If you ask small business owners to identify the different types of accounting, they’ll more than likely name the two methods of accounting they choose from in order to operate their business: cash or accrual accounting. What they may not realize is that these are just the primary accounting methods in one broader type of accounting—management accounting.
In reality, there are numerous other accounting types, each used for specialized purposes in business and government. Here’s a look at the different types of accounting and how some of them may impact your small business.
Management accounting is probably what you think of most often when you think of small business accounting. This type of accounting focuses on the income and expenses of your business and how you use the assets you have on hand.
The cash method and the accrual method are the most common forms of management accounting, with most small businesses opting for the cash method because of its simplicity. If you have inventory, though, you likely use the accrual method. Or you might employ some hybrid of the two that helps you best account for your business cash flow.
Management accounting is typically used to generate reports about operations that can help you track and gauge your business success. Weekly, monthly, quarterly, or annual reports can help you see what’s working for you and where you need to make changes—in collecting receivables, setting prices, instituting operating efficiencies, doing payroll, or any number of other areas—that can make your small business stronger.
Tax accounting is pretty much what it sounds like. It’s the accounting of business income, expenses, assets, and investments for the purposes of paying taxes. Tax accounting is based on the code of the Internal Revenue Service and other taxing authorities.
A big part of tax accounting is recording allowable expenses that you can deduct from your reportable income to make your tax bill smaller. It requires a deep knowledge of constantly changing tax laws, as well as a reliable recordkeeping system that provides you with timely and accurate information when you need it.
Financial accounting is targeted to entities outside your business. It’s necessary for large businesses, especially publicly traded companies. But it’s often important for small business, too. If you’ve ever applied for a small business loan, you know you need to provide certain financials for the lender to consider. These financials show the relative health of your business and allow the loan underwriter to make a decision on your loan.
Financial accounting is also key to attracting partners or investors. When searching for either of these, you will likely need to open up certain parts of your books for inspection. Financial accounting offers you a clear method by which you can report your finances in partnership or investment negotiations. You may also need financial reports for creditors when negotiating the terms for settling debts.
It’s essential that you accurately report your financial position, cash flows, and the results of your business. Not doing so can put you in legal jeopardy that could erode your business success.
Generally the purview of an entire department at larger companies, internal auditing monitors systems and process and corrects them to prevent inefficiencies, fraud, waste, information breaches, illegalities, and other problem-generating situations.
Internal auditors are generally interested in risk. As such, they spotlight high-risk areas of the company as they seek to reduce risk and create efficiencies that keep the company between the yellow lines.
In a sense, small business owners do their own form of internal auditing when they analyze management and tax accounting reports. The savvy business owner will periodically take a look at these to make sure their business is running smoothly, complying with laws, and not engaging in risky practices.
Forensic accounting is usually associated with a lawsuit or investigation. Forensic accountants often plow through vast quantities of information in an attempt to reconstruct what may have gone wrong in an intricate transaction or series of transactions.
The evidence forensic accounts collect and the conclusions they reach may be presented in a court or arbitration proceeding. It may be used to identify fraud or negligence, calculate damages, value or dissolve a business, investigate money laundering, make insurance claims, or audit royalty payments.
Most small businesses hope to avoid the need for forensic accounting. That’s another reason to stay on top of your finances and the laws that control them. However, forensic accounting may come in useful when, for example, a business needs to switch from a cash basis to an accrual basis method of accounting.
Since governments have unique needs, distinct from businesses, a different set of accounting standards have been developed to guide and control them. Government accounting allows federal, state, and local governments to keep a tight rein on resources and funding. Small businesses that work with governments may encounter certain financial requirements necessary in order to transact business.
At its simplest, public accounting refers to businesses that provide accounting help to other businesses. This assistance can come in the form of compiling financial statements, auditing books, preparing tax forms, handling tax audits, or offering any other accounting service that helps to make your business run well.
Accounting you can trust is important because it ensures that you save every possible dollar for reinvesting in your business. If you find that accounting matters are taking up too much of your valuable time, hiring a professional accountant can help to free you up to focus on what you do best – running your business.