What accounting is and who uses it

Accounting turns a business's activity into numbers that people can make decisions with. It does four things, always in the same order:

1. Identify the economic events that affect the business — a sale, a purchase, a loan, a fire in the stockroom.
2. Measure them in money, at an amount that can be supported by evidence.
3. Record them in a consistent structure (journals and ledgers), so nothing is lost or counted twice.
4. Communicate the results in reports that people outside and inside the business can use.

Bookkeeping is mostly step 3. Accounting includes the judgment around it: deciding whether something should be recorded at all, at what amount, in which period, and how to present it so it tells the truth about the business.

Every report answers someone's question

A bank wants to know whether a loan will be repaid. A shareholder wants to know whether the business is creating value. A supplier wants to know whether it will be paid on time. A manager wants to know which product is profitable and what next month will cost. The same underlying records feed all of these answers — which is why they have to be complete and accurate.

Financial and management accounting

Financial accounting produces general-purpose financial statements for people outside the business — investors, lenders, suppliers, regulators and tax authorities. Outsiders can't walk in and ask for a custom report, so the statements follow a common framework (such as IFRS Accounting Standards or US GAAP). That makes them comparable between companies and between years, and it lets readers trust how the amounts were measured.

Management accounting produces information for people inside the business. It has no required format: budgets, product costings, forecasts, cash projections and performance dashboards are all management accounting. It is usually more detailed, more frequent and more forward-looking than the published statements.

The three main financial statements

• The income statement (statement of profit or loss) answers "Did we make a profit this period?" — revenue earned less expenses incurred.
• The statement of financial position (balance sheet) answers "What do we own and owe at this date?" — assets, liabilities and equity.
• The statement of cash flows answers "Where did our cash come from and where did it go?"

A common beginner mistake is to think accounting is "the tax return" or "counting cash". Tax is one use of the records, and cash is one figure among many: a business can have plenty of cash and be losing money, or be profitable and run short of cash.

The same events, two views

When Lumen invoices Hollybrook 4,800, financial accounting records the revenue and the receivable, and both reach the published statements. Management accounting asks a different question about the same event. The project took 64 hours of Maya's and Theo's time, so it brought in 75 an hour. Their salaries for those hours cost about 1,200 (Lumen's payroll is 300 a working day for the two of them), before rent, equipment and everything else. Is that enough to take on similar projects, and should the next quote be higher? No published statement answers that; an internal report does.