Understanding Accounting in Business

Before we make an attempt to understand accounting lets understand what business is how it works?

Business is any activity that is carried out by person to earn and maximize profits.

Lets understand each and every part of this little definition:

  • Business is an activity: it can be anything, production, manufacturing, service provision etc. Here word activity means all such activities that are necessary to run and further business operations e.g. managerial activities to manage the business, sale and purchase of goods etc.
  • Activity is carried out by person: person can either be an individual (human) or artificial legal person (companies, corporate)
  • Earn profits: the basic aim of almost every business is to earn profits. Whereas profit can be defined as simply the excess of money received/earned over money spent/paid. If the money earned is more than the money spent then its a profit and if money earned is lesser than the spending then it is considered negative profit or loss
  • Maximize profit: Earning profit is not enough, business must strive to increase profits.

So if this is the aim of every business then how can we promise earning profits and maximization of profits?

Profits earning and maximization involves several factors which we will learn in this course over a period of time. However, we can understand one thing that profits can be earned and maximized if right decisions are taken on right time. Meaning, good decision may lead to business prosperity whereas a bad decision may end in a loss.

The people who take decisions and manage the business activities are called managers. To reach good decisions managers require information. Not just any information but the information that is:

  1. reliable i.e. it can be trusted
  2. relevant i.e. it is useful in the context in which decision is being taken

So until now we understood that information is an important ingredient in every business and managers need information to run the business successfully. But how to get such information which is also reliable and relevant?

This classical question has lead us to the advent of an information system called Accounting.

Accounting is a process or a mechanism of:

  1. identifying an event for which accumulation of information is necessary
  2. recording of information with all the necessary details so that nothing important is left out
  3. Summarizing the information in such a way that value of information is not lost but size of information is reduced significantly
  4. Communicating the information to right people on the right time so that they can decisions using such information.

The information processed through above four steps is now not an ordinary information and that is why it is called accounting information.

And because accounting can do the above four mentioned tasks pretty cleanly that is why it is considered an art. And some also consider accounting as a language of business because it can literally talk you through the activities of the business.

If any of the above four features are missing then it can be any other information system but not accounting.

Summing up the above discussion we can say:

Businesses are run with an objective to earn and maximize profits by taking correct and timely decisions by managers. To reach such decisions managers require information which they collect through a formal process called accounting.

Although managers are one of the users of information. But they are not the only one. Some other users of accounting information and why they need information are discussed in users of accounting information page.