Purpose of Accounting: Its Need and Importance

What is the Purpose of Accounting?

Even if you are not in business, chances are you work for somebody that is. Whether you fix the computers, write advertisements, or make sales over the phone, your role is designed to help your employer achieve one key objective — making a profit. Your ability to understand financial information makes you that much more valuable, not only to your employer but to your clients and customers too. By understanding accounting, you can understand how a business makes money, making you a complete professional and connecting you with your employer, your clients, and their goals.

We also cannot forget the benefits of good personal finance. Accounting/Bookkeeping is as much a personal tool as it is a business one. Money is a big problem for many people all over the world. Perhaps you are finding it difficult to make ends meet, or maybe you are trying to build wealth.

Accounting equips you with the skills you need to manage your money, where you can trace and categorize your expenses and effectively budget your income. This allows you to determine exactly how much you spend on non-essentials such as movies and fancy dinners, while also ensuring the important stuff such as rent and food for the family is always paid on time.

What is Accounting?

Accounting can be defined as the production of financial information. It means that accounting allows us to see things like how much money you are earning, how much you are worth, how much money you spend, and where you can improve to make even more money!

Why do we need Accounting?

Consider this scenario: You run a bakery, and you bake the best cream cake in the country. It is world famous, and you receive orders for your legendary cake from every continent!

However, one night a fanatic customer who believes you have a magic oven breaks into your bakery and steals it. You go ballistic. You need $10,000 to buy a new oven, so you decide to go to the bank and ask for a loan.

You ask the bank for a $10,000 loan. The thing is, you do not even have an accountant, so you do not have any financial information about your bakery.

The loan officer is a lady named Anne. She asks how much profit you made this year. You do not know, so you guess. You say it was maybe $30,000. She asks how much your assets are worth. You have no idea. She asks how much debt you have. You are not sure. She asks what your cash flow is each month. You do not even know what that means. Because you have no financial information, Anne says no.

Now let us say you go and find an accountant, who prepares some financial records for you. You return to the bank with the following information. You have $5,000 of cash in the bank.

• You have sold $52,000 worth of cakes this year.
• This year you made a profit of $27,000, and profit has been increasing at an average rate of 6% per year for the last three years.
• Your operating expenses are $25,000 this year. The largest is wages at $11,000 per year. The next largest is advertising at $7,500 per year. The smallest is telephone expenses at $600 per year.
• Your bakery has net assets of $122,000 and no debt.
• Your bakery had a net positive cash flow of $13,000 this year.

Now you can tell Anne, the loan officer, exactly how much money you make, how much you spend, what you spend it on, how much you owe, how much you have in the bank, and how much your assets are worth. Because she now has information, she can decide to loan you the money. This is because she knows how much money you make each month and can be confident you will be able to repay the loan.

Now, do not worry if you do not understand all the fancy terms up there like “cash flow” and “net assets.” We will be learning what all that means very soon.

So, why is accounting important? When you are in business, you need to know whether you are making money or not. Accounting helps you determine exactly that. And remember, it is important for the people you do business with (like the loan officer) to know that too.

Types of Accounting

Accounting is a broad field that is divided into several types, each serving a different purpose:

• Financial Accounting: Records and reports a company’s transactions in statements such as the balance sheet and income statement for external users.
• Management Accounting: Prepares internal reports, budgets, and forecasts that help managers make day-to-day and strategic decisions.
• Cost Accounting: Tracks the cost of producing goods or services so a business can control expenses and set prices.
• Tax Accounting: Focuses on preparing tax returns and planning to comply with tax laws while minimizing liability.
• Auditing: Independently examines financial records to confirm they are accurate and follow accounting standards.

Understanding these types helps you see how accounting supports both external reporting and internal management, making it useful across every kind of organization.

Functions of Accounting

Accounting performs several core functions that turn raw transactions into useful information:

• Recording: Every financial transaction is written down systematically, traditionally in journals.
• Classifying: Similar transactions are grouped together into accounts, such as sales, wages, or rent.
• Summarizing: Classified data is condensed into financial statements like the trial balance, income statement, and balance sheet.
• Analyzing and Interpreting: The summarized figures are examined to reveal trends, profitability, and financial health.
• Communicating: The results are reported to owners, managers, investors, and other stakeholders so they can make informed decisions.

Together, these functions ensure that a business always has an accurate, organized, and understandable picture of its finances, which is exactly what the bakery owner in our example was missing.

Advantages of Accounting

Keeping proper accounting records offers many advantages for both businesses and individuals:

• Informed decisions: Accurate records show profit, expenses, and cash flow, so owners can make better decisions.
• Access to finance: Lenders and investors, like Anne the loan officer, require financial information before providing money.
• Legal compliance: Proper accounts make it easier to file taxes and meet regulatory requirements.
• Performance tracking: Comparing figures over time reveals whether the business is growing or struggling.
• Fraud detection: Organized records make it easier to spot errors, theft, or unusual activity.
• Budgeting and control: Both companies and individuals can plan spending and keep essential costs under control.

In short, accounting transforms scattered financial activity into clear information that supports growth, borrowing, and everyday money management.

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