Accounting helps organizations to achieve their goals by recording, summarizing, and presenting accurate financial information to its users.
The following are the objectives of accounting that demonstrate the importance of accounting systems in any organization.
- Recording – Reliable accounting record forms the backbone of an accounting information system. The fundamental objective of accounting is to maintain a systematic, accurate, permanent, and complete record of all business transactions, such as sales, purchases, income, and expenses. Keeping a full history of all business transactions helps to avoid the possibility of omission and fraud. This record-keeping is essential for the functioning of any business. For this purpose, all business transactions are first recorded in the journal and subsidiary books and then further posted into the ledger.
- Planning – Budgets are prepared for financial planning. Accounting enables organizations to plan to use their resources, such as cash and labor, through budgets. The budgeting process helps organizations to plan by anticipating organizations’ future needs and identify potential bottlenecks. It improves the efficiency of organizations by diverting resources to the most critical operations.
- Management Decisions – Accounting information helps managers evaluate a range of decisions to improve the profitability and efficiency of the business, such as pricing decisions, limiting factors analysis, financing decisions, and investment appraisals.
- Performance measurement – Accounting helps determine how well a business performs by summarizing the financial information into quantifiable measures such as sales revenue and net profit expenses. Organizations need to measure their key performance indicators regularly and reliably to improve themselves by making valid comparisons against their past performance. The progress of a business is ascertained from year to year to evaluate how the business is functioning. Has it improved over the past years, or has its growth declined? This progress may also be measured against another company having the same business, which is industry benchmarks. This will help the company to compete with its competitors and overcome excessive competition in the market.
- Position analysis – Financial statements indicate the business’s financial condition by showing, for example, cash flows, capital investments, cumulative earnings, assets, and liabilities. For a business person, merely ascertaining the profit or loss of the business is not sufficient. A Businessperson must know the financial health of the company. For this purpose, a statement called “balance sheet” must be prepared, showing the value of assets and liabilities and the capital. The balance sheet is a screen picture of the business’s financial position; this is why the statement mentioned above is also called a “statement of financial position.” By just looking at the balance sheet, one can know how much the business has to recover from the debtors? How much the company has to pay to the creditors? How much the company has in the form of cash in hand, bank, inventory, and inform fixed assets?
- Liquidity Assessment – Mismanagement of cashflows is often cited as the primary reason for failure in many startups. Accounting helps businesses reduce the risk of bankruptcy by timely detecting potential bottlenecks by managing cash flows so that companies always have sufficient liquid funds available to pay for their financial commitments.
- Financing – Organizations that are low on funds need to present their accounting information to lenders to secure funding. Whether a business applies for a bank loan or investment by shareholders, it will need to provide its historical accounting record and financial plans, projections, and forecasts.
- Internal Controls – One of the key objectives of an accounting system is to place internal controls within an organization to protect its valuable resources. Assets of a business such as cash, building, and inventory are all susceptible to losses arising from theft, fraud, errors, obsolescence, damage, and mismanagement. The accounting information system should ensure that such risks are reduced to an acceptable level through various checks across the organization. A business person must detect the errors and frauds made in his business and find the person responsible for them and find out the areas where they occurred and why. This will help him to keep a better track of his entire organization.
- Legal Compliance – It helps organizations perform their statutory responsibilities by providing accurate information about their financial rights and obligations. Accounting is also a legal requirement for most businesses. Law requires organizations to maintain a precise accounting record and then report their financial results to stakeholders such as tax authorities, shareholders, and regulators on a timely basis.
- Information to Various Parties – Accounting is not just limited to the information needs of employees and owners of a business. Accounting fulfills the information needs of a diverse group of stakeholders, each with its information requirement. Another main objective of accounting is to provide information about the business to various parties. Those parties could be the owners, investors, creditors, banks, employees, government authorities, and many others. This information helps to make various decisions by different parties. For example, an investor would need such information to decide to invest in the company. He will assess the company’s liquidity position and make a sound decision if it is fruitful for him to invest in getting future earnings. Similarly, the government would need such information to check if the company is paying due taxes. Banks will check if the company can repay the loan and then grant further finance. Internal auditors will need the information to carry out an audit of the company, and so on.
- Calculate profit and loss – The main motive of any business is to earn a profit, and financial accounting helps determine profit and loss. For this purpose, a company prepares a Profit and Loss A/C. Trading and profit and loss accounts are prepared at the end of the year to ascertain the purchases, sales, unsold stock, and value, expenses, and revenues. Where the expenses increase the revenues, it results in the loss while, on the other hand, if the revenues increase expenses, the result is profit. With all this information, a business person can keep effective control of his expenditure.