Different Types of Accounting That Boost Business Success

You’re probably thinking to yourself, “Accounting is accounting, right? How many different types of accounting can there be?”

Here’s a look at what accounting is, the different types of accounting, and why each type is essential in ensuring your business is profitable and growing.

What is accounting?

Accounting is the recording of an individual’s or an organization’s financial transactions. Just like statisticians record statistics during a sporting event, accountants record transactions during a business’s (or individual’s) day-to-day operations.

There are five different types of accounting transactions:

• Revenue
• Expenses
• Assets
• Liabilities
• Owner’s Equity

Every accounting transaction affects at least two of these accounts. Here are several examples:

1. A customer pays cash for providing a product or service. This transaction increases both revenue and assets (cash).
2. You make a monthly payment on a vehicle loan. This transaction decreases assets (cash), decreases liabilities (the loan balance gets smaller), and increases expenses (a portion of the payment is interest expense).
3. As a business owner, you reward yourself with a bonus at the end of the year. This transaction decreases both assets (cash) and owners’ equity.

Why is accounting important for businesses?

At its most basic level, accounting helps monitor the health of your business.

After recording all transactions for a certain period, accounting reports can be created showing how much (or little!) profit your business has generated. You can then use these reports to make strategic decisions. For example:

• If your business has recently been extremely profitable, you may decide to expand locations or hire additional employees.
• If your business has recently been losing money, you may decide to ramp up your sales efforts or look for ways to trim expenses.

Different Types of Accounting for Different Situations

There are different types of accounting depending on which report you’re trying to create or what you’re trying to accomplish. We will look at the five most common types of accounting, the role each can play in your business, and how each type can help your business identify inefficiencies and increase profitability.

1.) Financial Accounting - The Backbone of Business Transparency

Financial accounting is the process of creating the following three primary financial statements for use by people outside of your business, such as investors and lenders:

• Balance Sheet - Reports a business’s assets, liabilities, and equity at a specific time (e.g., Balance Sheet as of December 31, 2023). Total assets will always equal total liabilities plus total equity.
• Income Statement - Reports a business’s income, expenses, and net income (or loss) for a specified period (e.g., Income Statement for the 12 months ending December 31, 2023)
• Statement of Cash Flows - Reports a business’s total cash and cash equivalents entering and leaving that business.

All other types of accounting are an outgrowth of financial accounting, which is why this type of accounting is often referred to as the foundation, or backbone, of accounting.

The financial accounting process starts with properly recording and classifying transactions in your business’s accounting system. These transactions are then used to create the aforementioned financial statements using Generally Accepted Accounting Principles or other financial reports, which will be detailed later in this article.

2.) Management Accounting - Strategic Decision Making

Management accounting is the process of creating financial reports to help people within your business make better management decisions. These reports focus on all aspects of your business, including revenue and expenses.

Here are some examples of financial management reports and how each report can be used:

• Accounts Receivable Aging - Lists a business’s outstanding payments from customers and how long these payments are past due.

Planning for the future: This report can be used to spot trends in the percentage of customers that pay on time and to update or revise your company’s customer credit policies.

• Accounts Payable Aging - Lists a business’s outstanding payments to vendors and suppliers and how long these payments are past due.

Planning for the future: This report can help you identify vendors and suppliers who may give you favorable payment terms if you pay early and those who may be ok if you pay late. The goal is to hang on to your cash as long as possible and prioritize when to pay each of your bills.

• Cash Flow Forecast - Estimates your business’s cash inflows and outflows for a specified period.

Planning for the future: This report can help you decide when you have enough cash to add a new piece of machinery or create a new full-time employee position. It can also help ensure you have enough cash to pay your recurring monthly bills.

• Variance Reports - Compares planned financial outcomes with what actually happened on balance sheets, income statements, or cash flow statements.

Planning for the future: This report can help you identify an area that is not trending in its supposed direction. For example, let’s say your net profit remains the same in 2022 and 2023. No cause for alarm, right? Well, maybe. What if your revenue significantly increased, but so did your salary and wage expenses? An increase in expenses could potentially hide an increase in revenue. Were you expecting an increase in salary and wage expenses?

3.) Cost Accounting - Optimizing Operational Efficiency

Cost accounting is the process of creating financial reports for use within your business that focus exclusively on costs and expenses. It tracks a business’s costs associated with making and providing its products and services and allocates them to specific products and services.

Example: You purchase a widget-making machine for $100,000 in 2023, anticipating that this machine will last for five years and make a total of 500,000 widgets. For each widget you sell in 2023, you would allocate a cost of 20 cents ($100,000 cost of the machine divided by 500,000 widgets).

4.) Tax Accounting - Legally Minimizing Your Tax Obligation

Tax accounting is the process of calculating, preparing, and filing a business’s income and expenses to taxing authorities. Many businesses spend a significant amount of time on this type of accounting to ensure they aren’t paying any more taxes than they are legally required to.

Keep in mind that the profit or loss you report on your income statement will often be different from the profit or loss you report on your tax return because of the following reasons:

• Income is included on your income statement but not on your tax return. Tax-exempt interest income, for example, from a municipal bond you may have invested in, is income you would include on your business’s income statement. But because it’s tax-exempt, you wouldn’t have to report this on your tax return.
• Deductions are included on your income statement but not on your tax return. If you paid to take a client or customer out to dinner, you would record the entire meal cost on your income statement. On your tax return, however, you can only deduct 50% of the meal’s cost.
• Deductions are included on your tax return but not on your income statement. The U.S. tax code is very generous with how much depreciation you can deduct in the year you purchase an asset such as machinery or a vehicle. You may encounter a situation where your tax return’s depreciation deduction is larger than your income statement’s depreciation deduction.

Partner With Accounting Experts to Ensure Business Success

Your business may not have each of these different types of accounting by name, but the essence of each type can play a vital role in making sure your business is profitable and growing:

• Financial accounting: Telling outside parties how well your business is financially doing.
• Management accounting: Analyzing your past transactions to make important decisions about the future.
• Cost accounting: Understanding every cost and expense in your business.
• Tax accounting: Accurately preparing tax returns so you don’t pay a penny more than you’re legally required to pay.

Partner with a 1-800Accountant small business accounting expert to help get the most out of each type of accounting in your business.