What is Accounting?
A simple definition of “Accounting”
Accounting is how your business records, organizes, and understands its financial information.
You can think of accounting as a big machine that you put raw financial information into it to record all your business transactions, taxes, projections, etc. and then it spits out an easy-to-understand story about the financial state of your business.
Accounting tells you whether or not you’re making a profit, what your cash flow is, what the current value of your company’s assets and liabilities are and which parts of your business are actually making money.
Accounting vs. Bookkeeping
These two overlap in many ways and some say bookkeeping is one aspect of accounting. But if we want to break them apart, we can say that bookkeeping is all about recording and categorizing financial transactions while accounting puts that financial data to good use through analysis, strategy, and tax planning.
The accounting cycle
Accounting starts with recording transactions. Business transactions—any activity or event that involves your business’s money—need to be put into your company’s general ledger. Recording business transactions this way is part of bookkeeping.
Bookkeeping is the first step of what accountants call the “accounting cycle”: a process designed to take in transaction data and spit out accurate and consistent financial reports.
The accounting cycle has six major steps:
-
- Analyze and record transactions
- Post journal entries to the ledger
- Prepare an unadjusted trial balance
- Prepare adjusting entries at the end of the period
- Prepare an adjusted Trial Balance
- Prepare financial statements
Accounting software automates most of these rules and processes, so we’re going to skip over the gritty details of the accounting cycle and talk about the end product: financial statements.
Financial statements
Financial statements are reports that summarize how your business is doing financially.
There are three main types of financial statements: the balance sheet, income statement, and cash flow statement. Together, they tell you where your business money is and how it got there.
Let’s say you’re a self-employed surfing instructor who bills clients for surfing lessons. Financial statements can tell you what your most profitable months are, how much money you’ve spent on supplies, and what the total value of your business is.
Accounting software can help you generate financial statements easily, or you can have a bookkeeper do it for you.
What is Tax Planning?
Tax planning is a process of analyzing and evaluating an individual’s financial profile. The aim of this activity is to minimize the amount of taxes you pay on your personal income. In short, employing ways that the government has provided to save tax is a perfectly legal method to cut down your annual tax liability.
What constitutes tax planning
There are three key characteristics of tax planning—investing to reduce taxes; planning your finances in such a way that you attract the least amount of tax, and the process of tax filing. So, tax planning affects all aspects of your money matters.