Accounting, financial analysis and budgeting are all finance-related responsibilities. The process begins with accounting. Once all the record keeping is complete, a set of financial statements is created. The analyst uses these figures to conduct a ratio analysis. This determines the position of the company in relation to its liabilities. Budgeting takes place toward the end of the year for the following year. The financial statements are used to show the available resources that can be used in preparing a budget for the following year. Financial analysis is needed to determine the company's ability to pay short- and long-term debt. The three disciplines create a circle that connects all of the financial needs of a business.
Accounting
Accounting is the record-keeping process that tracks all business financial transactions. The transactions are recorded and used to prepare financial statements concerning the company's assets, liabilities and operating results. Accounting is required for all corporations and large businesses. In addition to providing information for financial statements, the data is used for filing tax documents, borrowing money, selling stock and many others. Accounting is the language of business and is meant to communicate financial information to the people who need it to operate the company effectively.
Types of Accounting
There are two types of accounting: cash-basis accounting and accrual-basis accounting. Cash-basis accounting is recognizing revenue and expenses when the cash is received rather than when it's earned or incurred. This is a common method of accounting for a service business where inventory is not present. With accrual-basis accounting, revenues are matched to expenses. For example: If your business sells a product, that sale is counted as revenue, even though you have not received payment. The same is true with a bill. You count the bill when you receive it, not when you pay it. The expense is matched to the revenue.
Financial Analysis
Financial analysis is the next step in the process of managing a company's financial health. Financial analysis is an evaluative process to determine a company's liquidity, solvency, stability and profitability. It is performed by professionals who complete ratio statements to be presented to upper-management decision makers. In some cases the accounting department does this work as well, and other companies have separate groups conduct the analysis. There are several types of financial analysis; however, horizontal and vertical financial analysis is used frequently. Horizontal analysis compares the same item, or items, within a company's financial statements from two or more equivalent periods. Vertical analysis is a form of financial statement analysis in which each entry, belonging to assets, liabilities and equities, in a balance sheet is shown as a percentage of the whole account. This allows the balance sheets of different size businesses to be compared.
Uses of Financial Analysis
Financial analysis can tell a decision maker a great deal about the business and its trends. All businesses are cyclical. However, huge swings in profitability can be fatal. Therefore, year-after-year comparisons are made to try and predict the slumps. By comparing the data of past and present performance, one should be able to predict, with some degree of accuracy, the future.
Budgeting
Budgeting is the planned allocation of funds for future use. Each department within a company will usually have a departmental budget that is a part of the master budget. Budgeting is necessary for controlling overspending. By following a budget, management can shift money from less productive areas and increase funding for departments that generate significant income. This is a redistribution of funds. Budgeting is completed, most often, by non-accountants. Department heads and managers are the ones who usually complete a budget for their area of responsibility. This creates a sense of accountability and ownership for the budget.
Variance Analysis
Variance analysis is usually conducted throughout the year to determine variances from the original budget. This process allows management to monitor the actual spending by department in comparison to the budgeted spending. If a department is over budget it can be caught and corrected before it becomes too large of a problem.
