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The purpose of accounting
The core aim of any business is to survive. After this, if it is in the private
sector it will want to make a profit. If it is in the public sector it may want
to improve or expand the services it provides. Either way, it will need to control
its finances. By collecting all the available financial information and recording
it in various accounts a business can assess how well it is performing. This is
important both for a business internally as well as externally.
Internally, managers want to know how much they are selling, the level of their
costs and the amount of profit they are making. From this information they can set
budgets and performance targets to plan for the next trading year. An accountant
can show managers where financial problems might be occurring within their company.
Externally, all businesses are legally required to keep records of their finances.
A firm has to make its accounts available to the Inland Revenue (Corporation Tax),
and Customs and Excise (VAT). The larger the business, the stricter the rules on
what accounts it has to prepare. Most business have to prepare a:
- Trading and Profit and loss account
- Balance sheet
- Directors' report (describing the previous year's activities)
Limited companies also have to publish an annual report and final accounts because
they have a separate legal identity.
These accounts have to be checked by an independent person - an
- to ensure that they give a 'true and fair view' of what has happened to the business
during the previous year. Potential investors or shareholders, for example, will
want to know if a business is worth investing in. Potential creditors will also
want to know whether the company will be able to repay any loans or credit they
give them.
These assessments are based on two key accounting concepts: liquidity
and profitability.
Remember
Make sure you understand why accounting is important, what records are kept and
what the law requires. This is a favourite topic with examiners.
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