What is Accounting?
Definition, purpose, and who uses accounting information
* Why This Matters
Every business decision—from hiring employees to launching products—starts with a question: "Can we afford it?" Accounting is how you answer that question. It's the language businesses use to communicate financial health, make decisions, and prove they're not just guessing.
If you've ever tracked your bank account, split a dinner bill, or budgeted for rent, you've done accounting. You just didn't call it that.
What Accounting Actually Is
Accounting is the process of recording, organizing, and reporting financial information so people can make informed decisions.
Think of it like keeping score in a game. Without a scoreboard, you don't know who's winning, who's losing, or what needs to change. Accounting is the scoreboard for business.
The Three Core Functions of Accounting:
Recording
Writing down what happened financially (a sale, a payment, a purchase)
Organizing
Sorting those transactions into useful categories (revenue, expenses, assets)
Reporting
Summarizing everything into financial statements that tell the story
Accounting doesn't just track money. It answers questions like:
- Are we profitable?
- Can we pay our bills?
- Should we expand or cut costs?
- Is this business worth investing in?
The Purpose: Why Accounting Exists
Accounting exists for one reason: to help people make decisions.
Without accounting, businesses would be flying blind. Investors wouldn't know where to put their money. Banks wouldn't know who to lend to. Managers wouldn't know what's working and what's not.
Here's What Accounting Helps You Do:
Track performance – Are sales up or down? Are expenses under control?
Make decisions – Should we hire more staff? Can we afford new equipment?
Prove credibility – Investors and banks want proof you're not just winging it.
Stay legal – Tax authorities and regulators require accurate financial records.
Plan for the future – You can't budget for next year if you don't know what happened this year.
Bottom line: Accounting turns raw financial data into actionable intelligence.
Who Uses Accounting Information?
Accounting isn't just for accountants. It's for anyone who needs to make financial decisions about a business.
Internal Users (Inside the Company)
These are people who run the business day-to-day and need accounting info to make decisions:
| Who | What They Need | Why They Need It |
|---|---|---|
| Managers | Revenue, expenses, profit margins | Decide what products to push, where to cut costs, how to improve performance |
| Executives (CEO, CFO) | Overall financial health, cash flow | Make strategic decisions: expand, downsize, pivot, raise capital |
| Employees | Company profitability, stability | Gauge job security, negotiate raises, understand company direction |
Example: A restaurant manager checks accounting reports to see which menu items are most profitable. If the lobster rolls cost more to make than they sell for, it's time to adjust pricing or remove them.
External Users (Outside the Company)
These are people who don't work for the company but have a financial stake in its success:
| Who | What They Need | Why They Need It |
|---|---|---|
| Investors | Profit, growth trends, return on investment | Decide whether to buy, hold, or sell stock |
| Creditors (Banks, Lenders) | Cash flow, debt levels, ability to repay loans | Decide whether to lend money and at what interest rate |
| Tax Authorities (IRS) | Revenue, expenses, taxable income | Ensure the company pays the right amount of taxes |
| Regulators (SEC, etc.) | Financial transparency, compliance | Protect the public from fraud and ensure fair markets |
| Customers | Financial stability | Want to know the company won't disappear before delivering products/services |
| Suppliers | Ability to pay bills | Decide whether to extend credit or demand cash up front |
Example: A bank reviewing a loan application checks the company's accounting records. If cash flow is strong and debts are manageable, the loan gets approved. If not, denied.
Real-World Example: Coffee Shop Accounting
Let's say you run a small coffee shop. Here's how accounting helps:
1. Recording
You track every sale (revenue), every bag of coffee beans purchased (expense), every paycheck to baristas (expense), and every loan payment (liability reduction).
2. Organizing
At the end of the month, you categorize:
Revenue
$15,000
from coffee sales
Expenses
$6,000
rent, beans, wages, utilities
Profit
$9,000
what's left over
3. Reporting
You create an income statement showing revenue, expenses, and profit. Now you know:
- You're profitable
- Rent is your biggest expense
- You can afford to hire another barista
Without accounting? You'd guess whether you're making money, overspend on rent, and hire staff you can't afford. Recipe for disaster.
The Accounting Information Flow
BUSINESS TRANSACTIONS
Sales, Purchases, Payments, Receipts
RECORDING & ORGANIZING
Journal Entries, Ledgers, Categorization
FINANCIAL STATEMENTS
Income Statement, Balance Sheet, Cash Flow
DECISION MAKERS USE IT
Managers, Investors, Banks, Tax Authorities, etc.
Key Takeaway
Accounting is the language of business. It records what happened, organizes it into useful information, and reports it so people can make smart financial decisions.
You don't need to be an accountant to understand accounting—you just need to know it's the scoreboard that keeps everyone honest and informed.
Test Your Understanding
See if you've got the basics down. Click each option and check your answer.
Question 1: What are the three core functions of accounting?
Question 2: Who are considered *internal* users of accounting information?
Question 3: A bank is deciding whether to approve a business loan. What accounting information would they care about most?
Question 4: True or False: Accounting only matters for big corporations, not small businesses.
Want to Practice More?
You just learned what accounting is. Now it's time to see it in action. Record real transactions, organize them into financial statements, and make decisions just like a business owner. That's where it clicks.
Try the Practice LabWhat's Next?
Now that you know what accounting is, let's dig into the accounting equation—the foundation of all accounting.