Even the smallest business has more accounting data than it can shake a stick at. Nearly every transaction a business makes is recorded in the financial records of the company. This information can be quite powerful in the right hands. Understanding some of the ways accounting data is used to make business decisions can help you use the information you already have to make your business even better.
One of the most common uses of accounting information is to create budgets and forecasts for business planning. In many organizations, the budget process is a staple of annual planning. By incorporating accounting data from prior years, budget preparers have a figure to start from when projecting sales and expense amounts for the upcoming year. The budgeting process usually begins with sales projections and cash collection estimates. After these budgets are complete, the purchasing and expense forecasts are completed. Last, a projected cash balance is completed and forecast financial statements are created. At every step of the process, prior period accounting data is used to inform current year estimates.
Accounting data is not only used to predict performance in future periods, but this information is also used to analyze business performance after the fact. Many small-business owners review accounting information on a monthly basis by comparing actual sales, expense and profit performance to projected performance. If there are substantial variances in projected versus actual performance, small-business owners can implement changes in the organization to correct for these differences. As such, the more frequently accounting information is reviewed, the greater chance that management will recognize small issues before they become large problems.
When a company has an excess of cash, such as when receiving the proceeds of a loan or a disbursement from an investor, company management often uses accounting data to determine how to invest these funds. By examining the company's cash projections, management can determine how much cash is needed in the short term and how much will be needed in the long term. Once this is determined, management will then choose stocks, bonds or other investments suitable for holding cash for the period of time needed. When choosing investments, management will often review the financial statements or investment prospectus reports of the candidate investments, another use of accounting information.
Comparison of financial performance to internal budgets isn't the only way that small-business owners use accounting information to gauge performance. Benchmarking, the process of comparing company financial information to industry or other company financial data, allows managers to evaluate company performance relative to peers. While benchmarking can be useful, small-business owners should be careful. Often comparison companies are large publicly traded corporations. These companies might not always be the best comparison group. Management should take theses analyses with a grain of salt.
- Principles of Financial Accounting; John J. Wild, et al.