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Accounting
Accounting
Accounting is the process of communicating financial information about a business to stakeholders such as shareholders and managers, usually in the form of reports. It can be divided into management or managerial accounting and financial accounting. Management accounting is the process of preparing management reports and accounts to be used by the management of a company to make internal decisions, whereby financial accounting generates reports that are the primary source of financial information for external stakeholders of a company. Both forms of accounting aid decision makers in how to allocate resources - either within or to a company. Most managers have some knowledge of accounting in order to understand their business, but the majority of tasks are usually completed by dedicated accounting professionals.
Decisions based upon management accounting could be operational, marketing or strategic in nature. Monthly or weekly reports produced generally show sales revenue, orders, inventory, amount of available cash and outstanding debts. Internal auditors of a company also use these internal reports. In contrast to financial accounting, management accounting is forward-looking, and is not reported in accordance with accounting standards, but caters to the needs of managers. Specific elements of managerial accounting include cost accounting, lean accounting, and transfer pricing.
Financial accounting produces reports mainly for external stakeholders and is used to attract capital, invest capital or to evaluate management and the performance of a company. It is a very structured discipline governed by set rules and principles, which have been formulated to standardise accounting practices. The International Financial Reporting Standards (IFRS) are principles-based standards and interpretations adopted by the International Accounting Standards Board (IASB), which have been adopted in many parts of the world, including the EU. US firms use Generally Accepted Accounting Principles (GAAP). The US GAAP provisions differ somewhat from IFRS, and there are timelines for all US companies to drop GAAP by 2016.
It is an important skill for consultants to be able to understand the 3 main financial statements used in financial accounting; the Cash Flow statement, the Balance Sheet and the Income statement. Often these are presented in a company's annual report. Reading and analysing these three financial statements is the key to understanding the financial position or 'health' of a company. The Balance Sheet is rather like a snapshot of a company's financial situation, as it depicts the financial position of a company at a certain point in time. It is divided into two halves which must always balance, where Assets = Liabilities + Shareholder's equity. The foundation for the balance sheet comes from the Income Statement where revenues - expenses = net income or net loss. This shows the performance of the company over a certain period, and whether the company has reported a profit or loss. For this reason, it is also referred to as the profit and loss statement, (the P&L statement). It is often of greater interest to investors as it is a record of the company's operating results. The Cash Flow Statement reports the company's cash movements during the period, separating them by operating, investing, and financing activities.
In analysing financial statements, ratios can be used to assess a firm's financial condition and performance. The ratios examine the following key areas: profitability, liquidity, activity and debt. For example, the current ratio tests whether a company has the resources to pay its debts in the short-term, where, Current Ratio = Current Assets/Current Liabilities. While varying by industry, 2:1 is usually an acceptable current ratio. Approaching 1 may mean the company cannot meet short-term obligations, and approaching 3 or 4 may mean the company is not investing well. Ratios can also be used to compare companies' performances. When examining a company, it is also common to use trend or time series analysis, to examine the company's performance over time.
