Monday, 12 April 2010

Why go to all the Accounting and Bookkeeping Trouble?

The previous posts discussed accounting and bookkeeping. One might naturally ask what all the trouble is for. What benefits do these principles and procedures produce?

The answer is that there are several benefits.

Firstly, there is the issue of accounting for the resources entrusted to one's management. Owners do not always manage the businesses directly. Large corporations, in particular, are managed by professional managers. The shareholder owners are typically spread all over the country, if not the globe. They are also more interested in getting a return on their investment rather than taking the trouble of managing complex business operations.

In such a case as the above, the managers can demnonstrate how well they have managed the resources entrusted to them by keeping proper accounts of the business. The Income Statement shows how much profit they made while the Balance Sheet will show how sound the company's financial position is.

Secondly, if the Income Statement and Balance Sheet show that the company's operations and finances have been managed well, lenders and investors will be attracted to the company. Lenders want to earn a return on their money through interest on loans. They also want to be sure that their money will be safe. They can make an assessment of both these issues by looking at the Income Statement and Balance Sheet over a number of years.

Investors also examine the financial statements of companies before making investment decisions. They will look at the profitability record of the companies, asking such questions as how fast the company's profits have been growing over the years and how well its profitability compares with other companies in the same business. By analyzing the balance sheet, investors can also see whether the company's financial position is good enough for it to exploit new business opportunities quickly.

Then there is the government that wants to make sure that the company is paying the taxes it should pay. Again, it is the company's accounts that show what taxes are due from the company.

It will be evident that if the company does not maintain accounts that appear to show correctly its operational performance and financial position, it will be quite difficult for it to get the money it needs for expanding the business, or for tiding over temporary difficulties. Additionally, the company could land itself in serious litigation and other trouble, probably even leading to bankruptcy.

In fact, correctness and fairness of the position shown by financial statements are so critical that governments have passed laws making it compulsory for companies to get their accounts verified and certified by independent auditors. And investor protection agecies have made standard ways of publishing financial information obligatory.

There is another benefit that accounting provides, the benefit of facilitating control over performance. In this case, however, it is not the annual (or even quarterly) financial statements that make it possible. Instead, a whole new approach is required to use accounting techniques for managing the business. We will look at the details in future posts.

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