Be it large corporations or a freelancer, finance is the backbone of their operations. That’s where accounting is used to record, organize, and understand financial information. In other words, it points to a financial state which can include profit or loss, the current value of assets and liabilities, and cash flow. It is also known as the language of businesses and that’s for a reason. Accounting provides crucial information to owners, managers, investors, and other stakeholders to help them evaluate financial performance and make informed decisions. All these assist in ameliorating business processes. Now that we have covered the brief overview of accounting, it’s time we explore its advantages and disadvantages.
Advantages of accounting
Accounting is employed for maintaining and expanding the financial health of businesses. The following is a list of some notable benefits accounting brings.
It helps in preparing financial statements
Preparing a financial statement is essential as it provides information regarding the ability of the business to meet its short-term and long-term financial obligations. Accounting helps prepare financial statements that summarize the past performance and current financial condition of the business. This includes income statements, balance sheets, and statements of owner’s equity and cash flow. Furthermore, it follows accounting principles for accurate financial reporting.
Accounting measures the valuation of the business
Measuring the business valuation provides a comprehensive knowledge of assets. Accounting calculates the true and fair valuation of businesses. It gives accurate numbers that help business owners obtain insurance coverage. Alongside, it provides true company value that is useful in the case of selling, acquisitions, or mergers. Additionally, when businesses seek funds for growth, it attracts potential investors by providing them with a full company valuation report.
It assists management
Accounting is essential for effective management as it determines the performance of the business. It provides management with proper feedback on the financial status of the businesses. This further helps in creating budges and tracking the efficiency of various business activities. Additionally, it provides and analyses monthly financial statements that allow management to work with present-day data.
Accounting facilitates decision-making
Along with effective management, accounting enables decision-making. It conducts relevant cost analysis helping management explore all possibilities to make better and evidence-based decisions. Moreover, it aids in analyzing the cost-effectiveness of each operational choice to make effective operational decisions. It monitors and tracks performances, assisting management further in making real-time strategic decisions. Most importantly, accounting gives an understanding of the current financial state and tracks financial tendencies to make plans for the future of the business.
It helps with taxation
Businesses are required to comply with the tax law. Accounting is used to prepare tax returns and tax payments. Simply put, funds that come into the business and go out are tracked for taxation purposes. Accounting ensures that the tax-related finances of the business are in check legally. Further, it helps them prepare for the tax-paying season in advance. Failing to abide by the up-to-date tax laws will put businesses in legal trouble. Ergo, accounting is crucial in ensuring businesses comply.
Disadvantages of accounting
As it is said, you have to take the good with the bad. With that in mind, here’s the list of several downsides of accounting.
It only records quantitative transactions
Accounting is all about money, so only the quantitative aspect of the transactions is documented while the qualitative ones are ignored. This is to say that only those events that can be expressed in terms of money are included in the accounting. Whereas, the non-monetary events are left unregistered. Because of this, numerous items are never reflected in the financial statements of the company, making it a major drawback of accounting.
Accounting may be based on estimates
Like any other system, accounting uses assessments to make financial reports more complete. This means it includes events that are considered probable but in reality are merely anticipated. Even though the estimated data is revised as more information is available, some details may still be inaccurate. To summarize, when providing exact numbers is impossible or impractical for accounting, estimates are used. However, they must be improved continuously.
It ignores price fluctuation
The price instability is not taken into consideration in accounting. Instead, the historical costs are operated on to measure the value. This leaves factors such as inflation and price change out of the records. Additionally, accounting does not consider the market value of assets. Even the value of fixed assets changes over time. Sometimes the difference between the original cost and replacement cost is massive, and it is left out in accounting. Also, the value of money is not stable, making it more difficult to represent true financial results.
Accounting does not support forecasting
Accounting prepares financial statements and the records show the position of the company on the date of preparation. The investors are interested in the short-term and long-term future of the company whereas accounting provides no future assessment. Plus, companies operate in a dynamic business environment, where accounting records past events. To clarify, there is no accounting system for future events, unfortunately. It only deals with past data and not with what may be.
It may fail to reveal the true financial statement
One of the notorious limitations of accounting is that it can be manipulated. Firstly, financial statements are influenced by the personal judgment of the accountants. For instance, take the method of inventory valuation and the method of depreciation. Depending on the skills, competence, integrity, and experience, accountants make judgments on the true value of items.
In some cases, assumptions may be false due to mistakes on the accountant’s end. Whereas, in other cases, it can be intentional to distort reality. Also, accounting is done by humans, meaning the occurrence of human errors is inevitable. The situation where accounts are manipulated to cover frauds is hard to detect when done purposefully. Mostly, meeting sales or revenue goals is the common motivation behind manipulating financial statements. Either way, it becomes an extreme limitation of accounting.