides different information to its users. Financial accounting is mainly for external users, while management accounting is only for internal purposes. There are several aspects of accounting concerning decision-making. Reliable accounting information aids in performance evaluation, budgeting and forecasting, cost analysis, tax planning, and so on.
Creative Zone Tax & Accounting (CZTA):
We believe in accurate and reliable information that helps businesses make informed decisions. Through our team of professional accountants, we can assist in any particular area of accounting. Your goal should be to remain compliant and achieve business success. Our goal is the same as yours. Contact us today.
