What Generally Accepted Accounting Principles (GAAP) mean for your business
You know the drill – as a small business owner, you’re constantly juggling various tasks (and there seems to be no end in sight). It’s not uncommon to find yourself knee-deep in your back office trying to solve various financial problems that have been thrown onto your plate.
Often, business owners don’t realize that there are actually different methods of accounting that serve your business in different ways. Visit also: Chartered Accountants in UK
As a business owner, you have made a decision about the type of accounting you use in your business. But you may not have fully understood the differences and weighed the pros and cons, especially whether dual methods are important if you want to grow your business.
Here’s a quick overview and why you should know…
Some of the most common or widely used types of accounting include
– Tax Accounting – Governed by the Internal Revenue Code, tax accounting focuses on record keeping and preparation of financial documents for the purpose of secure tax filing.
– Audit Accounting – External auditing standards follow Generally Accepted Auditing Standards (GAAS), and audit accounting practices prepare a company for an audit by establishing sound internal financial controls and ensuring compliance.
– Management Accounting – Management accounting principles are used to track a company’s finances to develop and implement strategies, measure and improve performance, and illuminate a company’s key revenue or growth drivers. Management reporting and accounting are solely for internal use by a company’s executives. This type of accounting and the reports it produces are not intended for public dissemination, financial compliance, or tax filing.
– Pro Forma Accounting – Pro forma accounting allows a company to exclude items that it believes obscure the true nature of its financial position or projections. These may include one-time, extraneous expenses, or unusual cash inflows. Pro forma accounting does not produce an accurate financial report but rather aims to produce an accurate projection of a company’s financial future.
– Financial Accounting – Financial accounting follows Generally Accepted Accounting Principles (GAAP) as defined by the Financial Accounting Standards Board (FASB). The primary purpose of financial accounting and GAAP is to provide a standard for objectively comparing a company’s financial reports with those of other companies and prior financial reports. While financial accounting has some internal purposes, it exists essentially for external purposes.
As you can see, each type of accounting follows a different set of standards and rules, and each serves different purposes in running a business.
Let’s take a closer look at financial accounting and GAAP analysis…
GAAP analysis in financial accounting
GAAP provides general rules and guidelines that help govern the world of finance and accounting. By establishing a set accounting method, GAAP ensures that all businesses record and report their finances in the same way. This improves the consistency, clarity, and comparability of financial information across all companies and industries.
Essentially, GAAP establishes common financial language so that an investor or lender can be assured that the information reported in a company’s financial statements is based on the same rules and guidelines that any other company using GAAP would use.
Thus, GAAP creates transparency in financial information and makes it possible to compare a company’s reported revenue and growth with others.
Which companies are required to use GAAP?
The Security and Exchange Commission requires all publicly traded companies in the U.S. to present financial statements that comply with GAAP. This allows potential investors to consistently evaluate and compare financial health when making investment decisions.
But don’t stop reading just yet. Even if your company is not publicly traded, you will likely still need to prepare financial documents based on GAAP in order to operate.
Most banks, private investors, and other financial institutions require the submission of financial statements that comply with GAAP, either as a condition of loan approval or when making an investment decision.
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