Do Managers Need to Know About Accounting Fundamentals?

Introduction

 

Accounting is as old as the hills and money, however with the changing times its role has also been changing. Such a change can be attributed to the changing business patters, social, economical and technological developments. From being an art of recording, accounting has come to be known as a „process of identifying, measuring, and communicating economic information.“

A key skill that a business manager must learn is basic accounting. Understanding accounting will give you a better understanding of how your organization works. This has many benefits as it gives you greater control and confidence over your business budget and your own density. As we say money makes the world go sound and accounting ensures that business and commerce to happen. Accounting is necessary to track all the different financial transactions that happen with in the organization whether it is a small shop or a fortune 500 company. The transactions can be formalized into financial reports for analysis.

If you are working in a business organization as a senior manager, you need to know about the basic finance and accounting. You may not be directly involved in that but understanding the fundamentals of finance and accounting will help you perform better in your decision making functions. Finance and accounting are important functions which are related to all other areas of management because every activity in an organization needs money. Finance and accounting play a vital role in the various processes of management like strategy formulation, planning, decision making, and control. Similarly, all functional areas of management such as marketing, manufacturing, personal, research and development have to do with the finance.

You have to know how to differentiate between finance and accounting, understanding basics of accounting such as debits, credits, and double entry bookkeeping, be able to analyze basic financial documents like income statements and balance sheets, use financial tools to manage performance more effectively, decide how assets, liabilities, and equity affect your area of operation. Besides, you can apply financial risk and return principles to managerial decision making, justify your requests for new equipment and other capital investments, improve your budgeting skills, and relate your department’s financial performance to the bigger picture. You have to know how to address and communicate financial and strategic problems more effectively, how to identify relevant financial information, and how to apply the financial analytical skills needed to make more informed business decisions.

Most managers have limited accounting backgrounds, their back grounds are usually in Marketing, Engineering, Law, Human Resource and other fields. Business managers are very busy people with little time to spare. Accounting provides a frame work that monitors and controls the financial health of an organization. Through accounting methods and reporting management can make decisions on whether there is potential to expand or cut back. Accounting can also provide financial reports that can be used by top management and shareholders to determine the profitability and worth of an organization. This can be determined by analyzing the company’s assets and liabilities.

Assets

Assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered as an asset. Simply stated, assets represent ownership of value that can be converted into cash (although cash itself is also considered an asset). Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car, and other property.

Assets are divided into the following categories:

Current assets

Current assets represent assets that can be converted into cash quickly. These type of assts can also be referred to as liquid assets. Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, inventory and the portion of prepaid liabilities which will be paid within a year.

Fixed assets

Fixed assets, also known as a non-current asset or as property, plant, and equipment (PP&E) are a term used in accounitng for assets and property which cannot easily be converted into cash.

Liabilities

A liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

Liabilities are reported on a balance sheet and are usually divided into two categories:

Current liabilities 

These liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations and others.

Long-term liabilities

 These liabilities are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties.

Profit

Profit (also called net income or earnings) can be defined as the amount a business earns after subtracting all expenses necessary for its sales. To put it in a equation form

Profit = sales – expenditure

Capital profit

These are profits which are concerned from the sale of fixed assets or the properties of the business organization. For example, if machinery purchased for Rs. 40000 is sold for Rs 45000, then the amount of Rs5000 will be considered as capital profit. Similarly the money received on the issue of shares at a premium shall be considered as capital profit.

Revenue profit

These are profits which are earned during the course of normal business operations are known as revenue profits. For example, if a stock costing Rs.50000 is sold for    Rs.75000, then the entire amount of Rs.75000 will be treated as revenue receipts, but Rs.25000 will be the revenue profit. Revenue profits are always available for distribution as dividends amongst the shareholders.

Loss

Loss is a notional expenditure, i.e., expenditure without any benefit to the organization or entity.

Capital loss

These are losses which are not related with the normal business operations i.e., these have not been incurred due to normal course of the business.

Revenue loss

These are losses which are incurred in the normal course of the business operations, i.e., these have been incurred during the normal conduct of the business.

Income

Income is the sum of all the wages, salaries, profits, interests‘ payments, rents and other forms of earnings received in a given period of time. For firms, income generally refers to net-profit. Income means an excess of revenue over expenses for an accounting period.

Operating Profit

Operating profit means the profit earned from a firm’s normal core business operations. This value does not include any profit earned from the firm’s investments (such as earnings from firms in which the company has partial interest) and the effects of interest and taxes.it is also known as „earnings before interest and tax“ (EBIT) or operating income.

Non-operating Profit

Non-operating income, in accounting and finance, represents gains or losses from sources not related to the typical activities of the business or organization. Non-operating income can include gains or losses from investments, property or asset sales, currency exchange, and other atypical gains or losses. Non-operating income is generally not recurring and is therefore usually excluded or considered separately when evaluating performance over a period of time

Expenditure

Payment of cash or cash-equivalent for goods or services, or a charge against available funds in settlement of an obligation as evidenced by an invoice, receipt, voucher, or other such document.

Working Capital

Working capital is a measure of both a company’s efficiency and its short-term financial health. The working capital ratio is calculated as:

Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash, accounts receivable and inventory). It is also known as „net working capital“.

Conclusion

If you are in or getting ready for a management position… if you must prepare, interpret or approve budgets, financial reports or business plans… if you want to be able to better understand and communicate the financial results and performance of your organization… then you must know the  basics of accounting.

More than ever before, today’s managers are required to understand and speak the language of finance and accounting in order to achieve their goals, objectives and bottom line results. For that you must learn the practical financial concepts and skills that will help you make better management decisions. Accounting information will be always useful as a guide for making business decisions.

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Source by priya