Businesses operate based on money, generating revenue through sales and spending on inventory, salaries, and operating expenses. No business can survive in the long run without earning more than it spends.
Accounting is the process of tracking and summarizing information about the money coming in and going out of a business. Accounting is relevant to business decisions because it provides essential information to help you determine whether a particular effort will increase or decrease your profits.
Accounting information will be the roadmap for your business decisions, and here are the reasons why you should care about it.
1. Maximizing profits
Your business doesn't make the same amount of money on every product or service you sell. Some products have lower profit margins, but sufficient sales volume or customer appeal justifies this reduction in profit margin.
Product combinations are the careful balancing of products that make up what you offer your target customer base. Successful product combination decisions depend on detailed accounting information about the cost of selling each product and the revenue that each item generates.
The faster you turn over your inventory, the more money your business will make. If it takes too long to turn over inventory, consider holding back on extending credit terms with suppliers or focusing more on which items sell fastest.
2. Investing in human resources
Detailed and accurate payroll information is crucial for human resource decisions because it tells you whether your company can afford to add staff if you feel there is a shortage of personnel to ensure that the products and services delivered to customers meet standards.
If your payroll accounting shows that your payroll costs represent an unsustainable high percentage of your sales revenue, then reviewing staffing efficiency and reassessing your payroll system would make more sense than hiring more employees.
The ratio of salaries to revenue varies among businesses, but most industries aim for payroll costs to be between 15 and 35 percent of total revenue. Service-based businesses, which incur fewer expenses other than payroll, can sometimes maintain payroll costs as high as 50 percent.
If your payroll costs are more than 35% higher and your business isn't making a profit, your accounting data may point you toward making business decisions such as laying off staff or conducting a productivity review.
3. Optimizing cash flow
The amount of cash your company has on hand at any given time is closely correlated with your daily revenue and expenses. You may have sold inventory and not yet received payment, purchased inventory that you haven't paid for, or borrowed money that you will have to repay in the future.
Cash flow is the process of managing the funds your business has available and allocating them in a way that benefits you. Accounting is relevant to cash flow decisions because it tells you how much money you currently have and how much you are likely to have in the near future.
The information in your cash flow forecast can help you determine how to use your cash flow most effectively, when you will need to borrow money and when you will be able to repay it, allowing you to make informed decisions and avoid unnecessary financial charges.
4. Decisions on expansion and investment orientation.
Healthy businesses tend to grow, and business growth requires careful management with close monitoring of the numbers. A good accounting system will provide accurate details and give you crucial information about whether your business can pay off the money you borrowed to expand and how long it will take to do so.
If your business appears ready to move to a larger facility or ramp up production, your accounting system will tell you whether you have enough sales to make this move and, if not, how much more daily sales revenue you need.
Accounting data can help you decide when is the right time to invest in expansion. If your sales are steadily increasing and you are accumulating surplus capital, then your business may be well-positioned for expansion.
Investing in facilities and infrastructure can allow your business to increase efficiency and profitability. However, this heavily depends on assessing your cash flow situation, which will tell you when you can afford to make these changes.